Opec has lost its capacity to control oil prices

Several obituaries of Organisation of the Petroleum Exporting Countries (Opec) have been written since the mid 1980s. All of them have turned out to be exaggerated. Recent ones are also no different.

The Opec is not dead. Neither is it effective as it was in late ‘70s and it is reinventing itself now with Opec+ by pulling in 10 more countries like Russia, Kazakhstan, Mexico etc. This article deals with the reasons for some experts prophesying its death and also its waning power.

The Opec came into existence in 1960. Five oil exporting countries, Saudi Arabia, Iran, Iraq, Kuwait and Venezuela came together to put pressure mostly on the so-called seven sisters (now it is reduced to four, Exxon, Chevron, Shell and BP) to secure better deals. However, till 1973, Opec could not use its bargaining power to increase oil price.

After Yom Kippur war in 1973, when Opec embargoed oil supply, oil price quadrupled. When Iran/Iraq war broke up, oil prices doubled again to reach a high of $110 per barrel in 1980 (corrected for inflation). Today, oil prices are around $60 per barrel — drop of 30% since reaching high of $86/b in October. If we use oil price as a matrix to assess the effectiveness of Opec, its death is not farfetched. Opec has lost its capacity to control oil prices. This is despite the Opec spare capacity being around 2 millions barrel per day (mmbd) — a bare minimum.

Recently, Qatar has announced its intention to leave the 15 member OPEC cartel at the start of the new year. As analysts were trying to study its implications, experts at Barclays Bank floated the idea that Iraq could be the next member to leave the cartel. Iraq whose production has suffered during the civil war and is now able to increase its production, may feel unnecessarily constrained by Opec ceilings. It may feel that by being a member of Opec it may not get much benefit.

There have been such exits and re-entries of Opec members. Indonesia has suspended its membership twice, last one in 2016. Gabon and Ecuador also halted their memberships in 1990s to join again in later years.

In reality, Saudi Arabia is the de-facto leader of Opec controlling more than 70% of its spare capacity. It has often dictated its own policy to the detriment of other members. In early November, Wall Street Journal published a news item that Saudi’s think tank, King Abdullah Petroleum Studies and Research Centre was studying the potential impact of Opec break up on oil market.

But Saudi Energy Minister Khalid al-Falih categorically stated that his country has no plan to leave Opec and the think tank was just thinking out of the box since that is what a think tank is supposed to do. Still, one can question when there are so many out of the box things to reflect on, why did it think of Opec break up?

It became even a bigger enigma since the president of the think tank is Adam Sieminski, a former chief of energy information administration of the US. Currently, the US Congress is considering to adapt an anti-trust law against OPEC to curb their power on oil markets. When similar efforts were made earlier, former presidents threatened to veto them. However, Trump may support such efforts now. He may feel that he was betrayed by Saudi Arabia.

In 2014, the Saudi think tank had studied the role played by Opec in stabilising oil prices through its spare capacity. It estimated the benefit from $170 billion to $200 b. It found that in the absence of Opec, oil prices would have sky rocketed to $300/b during the Libyan revolution. Only during some limited periods, Opec has been able to dictate oil prices. However, it is true that in the absence of Opec, market would have experienced even more price volatility specially because of the speculation in futures market.

As we get ready to usher in the new year, oil pundits have started to give their usual price predictions. As in the past, most such predictions are not backed by any special expertise. Since they are mostly based on the current market conditions, they are likely to be wrong.

Predicting prices

But not many will be humble enough to state their inability to predict prices. General consensus is that in 2019 it will be around $70 per barrel with lower limit being set by the cost of the US break-even cost of shale oil which is around $50 per barrel.

World oil demand is likely to go up by 1.4 mmbd while non-Opec supply will go up by 2.0 mmbd. Therefore, if Opec+ has to balance supply and demand, they need to reduce supply by at least 1.2 mmbd since there is an over build of stocks of at least 0.6 mmbd.

If Opec+ members are prepared not to cheat and take advantage of production reduction by say Saudi and Russia, then there is every chance of the success. This will be further helped if the US succeeds in reducing Iranian export. However, if history were to be any guide, such a quota discipline is not likely. Even the recent reduction from January 2017 was possible only because of unplanned reduction in some member countries like Venezuela, Nigeria and Libya.

Since Opec+ has really not spelled any country specific quotas and is aiming for 1.2 mmbd cut by all, prices have not gone up significantly as expected after the announcement.

Since Opec surplus capacity is rather limited, and should there be any geopolitical event resulting in reduction in oil production, prices could easily climb above $100/b. However, such an eventuality is unpredictable. In conclusion, while Opec is not yet dead and trying to reinvent by enrolling countries like Russia, its ability to control price is limited.