Delegates from 12 member states of the Organization of the Petroleum Exporting Countries (OPEC) will gather in Vienna on 4 December. With the global oil and gas industry shattered by record low global crude oil prices, representatives of each OPEC country will get together for the second bi-annual meeting of 2015. If the cartel makes a decision to curb production, which is advocated by some of its members, global oil prices will start to rise. However, I believe that the meeting is unlikely to lead to fundamental changes in OPEC’s policies and that the future of oil and gas will continue to be defined by market forces.
A call for strategy re-evaluation after failing to curb competition from US producers
The previous December meeting a year ago, held in an environment of growing oil oversupply and falling prices, ended with a decision to retain the current OPEC production ceiling of 30 million barrels per day, instead of cutting it in order to stabilize the market. Many experts saw the outcome as signaling the beginning of an open price war between OPEC and US shale oil producers. Higher production costs in the competing US oil industry had to win the market for the cartel, pushing US competitors out.
However, US producers’ resistance to the oil price volatility was underestimated. US shale drillers are more flexible compared to conventional OPEC producers and are able to rise or to cut output as the situation changes. Furthermore, the US shale fracking industry is innovating at a blistering pace, with new technologies, such as horizontal fracking and mobile rigs, allowing US producers to operate at decreasing costs. As a result, one year on, the global market is still defined by staggering overproduction and the US remains the leading crude oil producer globally. October 2015 global oil supply equaled 97 million barrels per day, demand stood at 95.5 million barrels per day, and crude oil prices had fallen to around US$45 per barrel. The economies of oil-producing countries are facing financial losses on a daily basis and voices inside OPEC are calling for an urgent strategy review.
OPEC split over global strategy
OPEC is currently an amalgamation of very different countries with heterogenic oil industries, ranging from Gulf countries to Nigeria and Angola in Central Africa and Venezuela and Ecuador in Latin America. While countries like Saudi Arabia and the United Arab Emirates possess well-diversified economies, solid foreign currency reserves and can sustain contracting income from the oil sector in the short term, others are much less flexible. According to Euromonitor International, real GDP in Venezuela, where oil accounts for 89% of export income, is expected to contract by 10% in 2015. The government of Ecuador meanwhile forecasts that export revenue will plunge by 50% compared to 2014. In the case of Iraq, falling oil prices, together with prolonged fighting against Islamic State, are translating into a threat of reduced government funding and declining investments from international oil companies operating in the country. Algeria is completely reliant on oil and gas exports, accounting for 98% of total export value.
Iran is a special case. The country was OPEC’s second largest producer before 2012, when sanctions were enacted, but it is vocal about its desire to return to the ranks of oil exporters after the export ban is lifted. The Iranian authorities are arguing to retain the current 30 million barrels per day (bpd) quota; however, given that it includes Iran’s share, otherwise the country will not feel bound by any production limits and produce as much as it can. Iran aims to increase oil output by one million bpd in 2016.
Venezuela, Ecuador, Iraq and Algeria are arguing for more aggressive market intervention in terms of restricting the extraction quota and the introduction of an oil price floor. The Venezuelan Oil Minister has already expressed fears that if OPEC does not take action to stabilize the market, oil prices might drop to around US$25? per barrel. Other members, led by Saudi Arabia, however, are keen to continue with the strategy of defending the market share against non-OPEC competitors and hoping for better times, even if it means short-term losses. Kuwait announced that volume reductions which would support prices in 2016 should come from high-cost producers first, underlining the essence of OPEC’s current strategy. In reality, it seems like OPEC does not have a choice; a volume reduction would only allow producers from the US or Russia to increase their outputs at the expense of the cartel. Furthermore, even if the quota is reduced, there is no guarantee that it will be respected, as, even now, the OPEC produces about 1.5 million bpd above the ceiling.
A relic from the 20th century?
The question arises: if an increasingly large share of oil is produced in non-OPEC countries and the global oil industry is largely running on free market rails, what is the role of the cartel in the current environment? With the decision to keep production unaltered in December 2014, OPEC, led by Saudi Arabia, clearly recognized that ensuring price stability, the original reason behind the cartel’s existence, is not under the power of OPEC anymore and the future of oil producers will depend on their readiness to operate under free market conditions. It also seems that OPEC members have rather incompatible objectives and too different economies to pursue a united direction, and, according to the Iraqi authorities, should come up with their own policies in regard to long-term strategy. Its lack of power to implement the main function and incompatible objectives of its members indicate that OPEC, as an organization, is becoming largely irrelevant in the current oil market and will have to reform to continue playing a role in future.