National Post (National Edition)
OPEC struggles to right the ship
Investors have questions
When the Organization of Petroleum Exporting Countries came to an agreement last week, it was by turns hailed as a watershed and a “meh” moment. The question on investors’ minds now is: Which is it, really?
On the “watershed” side, the undertaking to cut production (to 32.5 million barrels per day from about 33.2 million) marked the first time since 2008 that OPEC had agreed to cap output. It followed two years of a pumpat-will policy spearheaded by Saudi Arabia, which was keen to consolidate its market share by putting higher-cost producers out of business. (That sort of worked: Thousands of marginal U.S. producers have come off-line, and Big Oil has suspended many billions in new development around the world.)
The OPEC reversal also marked a watershed in Saudi-Iran relations.
Under the tentative deal, Iran, which has only recently come out from under international sanctions, will be allowed to continue to increase production. By all expectations, Saudi Arabia will have to bear the brunt of production cuts, while its regional arch-enemy keeps on pumping.
It’s a sign of the degree of the Saudis’ capitulation, but more optimistically it suggests that political (and religious) opponents within OPEC are finding a way to work together.
Meaning OPEC is back in the game. Maybe.
That’s the bright side. And in the immediate wake of the announcement, investors paid attention, driving oil futures higher. By Friday, oil futures had capped a 7.9-percent increase over September.
It’ s remarkable, however, that the up tick wasn’t higher. That’s largely owing, clearly, to the market’s skepticism about the deal — whether it will happen in the first place, and what impact it will really have on oil supply if it does go through.
After all, this is a tentative deal, and the details of who will cut how much still need to be worked out at OPEC’s next formal meeting, on Nov. 30. Given the players involved, any agreement-in-principle still needs to be considered tenuous. A lot could happen in two months.
Even if the deal goes through as announced, it begs a lot of questions. First is the effectiveness of OPEC at adhering to agreed production limits. Some countries (such as Libya) are already running above expectations. And there’s always the possibility that some members in desperate need of revenue will blithely ignore their commitments.
As well, if the production limits raise the oil price by US$10 a barrel, as some analysts expect, then that will encourage non-OPEC producers to get back in the game. Despite cutbacks and downsizing, U.S. shale producers have proven remarkably resilient and elastic to changing conditions, cutting costs and becoming more efficient. A price uptick is good news both for those who survived and for the marginal producers looking to get back into production. That will tend to mitigate the impact of the OPEC production caps, putting prices under pressure yet again.
Meanwhile, the world’s largest oil exporter, Russia, officially says it supports output limits. But it has been pumping more oil than ever in post-Soviet history. It is also clearly skeptical that the OPEC agreement will have much impact: In its current budget deliberations, Russia is assuming a US$40 price.
Clearly, the Saudis’ capitulation on production is only one factor among many that will determine future prices. Even if OPEC can manage to significantly affect supply, it has no control over the other half of the price equation: demand.
If you think about it, Saudi Arabia’s 2014 gambit on pump-at-will was a big bet on the global economy. If all had gone as planned, low prices would have helped stimulate economic growth, destroy upstart competitors and eventually contribute to resurgent demand. That hasn’t really happened.
International Monetary Fund projections for global GDP growth have been steadily revised downward this year; so have the International Energy Agency’s expectations for demand growth. The IEA has already lowered its projections by 100,000 barrels per day for 2016; the agency expects a decline in demand growth of another 100,000 bpd next year.
Before the OPEC deal, the IEA anticipated demand and production growth won’t balance out until late 2017. Now, with the deal, that magical balance might come sooner — if demand growth doesn’t continue to disappoint. Add in high inventories, and the hundreds of millions of barrels China is holding in “strategic” reserves, and the demand picture begins to look very cloudy.
In a way, OPEC’s dilemma is similar to the one faced by central bankers, who are now nearing a decade of extraordinary monetary policy that has done little to spur GDP growth. The Saudis’ free-market gamble hasn’t paid off, either — and it cost them US$150 billion in foreign reserves. Now they are trying desperately to right the ship, like a central banker who decides to raise interest rates, damn the torpedoes.
But like that (theoretical) central banker, who in raising rates could kill economic recovery, OPEC is in a tough situation: Lower prices hurt too much, but higher prices won’t do much to spur demand either. That’s assuming it can even engineer meaningfully higher prices — there are enough non-OPEC players in the industry now that the effort might fail.
The Saudis and its OPEC partners let the genie out of the bottle in 2014. It’s not going back in anytime soon.