Unrest in OPEC could pump up oil prices

Oil watchers are focused on the Organization of Petroleum Exporting Countries (OPEC) this week as it convenes for its end-of-year gathering. While the question regarding whether OPEC will make a small additional group cutback for 2020 or just roll over its current OPEC plus production pact with Russia and other key non-OPEC producers might be headline-grabbing for a few days, the end result might turn out to be moot. The question next year might not be what the oil cartel intends to produce, but its worsening reduction in operational flexibility. Various OPEC national oil companies are finding new risks to their ability to manage how much oil leaves their shores.

The laundry list of OPEC members that are facing internal operational constraints today is a long one. U.S. oil sanctions on Iran have reduced Tehran’s exports to a trickle. The country’s oil industry faces an exit of foreign investment partners and must overcome technical hurdles to maintaining its production capacity in the face of trade restrictions. Lasting internal mayhem in Venezuela has all but destroyed its oil sector. Russia’s entry into Libya’s civil war backing regional opposition leader Khalifa Haftar has raised the prospects that the country’s oil industry could see increased disruption again from escalating violence. Last week, warplanes pounded targets near oil fields in southwest Libya. Importantly, Iraq’s oil industry is also suffering from local turmoil where protesters have briefly closed off workers’ access to port facilities and roads leading to Iraq’s southern oil fields. Unrest in Iraq has been widespread, and protesters are calling for a major reorganization of the government that would scrap existing political parties and limit Iran’s interference in Iraq’s political affairs. Protesters are calling for an end to rampant corruption and political patronage in favor of a new system and new leadership. Iraq’s prime minister, Adel Abdul Mahdi, resigned amid the deepening political crisis, but it remains unclear how the situation will be resolved.

Disruptions caused by internal turmoil in OPEC countries are not new. President Obama released the U.S. Strategic Petroleum Reserve (SPR) in 2011 amid civil war turmoil that disrupted exports from Libya. But there seems to be almost no OPEC country that isn’t facing some sort of challenge these days, and that raises the probability that oil markets could tighten unexpectedly.

Global oil markets are used to pricing in the latitude of OPEC powerhouse Saudi Arabia to exercise a wide range of operational flexibility. For decades, the kingdom has maintained a vast network of redundant processing equipment, oil production and export capacity to ensure it can serve as the central banker of oil, signaling market participants that it has the ability to change its output level at will by a large margin and effectively able to change the price of oil. This ability has several functions, but importantly over the years it has been a mechanism for OPEC output discipline. Too many OPEC members gaming the system by increasing production out of line with cartel group decisions risked a response from Saudi Arabia, which could significantly increase its own output with a materially negative impact on oil prices. Saudi Arabia’s ability to change its output decisions also provides a potential buffer for sudden accidental supply cutoffs or geopolitical threats such as when Iraq invaded Kuwait in 1990.

But now, in the aftermath of the Sept. 14 attack on Saudi oil facilities, state oil company Saudi Aramco’s ability to rapidly increase and decrease output at will could at some point be temporarily hamstrung by ongoing repairs and maintenance. Market watchers are also actively speculating on how Saudi Aramco’s production decisions will be influenced by transparency that comes with the careful issuance of company shares to be traded on the Saudi stock exchange.

Russia is also pleading operational inflexibility for its condensate production, given high associated natural gas sales needed for winter. That might be the least of Moscow’s problems since not only have Western sanctions against Moscow tightened access to capital for Russia’s oil sector, but also melting permafrost in some oil producing regions in Siberia has shortened the winter drilling season when ice roads and frozen ground facilitate transport of heavy machinery.

For U.S. shale producers who were forced to set conservative 2020 drilling budgets amid talk that lastingly oversupplied oil markets mean oil prices could never rise again, OPEC’s ongoing operational problems have failed so far to bring renewed investor faith back to the sector. Capital discipline can mean that many shale firms will be less well positioned to respond, should something new go awry with OPEC exports. That could take the “never” out of oil prices’ inability to rise, leaving a different outlook for oil’s economic role than currently expected.