OPEC Out? An old player in a new world

 

As oil prices have been plummeting in the last months, it seems that history keeps repeating itself. Back in 1986, 1998 and 2009 this drop in oil prices have been producing social and economic crises in oil-producing countries. Each time, the collapse of prices recalls the necessity of economic diversification in order to reduce the dependence on oil products, very lucrative but also very volatile.

OPEC has historically been a global player in the world market. Image: SCR

The OPEC  (Organization of the Petroleum Exporting Countries) was founded in 1960 and was led by some the most influential oil-producing nations in the world, Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Defined as a “permanent, intergovernmental organization” on their own website, the OPEC started with the belief that it would never become irrelevant or obsolete. Permanence has been presumed for over half a century now. In the 90s, they survived the Asian crisis, the hostilities in the Middle-East and capitalized on the markets that started growing in a post-Soviet world. In the 2000s, they sold at record prices, pushed through the global crisis and evolved with the times by establishing stable energy markets, sustainable development and the environment as three guiding themes.

So why are things looking down for OPEC now? 

Weak global demand and booming U.S. shale oil production are the two most important factors that conducted to the fall of prices through a chronic exceeding offer on international markets. The recent increase in shale oil production demonstrated to be a double-edged sword that struck the organization. On the one hand, the OPEC lost its biggest client of the last decades (the US). As a consequence, OPEC’s share of the global oil market has plunged in recent years and after reaching a peak in 2012, the demand from OPEC members has been declining by around 24 percent. On the other hand, as the US became the largest producer of oil in the world, the country is now able to limit the capacity of the OPEC to manipulate prices. This showcases the failure of the OPEC as it seems to  be far from its determined goal of stabilizing oil prices in the last half-century.

With USA become the largest producer of oil and playing a major part in global shale gas production, where does OPEC stand? Image: RT

This shift in the oil market configuration conducted to a reformulation of OPEC’s strategy.  The group decided to maintain its production to preserve market share instead of lowering it to keep prices high. In the last years, most of OPEC members accumulated several hundred billion dollars in the bank, this permitted them to maintain a stable production in the last months, which accelerated the fall of crude oil prices. Edward Morse, global head of commodities research at Citigroup, highlights that those circumstances conducted them to focus on the North American production and to confront the shale revolution preventively while they still have sufficient financial resources. However, the different innovations in the US and Canada permitted to lower the cost of production and reach profit.  Consequently, while low oil prices resulting of OPEC’s new strategy are hurting shale and will lower the production, domestic production is still expected to rise this year, at a slower pace. However, George Koutsonicolis, managing director with financial advisory firm SOLIC Capital Advisors believes that, although those circumstances have been weakening the organization, the cartel is still playing an important role, especially through its leader, Saudi Arabia. He stated that “despite the decline in oil prices and the impact in terms of oil export revenues, they have the financial wherewithal to sustain this game of chicken, at least in the near to the intermediate term”. The question that will determine OPEC’s role is how much economic pain American shale oil producers can stand as oil prices continue their decline. He notes that “there is evidence of stress and distress, given the decline in oil prices, in more thinly capitalized producers.” The lowering of prices have been squeezing high-cost producers like shale producers in the US and Canada. Therefore, Saudis move to maintain production might be paying off considering the progressive increase in oil prices in the last weeks. The International Energy Agency stated that oil production by non-OPEC members is likely to grow more slowly this year, as falling prices cause North American energy companies to halt drilling in less profitable areas.

However, Bill Witte, associate professor emeritus of economics at Indiana University highlights that this new strategy might not be as consensual within the organization as it appears, it is also due to a power struggle in the Middle East that is exacerbating the division that have always been part of the OPEC. There have always been two types of countries in the group, the price hawks and the price doves. Hawks, the spenders, are countries that rely heavily on oil money to keep their economies healthy, including Iran, Iraq, Venezuela and Algeria. Doves, the savers, are countries that have hefty bank accounts and are able to sustain several years of low revenue from energy, including Kuwait, Saudi Arabia and the United Arab Emirates. As Atif Kubursi, former adviser to OPEC, pointed out: “there was always this conflict between the spenders and the savers. This has never changed”. Indeed, during the 1998 oil crisis, although Saudi Arabia wanted to enforce quota in order to stem the fall of prices, several countries (especially Venezuela) refused to do so and started to steal market share from the other countries. Today, Saudi Arabia is not willing to do this mistake anymore and prefers to skip over the meaning of the organization. Therefore, Saudi Arabia refused to slash production in order to weaken its major regional rivals such as Iran and Russia.  Bill Witte explains that “OPEC has always been a sort of loose coalition that has depended on the willingness and ability of Saudi Arabia to moderate or amend their production”. The Saudis have always been the key actor with market-moving power. The Iranian President Hassan Rouhani publicly denounced the existence of “political motivations” behind the fall of oil prices in December 2014.

Of the biggest issue is that this change in Saudi Arabian policy might be permanent considering the perspectives of the oil sector. OPEC members are seeing a new and massively changing energy landscape not only due to the increase in shale oil production. The US and China agreed to bilateral carbon reduction targets and a report of Nature concluded that, in order to achieve anything better than a 50/50 shot at keeping global warming under 2 degrees centigrade (the most widely accepted threshold) 38% of proven Middle-east reserves have to remain in the ground. This represents 260 barrels, a loss that worth tens of trillions of dollars. Considering those perspectives, Saudi Arabia is embarking in an unilateral path to preserve its industry. Current Saudi oil minister Ali al-Naimi stated in December that “it is not in the interest of OPEC to cut their production whatever the price is”. Saudi Arabia is willing to get its oil out of the ground regardless of how thin its profit margin becomes. In addition, the recent negotiations over Iran’s nuclear deal are destabilizing the oil market. Any positive resolution is seen as negative for the commodity, as the lifiting of sanctions would permit Iran to release more oil into an already oversupplied market.

Does Saudi Arabia with all it’s reserves really need the OPEC? Image: Arabian Business

In such an environment Saudi Arabia no longer needs OPEC. With the technological progress offering alternatives to oil dependence and the growing consensus around reduction of carbon dioxide emissions Saudi Arabia has engaged (as Sheikh Yamani had predicted) in a race to produce, regardless of price, so that it will not be leaving its oil in the ground. Many years remains of course before the death of the oil age but Saudi Arabia sees that this end is not so far away and is not willing to leave its own oil untapped one day in the future, regardless of the cohesion of the OPEC. As John Lichtblau, chairman of the Petroleum Industry Research Foundation, argued “this may be the end of the old OPEC” with Middle Eastern producers losing their exalted place in the energy firmament once and for all.

Alex Chunet

Alex Chunet

Editor, International Crime at InPRA
Alex Chunetcompleted a Master in International Public Management at Sciences Po in 2016 and is currently enrolled in a one year post-graduate program at LSE in Local Economic Development.

He had the opportunity to work in diversified institutions from the international organisations sector (OECD, UNODC), public sector (French embassy in Buenos Aires), private sector (BSD Consulting), and the academic sector (J-Pal Poverty Action Lab).

Through those experiences, he managed to acquire significant knowledge and experience in the design and analysis of economic and social public policies in emerging economies.
Alex Chunet

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