The oil price has been pumped up by Opec, but it comes at a cost
The cartel’s latest show of strength may fuel the return of US shale producers and cut its influence long term
THE oil market by nature is binary: buyers collide with sellers, bulls battle bears. But as 2017 draws to an end, the market is divided once again: between those who believe the world’s largest oil producers have regained control of the market, and those who fear they have ceded power in the battle to resuscitate prices.
It is more than three years since the Organisation of Petroleum Exporting Countries (Opec) shrugged off responsibility for the faltering oil price amid rising output from US shale producers. Without intervention to stem the flow of crude into the oversupplied market, prices plummeted. Opec’s plan was to wipe out its competition – even if its own members suffered from prices crashing below $30 a barrel.
The cartel’s return to its role of gatekeeper, carefully managing the supply of crude out of established regions, has been key to breathing life back into oil prices, which now sit comfortably above $60. But by reversing its strategy to extinguish US shale, the cartel has fanned the flames of its return.
As a result, the drivers behind the oil price in the future will lie in the Texas shale fields and in the energy demand centres of Asia. The reversal invites the question: has Opec’s latest show of strength weakened its future influence? Jon Rigby, an oil analyst at UBS, says 2018 will be “the end of the beginning” for the new oil world order.
“In 2016 investors saw the oil price find its floor and rebound. In 2017, a clearer picture emerged in how to think about the market,” he says. From next year, Opec appears likely to achieve its target of bringing crude inventories under control but the fine balance will depend on rising demand for crude and the extent to which US frackers return to the rigs abandoned during the downturn. Both factors are largely out of Opec’s control.
By any measure it has been a landmark year for Opec’s diplomatic might. The historic deal between Opec and non-opec oil producers, brokered by Saudi Arabia and Russia, in late 2016 steadily drove oil prices from an average of $52 a barrel in January to their current level. The first deal of its kind hammered out by the world’s largest oil producers was extended in May, with members of Opec vowing to cut 1.8m barrels of oil a day until March 2018. In a meeting at the cartel’s Vienna headquarters in November, the deal was extended again until the end of next year, amid almost unprecedented compliance with oil quotas.
Saudi Arabia’s energy minister Khalid Al-falih has acknowledged that the coalition has “only recently passed the halfway mark” in its goal of reducing oil stock levels to their five-year average. It hasn’t stopped the cartel from taking steps to expand its influence. Within weeks of the deal to extend the cuts, Opec secretary general Mohammad Sanusi Barkindo met with Nur Bekri, of China’s National Development and Reform Commission, in what the cartel called “a turning point in relations between China and Opec”.
“The importance of China as a major consumer and producer of oil, as well as an engine of global economic growth, makes intensified co-operation
Jon Rigby, an oil analyst at UBS, says 2018 will be ‘the end of the beginning’ for the new oil world order
between both parties a necessity. This is not only in the interests of China and Opec member countries, but also the global economy,” Opec said.
Under the agreement the pair will share data, information and outlooks for supply and demand. It’s a deal that could help Opec tighten its grip on the global oil market, but it also underlines its increasing powerlessness as a standalone group. Geopolitical cracks, fast spreading between the group’s Middle Eastern members, also threaten to undermine its goal of buoying oil prices against the twin threats of a slowdown in demand and resurgent US shale.
Ole Hansen, head of oil at Saxo Bank, says unity in Vienna “was a classic example of realpolitik, with the economic importance of keeping prices supported outweighing fraught relations between several countries, not least between Saudi Arabia, supported by its Gulf Co-operation Council allies, and Iran, often supported by Russia”.
Opec faced early resistance from Russian oil minister Alexander Novak – who warned that oil prices above $60 a barrel could reignite a production boom in the US shale heartlands – before ultimately agreeing to the terms.
Cailin Birch, a commodities analyst at the Economist Intelligence Unit, says that Novak’s diplomatic “manoeuvring” before agreeing to the deal helped Russia’s bid to cement its position as a “global energy superpower”.
But more dangerous tensions are simmering at the core of Opec. Saudi Arabia and Iran stand on either side of neighbouring Yemen’s bitter civil war. Matters have only worsened following a missile attack on the Saudi capital Riyadh this week.
Hansen adds that Iraq is one of the candidates that may struggle to keep to its oil limit commitments.
“While southern Iraqi oil sales have jumped to a record, Jabbar al-luaibi, the oil minister, in Vienna expressed some very ambitious plans to improve the fields around the northern city of Kirkuk,” he explains.
Higher oil prices may also tempt other low-cost oil producers to break rank while handing higher cost regions, including the US, a renewed licence to drill. So 2018 may prove to be the end of the oil market’s new beginning, but Opec will need to prove it is not the beginning of the cartel’s end.