The Organization of Petroleum Exporting Companies (OPEC) has lost its mojo. Actually, it’s been disappearing for years and most people are just beginning to notice. The cartel has not controlled crude oil prices for at least the last seven or eight years and its position is deteriorating fast.
Last week’s meeting of OPEC ministers concluded with the unsurprising decision to maintain the cartel’s official production quota of 30 million barrels a day. Iran, though, was very clear that it plans to boost production well above its current level of 2.8 million barrels a day, targeting 4 million barrels a day by the end of next year.
The Saudis are now in the position either of supporting a rise in the quota — and the concomitant drop in prices — or cutting its own production to accommodate Iranian plans. But the Saudis can only do that for so long; the country’s economy is built on oil exports and any long-term cut to production raises serious problems for the princes who run the Kingdom.
And none of the other cartel members has shown the slightest inclination to cut production because their countries’ economies likewise depend on crude oil exports. Some, like Libya and Nigeria, want to export more which only adds to the pressure on the rest of the cartel’s membership.
OPEC’s only remaining leverage on oil markets is its ability to control the amount of its production. Effectively the members can open or close the oil spigot more easily than can either the U.S. or Canada or Russia. But if they tighten the flow of crude, they risk cutting off the revenues most of them depend on.
The source of all these troubles, of course, is booming production in North America. The U.S. is positively swamped with crude and the surfeit has been driving down the price of WTI, except when investors cling to the mistaken notion that an improving U.S. economy and jobs outlook will somehow spark demand for more crude, bidding up prices for no reason related to supply and demand.
As the price of WTI falls in the U.S., the price of Brent has to fall as well because countries that import Brent can buy refined products from the U.S. even if the American ban on crude exports is never lifted. Even if Brent prices don’t fall, crude oil that is benchmarked against Brent will be overpriced, opening world markets to U.S. products like gasoline and diesel fuel which will be very price-competitive.
New exploration and development projects outside North America have been delayed or cancelled, reducing reserves replacement that could drive up prices when the U.S. shale boom finally winds down. But that appears to be at least a decade away. On a global scale, OPEC investments have been targeted at replacing falling production, not searching for new fields. When (or if) U.S. production begins to decline, global demand could quickly outstrip supply.
OPEC’s leverage is that if it waits to boost production until North American production begins to wane crude will be scarce and very expensive. In other words, some luckless buyers will have to pay a premium price for OPEC crude in order to save the world. Good luck with that idea.
And then there’s the politics. The recent agreement by the U.S. and its partners with Iran over that country’s nuclear program is particularly worrisome to the Saudis who worry that the deal means a change in U.S. strategy in the Middle East, a strategy that up to now has supported the Saudis and vilified the Iranians.
There are so many moving parts in the global oil machinery that any change can be far more disruptive than its initial impact may lead one to believe. OPEC members seriously underestimated the disruption to global markets that horizontal drilling and fracking would cause. They are now getting the message and they don’t like what they hear.