Energy Special Report: Is this the end of the road for OPEC?
When the Organisation of the Petroleum Exporting Countries (OPEC) finally reached a deal to cut oil output by 1.2m barrels per day (bpd) oil prices immediately surged.
The deal, which was thrashed out in OPEC’s headquarters in Vienna, Austria, last November, was lauded as the right course of action to support oil prices, which had plummeted from over $100 a barrel in mid-2014 to around $50 a barrel during 2017. Oil prices have been under pressure because of weak demand and the boom in using unconventional hydrocarbon production, such as shale, deep water, and oil sands.
Among the delegates representing Nigeria and Libya, the reaction to the deal was one of ecstasy as both nations secured exemptions from the original deal due to armed conflicts affecting oil output capacity. Nigeria was tackling an upsurge of militancy, which has now subsided, in the oil heartlands of the Niger Delta; meanwhile, Libya has been mired in a protracted civil war but moderate oil production has returned to parts of the country.
Yet only six months later, OPEC and 11 non-member nations, including Russia, were forced to extend the cuts until the end of the first quarter of 2018 because oil prices had not risen over the $50 a barrel threshold for a significant period. The OPEC cuts have had a mixed level of success in supporting oil prices but the original cuts did not go far enough, according to Paul Stevens, a Middle East energy analyst at think-tank Chatham House.
“The OPEC cuts have been effective in the way that there has been a reasonable degree of compliance, although that compliance is steadily weakening, as anyone who knows the history of these things will expect, because the longer these things go on the less people are willing to stick to the rules,” he says. “However, the problem in the first place was that the cuts weren’t sufficient in order to balance the market. So despite the fact that there have been cuts the supply overhang reflected in the very high level of stocks continues and shows very little sign of disappearing in the near future.”
The deal has also been compromised by the fact that Nigeria and Libya have shown little appetite to join in with the cuts even though oil output has lifted significantly in both nations, and Iraq has been dragging its heels as well, according to Alfa Energy chairman John Hall, an OPEC expert.
The long-term options left open for OPEC are limited. In the first scenario, the cartel continues on the current path of cutting output to prop up prices into the foreseeable future. However, according to energy economist Phil Verleger, this would lead to low-cost OPEC producers – Saudi Arabia, Iraq, Kuwait, Qatar, and Iran – losing 9% of their market share by 2022.
The other scenario would be to ramp up production so prices crash to around $20 a barrel. At this level, the low-cost OPEC producers would still be marginally profitable. Such a move, however, would spell the demise of the high-cost producers – including Nigeria and Angola – who will have to vacate the market.
Maximising output may still appeal to OPEC’s de facto leader Saudi Arabia because it would also price US shale out of the market. But there is no guarantee that increasing oil output to slash prices will succeed when you look at history, according to Stevens.
“The difficulty with this strategy is that Saudi Arabia has already tried to go for market share by bringing prices down to take down the high-cost producers, but they grossly underestimated the power of technology and the ability of producers, particularly in the US, to reduce costs through improved efficiencies and technology,” he says.
Stevens adds that it is unthinkable that the other high-cost OPEC producers would accept a strategy which would collapse their own oil sectors and create further economic chaos.
The weak oil prices have already created an economic crisis in many OPEC member countries including in Saudi Arabia. African member countries have not been immune to the woes facing the sector, with the two largest producers in the region Nigeria and Angola experiencing a technical recession over the last year.
The former has returned to marginal levels of growth. The crisis facing OPEC has left many wondering if the organisation, founded in 1960 and accounting for around 40% of global oil output, has a future.
OPEC and US shale have been on a collision course since fracking became pervasive almost a decade ago. OPEC has repeatedly attempted to push US shale producers out of the market by manipulating prices through oversupply.
However, the shale firms have proven to be resilient by slashing production costs without losing efficiencies. Meanwhile, OPEC’s strategy of cutting output to bolster prices has only encouraged the shale producers to increase output to replace the removed stock.
It seems that the struggle between US shale and OPEC will only emerge with one winner, according to Ed Morse, global head of commodities research at Citigroup. “In regards to the OPEC vs shale conflict I think the market is going to win, so it’s going to be shale,” he says. “The OPEC position even with Russia is not sustainable in the long term. They are losing revenue [because of the output cuts] and the US producers [are] hedging through 2017 to 2018 so they can survive at a lower price.”
The standoff means that oil prices, absent geopolitical shock, are unlikely to rise above $60 a barrel in the near future, throwing into question OPEC’s current strategy. The situation is compounded by the potential introduction of additional shale oil players into the market, with Russia, which has the second largest shale oil reserves in the world, and China researching the technology to extract the shale oil.
Russia has around 75bn barrels while China has an estimated 32bn barrels, but the US leads the way with over 78bn barrels. Once they tap these resources, the market will be flooded with additional stock, which will negatively affect all OPEC nations. But while the headwinds might point to the end of the road for OPEC, there have been some positive developments in the second half of 2017.
Positive market outcomes
One of the key developments which has caused optimism within OPEC is the growth in oil demand. According to the US-based Energy Information Administration (EIA), global inventories of oil have been on the decline in the first eight months of 2017, while demand has lifted from 97m bpd to around 99m bpd.
The uptick in demand and destocking has helped strengthen oil prices, with the basket of OPEC members’ oil holding firm at $53 a barrel. US shale has also experienced a slowdown with the number of rigs targeting oil falling slightly and output declining.
“The increase in output from shale hasn’t happened as quickly as people thought it would, and it has faltered and this is because of the current oil price level,” says Hall. “There is a view that if the price of oil does go below $50 a barrel then some shale production won’t survive.” All of this, especially the increase in demand and the reduction of stock levels, should lead to optimism within OPEC that it can survive the current crisis.