OPEC loses a seat at the table

Written by Maarten Brouwer and Petteri Pederson.

On an elementary level, OPEC has three jobs: lowering global oil prices by controlling production; market share, selling its oil outside the cartel; and profitability, producing as much as possible while selling at the best price possible.

Yet just as its third purpose is increasingly being called into question, its core task is also facing a similar challenge.

Unfolding over the past two months, Oicron (see equation below) is an unusually rebellious client who is publicly attacking OPEC. Despite the relatively conservative Russian oil minister and Saudi Arabia’s leader, their recent statements to an industry convention in the USA sent a warning signal about the challenges facing OPEC when Oicron does not co-operate and prices continue to tumble.

The “Islamic revolution”

To be sure, the United States has always imported more than it has exported.

Oil consumption is on the rise everywhere in the world with only a few exceptions. For the global market, an OECD consumer market, OPEC has worked in tandem for decades with its Western counterparts to balance oil markets, for example, by reducing supplies in the summer when demand was strong and slowing them after the shoulder season, adjusting output by lifting output if the market ran too low and slowing production when it overheated.

OPEC has deployed a range of instruments to accomplish this, many of which remain in place today. Still, with Western market share slightly declining, and this being a global problem, many smaller oil producing countries no longer follow the cartel’s dictates.

Let’s call it the “Islamic revolution”.

OPEC member states are not only producing more, they are still exporting more than the normal amount, which effectively cuts supply as the price rises and keeps it higher than demand, as OPEC had done all along.

Meanwhile, Oicron itself has been outspending its cash reserves. And while the producer group only wanted to limit production at 1.4 million barrels a day in December, Oicron has said that its 2018 production target is to be bigger, while abandoning some areas entirely.

Yet for all of the insistence that the Saudi government had so far put some “stiff” discipline on its members, in its recent statements it has complained about how much cheap oil was being shared with non-OPEC members.

In the current oil market, this conflict is what causes a stir. Especially at the start of the year, when oil was reaching a six-year high, during an OPEC meeting the Kingdom instead agreed to raise production and bring down prices, causing Oicron to put out a statement critical of its member countries, as if to say: “Hey, I am the one that pays the bills.”

In the meanwhile, an age of price wars is upon us. By the end of 2018, price wars will likely be much in vogue. The USA will be embarking on at least one of them. Europe has its competition coming from Russia’s new Arctic projects, and meanwhile Iran is a potential war zone.

The current price of Brent is roughly around $64 per barrel, compared to about $140 in 2015, as noted in a recent Bloomberg article. The price drop in its past months means that no company has achieved profitability, no company is happy and all of them are looking for a way out.

Oil is booming in the Middle East — but when will Saudi Arabia lower oil prices to maintain profitability?

Last week, Saudi Arabia told its state oil company, Saudi Aramco, to stop all joint ventures with international oil companies, including banks, and merely focus on oil production and retail sales. In a dramatic change from Saudi Arabia’s priorities to change growth, it is far from clear whether the effort will yield a positive result.

OPEC on the block

The problem with this strategy is obvious: production cutbacks are far from the only means to lower prices. In recent years, there have been some other, more direct approaches — including crude derivatives trading.

Regardless of Saudi Arabia’s action, OPEC has a problem with Oicron, and its rationale does not pass the smell test. While I am afraid Oicron will probably change in the near future, the challenge from Oicron just added to OPEC’s woes, and the price wars may soon be upon us.

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