Shutting down Saudi-led war on oil prices
There are early indications that the world’s oil-price plunge has bottomed out and a gradual recovery is not too far off. These signs have gone largely unremarked upon, because the price slump has been devastating (a 73-per-cent plunge since the 2008 peak) and because the misery for producers has lasted long enough to seem like a new permanent reality.
The 11-month market-share war spearheaded by Saudi Arabia — with the Saudis and their OPEC partners hoping to arrest losses to upstart U.S. shale-oil producers — is a few months away from winding down. It has served its purpose, driving enough U.S. producers to the wall to yield a net reduction this year in U.S. oil production.
We always knew, or should have, that this war was unsustainable.
OPEC’s quest to regain the market share lost to the shale producers has caused enormous damage to bystanders like Alberta, of course. But OPEC members and non-OPEC producers such as Russia, which is mired in deep recession, have paid a much bigger price.
The pain is acute enough that Venezuela, Algeria and Ecuador are calling on their OPEC partners to ease the cartel’s full-throttle production, in order to restore the world price to $70 (U.S.) or thereabouts instead of the current $50 or so.
Many OPEC countries are now in budget deficit, in some cases for the first time in 30 years. Remarkably, each of Saudi Arabia, Iran, Iraq, the United Arab Emirates, Qatar, Libya and Algeria are in fiscal deficit. In the Saudis’ case, the deficit is a whopping 20 per cent of govern- ment spending. At least one prominent industry expert has called the OPEC gambit a “strategic mistake.”
Libya, already coping with post-Arab Spring political upheaval, is now also struggling with social unrest due to plunging oil revenues.
Especially hard hit, Venezuela has run down its foreign-exchange reserves to a 12-year low. Caracas “appears poised for a near-term crisis,” according to RBC Capital Markets Ltd. analysts Louney and Helima Croft.
Venezuelan protesters have taken to the streets over mounting unemployment and shortages of basic goods in stores.
The “Fragile Five” is the new nickname for Venezuela, Algeria, Iraq, Libya and Nigeria. These major oil producers lack the foreign-exchange reserves and sovereign wealth funds of Saudi Arabia to cushion the blow from dropping oil revenues.
And the rule of unintended consequences has kicked in.
In reaction to the Western sanc- tions against Russian oil imports over Vladimir Putin’s predations in Ukraine, the Kremlin has turned to China as its oil buyer of last resort.
Russia is adamant about maintaining full-out production; it needs the money. But China’s effective bailout of Putin by purchasing Russian oil is conditional on China also being allowed to buy Russia’s latest-generation military hardware, something Moscow has always refused to permit.
Keeping the spigots wide open has thus compromised Russian geopolitical dominance.
Saudi Arabia, meanwhile, finds itself losing market share in China, its biggest customer, now that Beijing is taking Russian oil.
Since OPEC’s founding 54 years ago, “cheating” on agreed production quotas has been a notorious feature of the cartel.
Internal pressure on Saudi Arabia for an end to the market-share war will intensify among the most hardpressed OPEC members. And it’s likely Saudi Arabia will eventually relent, rather than invite cheating by a Venezuela or Nigeria that decides to cap production to boost the global price and its own oil revenues.
The U.S. shale-oil phenomenon propelled America into the front rank of world producers. America’s oil output rose a stunning 74 per cent in the short space of six years to 2014. OPEC had little alternative than to react to its market-share losses.
OPEC’s relentless oil pumping, and the global oil glut that resulted, cut the world price by as much as 65 per cent since OPEC unveiled its war on the U.S. producers last November.
The OPEC plan has worked. Because most OPEC producers have lower production costs than their U.S. rivals, OPEC drove many U.S. producers out of business. (Athabasca heavy-oil production costs are even higher — the world’s highest, in fact.)
Result: U.S. production has slid back close to where it was when OPEC launched its war last year. And OPEC’s share of the global market has been largely restored.
But the price to OPEC members has been enormous, about $370 billion (U.S.) in foregone export revenues.
Yet no one is expecting outright buoyancy in the world oil price. Even long-time bulls like Gary Ross of the U.S.-based PIRA Energy Group are calling for a return to $75 oil in 2017. That’s a long way off, and a much lower price than the peak $147.50 of 2008.
OPEC’s victory is almost certainly a Pyrrhic one, however. One of the factors defining this new century will be the adoption of alternatives to fossil fuels.
At the front end of that revolution, wind and solar are already making inroads on traditional energy sources. And there are sources yet untapped — indeed, unknown — because they aren’t yet technologically or commercially feasible.
That was the story with U.S. shaleoil reserves, which were ignored for generations until breakthroughs in drilling technology in the past two decades.
OPEC must also contend with soaring fuel efficiency. Incredibly, Americans are consuming less oil today than in 1997, despite a near 50-per-cent increase in GDP in the same period.
Every major automaker is experimenting with new types of batteries for electric-powered vehicles and re-tooled engines that squeeze more power from every BTU of energy.
Finally, the developed world has a growing population of retirees who do little or no driving. And while the developing world will eventually achieve an affluence that generates demand for vehicles, by that time the 130-year-old internal combustion engine will have given way to widespread use of far more energyefficient alternatives.
For now, though, the stupendous cost to OPEC of reducing total U.S. oil production by a mere 2.6 per cent in the past year — at a cost of $370 billion (U.S.) and hardship for tens of millions of residents of OPEC countries — is a classic example of why pursuit of market share for its own sake is a fool’s mission.
Roger Enrico might have best described that iron rule of commerce when he headed PepsiCo Inc. in the 1980s. The veteran of marketshare wars with Coca-Cola Co. said: “Managing share without profit is like breathing air without oxygen. It feels OK for a while, but in the end it kills you.” dolive@thestar.ca