As ministers from the 12 members of the Organization of the Petroleum Exporting Countries (Opec) prepare to fly to Vienna for their 166th meeting next week, the quiet consultations and soundings have already begun. Opec must decide whether and how to respond to the 30 per cent decline in oil prices since the middle of June, in what may be the organisation’s toughest test in five years.
Slower oil demand growth and rising competition from non-Opec suppliers, especially US shale producers, pose a common threat to all the organisation’s members. But formulating a common response will be hard because the slowdown in demand and the shale revolution have had a very different impact from member to member.
Saudi Arabia, Kuwait and the UAE are producing and exporting close to their highest-ever levels of crude, according to the BP Statistical Review of World Energy. All three have built large financial reserves so they could weather a prolonged period of lower prices without too much effect on their day-to-day government operations.
In contrast, production and exports from Iran, Iraq, Libya, Venezuela and Nigeria have been variously hit by war, sanctions, unrest, expropriations and mismanagement. None of those countries has significant foreign exchange reserves and the drop in oil revenues will quickly feed through into reduced government spending and/or inflation.
The light oils being produced in the US are not much of a direct threat to the heavier crude grades exported by Saudi Arabia and other Gulf countries. But they compete directly with the very light oils exported by North and West African producers, including Libya, Nigeria and Angola.
Formulating a common response is made complicated because ministers are negotiating on two separate issues: (1) Opec’s share of the world oil market versus non-Opec producers; and (2) how Opec’s share is allocated among its members.
Opec has struggled with these issues, on and off, since the early 1980s, so it is familiar territory for the ministers. But sharing out the market is much easier when oil demand is growing rapidly and non-Opec supplies are flat or falling — a situation that describes much of the last decade.
It is much harder when demand is stagnating and non-Opec output is surging — putting the organisation back into the difficult position in which it found itself 30 years ago.
Ministers must decide whether to cut production, and if so by how much, and how to share out the reductions. The first option is to do nothing, allowing lower prices to force a rebalancing between demand and supply: the best cure for low prices is low prices.
Prices might remain stuck at current levels, perhaps even head another $10 or $20 lower in the short term. But eventually demand will pick up as moves towards energy efficiency take a back seat in consuming countries and incomes rise in emerging markets.
And supply growth will fall as shale producers cut back and new capital spending around the world is postponed or cancelled. The market would tighten again over a 12- to 24-month period and prices begin to rise.
Saudi Arabia, Kuwait and Abu Dhabi could ride out a period of lower prices with comparative ease. But for the organisation’s other members, it would be much tougher.
The second option is to cut production, sacrificing market share in the hope of obtaining higher prices and higher revenues overall, and perhaps also speed the adjustment process.
But there is no guarantee production cuts would produce a big enough rise in prices to offset the fall in volumes. If prices rose too much, shale producers would be unlikely to cut back, and the necessary rebalancing might not take place at all.
If the organisation does decide to cut, the question becomes how to share the reductions. The producers that are best placed to cut their output (Saudi Arabia, Kuwait and Abu Dhabi) are also the ones with the least incentive to do so. The countries that most need higher prices (Iran, Iraq, Libya, Nigeria and Venezuela) are the least able to afford to reduce their output.
Iran blames Saudi Arabia for taking advantage of US sanctions to increase its market share at the expense of Iranian exports, and expects Saudi Arabia and its allies to shoulder the bulk of any cuts.
In fact, Saudi Arabia’s share of global oil exports has remained broadly flat. It is US shale production (up 3 million barrels per day in the last five years) which has filled the gap left by sanctions, war and unrest across the Middle East.
If there are to be production cuts, Saudi Arabia will almost certainly insist all the organisation’s members participate. There is no reason for the kingdom to accept a significantly greater share of the cuts than its historic market share.
Cuts totalling around 500,000 barrels per day (bpd) would be too small to make a significant difference to prices or market balances in the short term.
To have any impact, the organisation would need to find cutbacks amounting to at least 1 million bpd.
Based on Saudi Arabia’s historic share of Opec production, which has been around 30 per cent since the late 1990s, the kingdom might contribute 300,000 bpd — which could perhaps be stretched to as much as 500,000 bpd.
Kuwait and Abu Dhabi might contribute another 150,000 to 250,000 bpd between them based on their financial strength. That would leave the other members needing to find relatively small and symbolic cuts totalling around 300,000 to 400,000 bpd.
Production cuts would demonstrate that the organisation is not powerless to respond to the challenge posed by the shale revolution. But by propping up prices, production cuts also prop up non-Opec suppliers who contribute nothing to the cutbacks.
Free-riding has always been the organisation’s biggest problem. In the past, it was Britain, Norway, Mexico and Russia that benefited most. Now it would be US shale players.
If prices do bounce and non-Opec supply growth continues unabated, Opec could be forced to cut again in 12-18 months, and face the prospect of a permanent loss of market share.
Opec must determine the best joint path for its output, prices and the output of non-members. This is fiendishly difficult, given the large uncertainties around the demand outlook and the sensitivity of U.S. shale producers to falling prices.
So there are no good options for oil ministers in Vienna next week — only a choice between poor alternatives in the hope of finding the least-bad one. And there is no guarantee that they can reach an agreement at all.
— Reuters
