OPEC, IS, oil games and plunging prices
When the Organization of the Petroleum Exporting Countries (OPEC) was created in 1960, it brought together a powerful club of oil producing countries that wielded considerable influence on the oil market. Such was the power of the cartel that it has been used to promote political goals as well as economic leverage over the years.
But the latest crisis in oil markets, which has seen oil prices plunge by around 45% since June to between $55-$60 a barrel, has demonstrated the increasingly difficult predicament that OPEC faces. In a surprise move last month, OPEC members decided not to intervene by reducing output and theoretically providing an adequate floor for oil prices, thus accelerating the plunge further.
No doubt there were also political connotations with such a decision. Some members, particularly Saudi Arabia, the biggest oil producer by far in the cartel, refused to cut supply as it would threaten their market share.
The simple fact is the global thirst for oil is no longer so firmly in the hands of OPEC. Vast jumps in technology to extract shale oil and gas has seen the US, a historic consumer of Saudi oil, become a net exporter and flood further supply.
Then there is of course the huge oil supply of nonOPEC producing countries such as Russia and Norway. The math is simple. There is a glut of oil supplies and not enough global demand. Fears over the strength of the global economic recovery are true, but even then it doesn’t warrant a 50% drop in oil prices in merely a few months, leading to prices at levels not seen since the 2009 global economic crisis.
the OPEC countries rely heavily on oil revenues as main source of income to support their economy and balance their books. Some countries, such as Saudi Arabia, can survive in the short-term due to vast foreign exchange reserves but even then the games cannot last.
Each country has a base price they need to maintain revenues and almost all cannot survive at circa $50 a barrel in the long-run.
What it does in the shortterm, is inhibit or even bankrupt some shale producers whose operational costs will much higher owed to more expensive hydraulic fracturing and horizontal drilling extraction methods from shale rock. Less shale oil will of course mean less supply of oil.
The declining prices hurt Iran and Russia more than most. This places additional pressure on the respec- tive governments. First sanctions and now drastically lower oil prices has severely crippled the Russian economy. It remains to be seen how much the economic bite may force a stubborn and determined Russia to change course over Syria and Ukraine. Iran is hardly in a much better economic position with its own sanctions never mind its expensive foreign policy in propping Bashar al-Assad and other Shiite forces in the region, and low oil prices over the long-term may influence its negotiating stance over its nuclear program.
And one can hardly forget the newest member “state” of the oil export club – the Islamic State (IS). The richest terrorist organization in history is bolstered by a reported daily income from oil fields they control of anything between 1-3 million USD per day.
IS would not be running a fairly productive oil market if it didn’t have willing buyers across the Middle East. IS oil was sold at anywhere between $30-60 per barrel, at over 50% discount from market prices, before the oil crunch, making it a tempting option for many.
But if IS has to sell oil at $15-$30 per barrel that obviously greatly diminishes its financial clout and its appeal on the black market.
The problem with any cartel is that it must benefit all members, regardless of any political pressurecards. Long-term splits amongst members will further dilute OPEC influence. OPEC may be forced to strike a deal with other non-OPEC producers over supply to bring long-term stability.
In the short-term prices will remain low, but if shale producers and certain other countries cannot meet export targets due to cost, this may use up remaining spare capacity and the second half of 2015 will see a spike in oil prices.
But then what? The games resume with some casualties out of the picture but fundamentally the problem remains the same (lack of control of supply versus demand)
Many oil producing countries are no way near their capability. Take Iraq, which has potential for the most growth in exports amongst the OPEC members. Add to its symbolic deal with the Kurdistan Region over oil-exports and revenue sharing that ended a bitter long-running feud, then the scene is set for a new dominant role for Iraq. It needs billions of investment to support its oil export growth targets and of course oil itself will need to be the main source of that funding.