Oil: What is OPEC doing ?

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11/02/2018 | 04:57 pm
Oil prices have tumbled by around 15 percent over the past month, as markets are concerned about oversupply. Supply is at record levels among the major producers. Saudi Arabia and Russia are meeting their commitments to increase production. The United States is also pumping at full capacity, leading to an increase in stocks given that US exports are unable to keep up with the pace imposed by producers. This raises the question : what is OPEC doing ?
The OPEC does have some leverage to influence prices, although the level of oil prices remains largely linked to geopolitical interactions between producing countries, whether or not they are OPEC members, and the rest of the world. As such, the recent American sanctions against Iran, or Venezuela's economic decline, perfectly reflect this economic reality. This growing politicisation of oil markets gives a leading role to the Organisation of Petroleum Producing Countries, which enjoys, not without difficulty, the historic role of regulating oil prices.

OPEC Member Countries

Created in 1960 at the Baghdad conference, OPEC's first missions (formed by 5 countries: Saudi Arabia, Iran, Iraq, Kuwait and Venezuela) were limited to better controlling the oil revenues collected by its members. As early as the following decades, the waves of nationalization of the oil industry, coupled with an increase in the number of members and greater volatility in oil prices, quickly gave the cartel a leading role.

Today, the Intergovernmental Institution based in Vienna has 14 members. In addition to the founding members, OPEC includes Algeria, Angola, Ecuador, Gabon, Equatorial Guinea, Equatorial Guinea, Libya, Nigeria, Qatar, and the United Arab Emirates.

A major swing producer...

With a cumulative production of around 40% of world production, for a control of nearly 70% of world oil reserves, OPEC is THE swing producer in the oil markets. In other words, the cartel, with Saudi Arabia at the top of the list, has a sufficiently significant weight to affect the price per barrel by adjusting its production.

OPEC's mission is therefore to respond to imbalances between supply and demand in order to guarantee price stability on the one hand and a remunerative price for its members on the other. In the end, the interest remains to limit price volatility, which is not only a scourge on the budgetary balances of producing countries, but also a serious obstacle to investment by the oil sector.

... which is crumbling with the rise of non-conventional hydrocarbons...

If the cartel has been able, with varying degrees of success, to fulfil this task of regulator, the rapid growth of American shale oil seriously undermines its influence. Much more flexible in response to demand thanks to a significantly shorter investment and production cycle, US shale oil producers are in pole position to gain market share from OPEC.

Following a logic of profitability, the United States is on the way to becoming the world's leading oil producer, ahead of Russia and Saudi Arabia. Technological advances, constantly improving the hydraulic fracturing process, have allowed American producers to double their production since 2009, to nearly 11 million barrels per day.

This new competition has prompted OPEC to radically revise its strategy. While initially the priority was to defend its market shares in the face of the rise in US production (pushing prices down in 2014 to USD 25 per barrel), the cartel joined forces for the first time with non-members of the organisation, including Russia, to halt the fall in prices through the introduction of production quotas.

The role of supplemental producer is therefore no longer fully supported by OPEC. While this is an admission of failure for the cartel, which cannot regulate oil markets on its own, it seems obvious that this unexpected alliance nevertheless allows OPEC to safeguard its credibility.

... and internal conflicts.

In addition, there are internal divisions, which significantly affect the unity of the cartel. Beyond the entrenched ideological differences that complicate the cohabitation of some members, particularly between Saudi Arabia and Iran, there are significant inequalities in resilience to fluctuations in the price of oil.

More specifically, the degree of dependence on hydrocarbons and average cost prices vary from one country to another. It is difficult in this context to move towards decisions that fully satisfy the 14 members of the cartel. The risks of disagreement are therefore high.
Romain Fournier
MarketScreener.com 2019
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