Has OPEC lost its clout?

“The slump in oil prices since mid-2014 has ravaged national economies dependent on oil revenues. “

By Naman Patel

The slump in oil prices since mid-2014 has ravaged national economies dependent on oil revenues. While economically fragile countries, such as Russia, Nigeria, Venezuela, and Brazil, have undoubtedly been battered by the price decline, countries such as Qatar and Saudi Arabia have also witnessed large enough decreases in revenue to necessitate a retrenching of expenditures. While WTI Crude Oil has recovered from its 2016-trough, and now trade at $52.65 per barrel for February delivery, its price is nevertheless too low to provide relief to many oil exporters. In fact, this past October, the IMF predicted that an average price lower than $79.70 per barrel would result in a 2016 fiscal deficit for the Saudi government.

It might be expected that in times of such trouble–when oil prices are depressed due to excess market supply–the Organization of Petroleum Exporting Countries (OPEC) should successfully negotiate an agreement to curb oil production that is likely to maintain adherence from, and provide long-term relief to, its member states. Yet, historically, OPEC has been unable to realize such an agreement; even today, the cartel has failed to negotiate an agreement that has the potential to raise and maintain oil prices to a suitable level. In recent times, OPEC’s ineffectiveness has been the result of the member countries’ differing production costs and economic strength, Iran’s return to the global oil market, and competition from non-OPEC oil exporters.

OPEC members are very distinct from one another. They all produce and export oil indeed, but the similarities end there. Per barrel costs for extracting oil, dependence on oil revenues, and economic stability all differ by member states. While Saudi Arabia can produce oil for slightly less than $10 per barrel, costs for Libya and Venezuela are double that amount. Angola produces oil at a cost of $35.40 per barrel. As a result, while OPEC’s high-cost producers may be willing to collectively freeze or cut output, lower cost producers such as Saudi Arabia, Iraq, and the UAE may not be pressured to do the same. In fact, Saudi Arabia has increased oil production in this low cost environment: drive out other producers and further its control over the oil markets. Lower cost producers would rather endure the cheap prices to drive out high cost producers and gain market share. Varying degrees of oil dependence also diminish the incentive for some countries to cut oil production. In Kuwait, oil sales constitute more than 50% of national GDP, and efforts to diversify its economy have been unsuccessful. As a result, Kuwait has signalled its willingness to cut production. Countries that have strengthened non-energy sectors, such as the UAE, are better able to persist a low price environment. Lastly, differing economic strength also plays a major factor. For example, Venezuela, which is in danger of defaulting this year, is more likely to support production cuts in order to realize higher prices than economically stable countries.

Since the removal of international sanctions in January of last year, Iran’s return to the global oil market has also thwarted many would-be OPEC deals to cut production. In early 2016, Iran insisted that it would not participate in production cuts until its oil production levels reach pre-sanction levels. Rival Saudi Arabia, OPEC’s largest oil producer, refused to cut production so long as Iran did not pledge to do the same. As a result, meaningful OPEC deals were unable to materialize for much of 2016. Even today, though Iran is producing more oil than it did before sanctions were instituted, Iran has been unwilling to significantly curb production.

Competition from non-OPEC members–particularly the United States–has made OPEC members less inclined to pursue higher prices. Oil prices were high enough before mid-2014 to encourage investments in onshore and offshore oil exploration and extraction in the United States. Moreover, technological developments in fracking unlocked the U.S.’s vast shale oil reserves. This meant that the United States became a key competitor for OPEC, one that also had the ability to influence the market. However, the low prices that followed rendered many of the U.S. producers unprofitable, forcing them to withdraw from the market. OPEC is keen to keep these U.S. producers out of the market and knows that large production cuts that lead to substantial price gains may incentivize U.S. producers to return–thereby stealing market share and control.

Surely, OPEC’s members were successful in negotiating a deal this past November. The prolonged and damaging price decline and pragmatic thinking of Saudi Arabia allowed for an agreement to be struck. Members of OPEC–barring Libya and Nigeria–pledged to begin cutting production on January 1, 2017. However, this deal is not only shortsighted, but also tenuous and meager. The deal will be in place for six months, and Saudi Arabia has already concluded that it sees no reason to extend the deal any further the quoted period. This means that, in July, member nations will be free to once again ramp up production. Moreover, the deal has already shown signs of fracture. Iraq, OPEC’s second largest producer, committed to decreasing oil production by 210,000 barrels per day. However, much of its oil production is under control of the Kurdish government and international oil companies. It is unclear whether Iraq will be able to convince the Kurds to reduce oil production. Furthermore, if Iraq forces international oil companies to reduce production, the government will have to compensate them for lost revenue. Iraq’s inability to curb oil production would raise questions about the deal’s legitimacy. Lastly, the deal does not go far enough. It allows Iran to increase oil production even more as long as its average 12-month production by the end of May is less than or equal to 3.797 million barrels per day. Iran has also been selling oil stored on oil tankers, making it difficult to determine the country’s actual level of production.

OPEC’s ability to control the global oil market is certainly weak. Internal fragility stemming from the member states’ dissimilarities to one another, Iran’s challenging situation, and threats from outside OPEC have rattled the cartel. OPEC is not in a position to engender sizeable shifts because, for some members, moderately low prices are manageable. Under current circumstances, OPEC will fail to be the market-moving cartel it once sought to be.

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Image Source: https://pixabay.com/en/sunset-tanker-oil-tanker-sea-654867/
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