- April 30, 2016
- Posted by: sbi
- Category: SB Oil, South Sudan
The Organization of Petroleum Exporting Countries (OPEC) was established in 1960 to coordinate the production of its member countries. The influence of OPEC hit its peak in 1973 when the oil embargo showed how vulnerable the U.S. economy was when it came to energy. Since then; however, the importance of OPEC has been downplayed as internal production disputes undercut its collective power. In this article, we’ll look at what happened to OPEC and its economic might.
How OPEC Should Work
OPEC’s objective is that the members raise and lower production to support prices at a level that the group deems appropriate. When prices are weak, the members all agree to lower their production targets so that the world supply drops enough to force prices up again. At least, that is how it works in theory. What often happened is that all the members would agree to lower production and while key members, usually Saudi Arabia, actually would, the others cheated. Saudi Arabia’s production on its own was usually enough to impact the market. Somewhat inevitably, Saudi Arabia seems to have become less than enthused by this arrangement. (For more, see These 5 Countries Move the Supply of Oil.)
One of the critical issues facing OPEC is that the members are now operating under very different goals. Many of the OPEC members want a higher price, but they can’t idle production because they need the cash from selling oil to pay for their national budgets. Saudi Arabia, on the other hand, is looking to gain market share on every other producer across the globe, hopefully shuttering some of the competition in the process. So we have producers who won’t cut and are pumping to keep the lights on combined with one producer who is fine with the lower price as long as its market share keeps growing. For oil prices, this is the proverbial spot between a rock and a hard place.
Presumably, most of OPEC would like to see higher prices and even Saudi Arabia wouldn’t be opposed to that as long as it maintains its market share. So why can’t they negotiate lower production targets where all the members share smaller cuts? One, as mentioned, previous agreements have been violated, probably hurting the trust in any proposal. Two, there is no guarantee that the market would react significantly to a cut until reserves in storage start to dwindle, and some of the OPEC members will be hurt worse selling less oil at a low price compared to now as the overall revenue they are seeing would drop. This is likely the reason that the December meeting resulted in a wait and see approach rather than any significant action. (See also OPEC and Its Limited Control Over Oil Prices.)
Saudi Arabia Giving OPEC A Time Out?
OPEC could still be a force if it can move in concert, but that is looking less and less likely. Non-OPEC production is declining, but members of OPEC are feeling as much or more pain as a result of this low price environment. The big question is why Saudi Arabia is persisting in driving production up. The market share argument has a weak spot in that the non-OPEC production in the shale deposits can be tapped whenever the market makes it feasible. The deposits and the technology to extract it are not going away, even if some of the North American producers themselves go under in this glut. (For further reading, see: How Oil Prices Impact the U.S. Economy.)
One alternative theory is that OPEC is doing this to teach a lesson, not to the non-OPEC producers, but to its members to ensure compliance with future decisions. The main reason OPEC has fallen so far is because it isn’t working in concert. Saudi Arabia knows that the other members need a higher price (and lower overall production) more than it does, so this could be a power play to pull everyone into line.
The Bottom Line
OPEC was a significant force in the global oil markets and can easily be again, if the members actually fall into line on production targets. The OPEC reserves are both significant and easy to extract for the most part as compared to the more challenging tight oil deposits that North America has tapped for its production growth. That said, until every member buys in, Saudi Arabia is poised to do what it sees as necessary for its interests. So, while it is possible that OPEC will once again be a market force, right now OPEC looks like a weak team with one dominant player.