By Nathan Bomey | –
When his final press conference as secretary-general of the Organization of the Petroleum Exporting Countries came to an end last week, Abdallah Salem el-Badri finally addressed the whispers that have been circulating throughout the oil markets.
Energy industry observers are howling that “OPEC is dead,” El-Badri acknowledged, after the group again failed to reach an agreement to cap oil production that would bolster sagging prices.
His frustration was evident. “I have heard this comment maybe five, six times in my career,” he told reporters in Vienna. “Don’t take that notion that OPEC is dead. OPEC is alive. OPEC will be a very important segment of the economy, of the world.”
That might be wishful thinking.
After its failure to reach a consensus on capping oil production at its meeting early this month, OPEC, once infamous for keeping a tight grip on global oil supply and demand, is bleeding power. It’s a major turnabout for a cartel that once looked unstoppable.
But new oil-drilling technology that spawned a shale oil and gas boom and a rise of U.S. producers has had a major role in changing all that. With less control over global production, market dynamics such as investor focus on economic growth, inventory data and political disruptions — not OPEC production quotas — have taken a larger role in driving prices. The result: greater volatility in oil prices, as the market constantly adjusts to the commodity’s underlying economics and sovereign self-interests.
“OPEC’s power is not waning — I’m sorry, OPEC is finished,” said Hossein Askari, Iran professor of business and international affairs at George Washington University who has studied the oil industry for years. “OPEC is just powerless. They cannot agree to anything, both for political reasons and economic realities.”
Starting with the oil-price shocks in the 1970s, OPEC exerted its influence on production, infuriating consumers forced to pay handsomely at gasoline pumps and creating tension among governments over supply. Member countries fell in line with OPEC’s production targets, keeping prices above levels that would be dictated by a free market without output quotas.
Meanwhile, OPEC has experienced an increase in political tension as the ambitions of the organization’s members diverged. What’s clear now is that if Saudi Arabia, as OPEC’s largest oil producer and the world’s low-cost leader in petroleum production, doesn’t want a deal, no deal will get done.
“I think we’re in a newer paradigm for the oil market,” said Rob Haworth, investment strategist and commodities expert at U.S. Bank Wealth Management. OPEC “can’t afford to cut production in a meaningful way, so we are back to the market and the fundamentals of supply and demand and cost of production being the driver of price.”
Since Saudi Arabia refused to slash production at a critical OPEC meeting on Nov. 27, 2014, oil prices have fallen by more than 30% to around $51 per barrel last week.
That diminishes OPEC’s reputation as a cartel. It’s not a cartel when one country’s position is all that matters.
Amid a stiffening geopolitical dispute between Saudi Arabia, a majority Sunni Muslim nation, and economic-sanctions-free Iran, a majority Shiite Muslim nation, OPEC’s ability to reach a consensus is rapidly deteriorating over political divisions.
As market dynamics roil the oil market, Saudi Arabia is charting its own path toward gradual oil-market liberalization. The country is expected to sell about 5% of its state-owned oil giant, Aramco, to investors in an initial public offering. That move will invite external shareholders to examine the company’s books and, inevitably, expose Saudi Arabia further to market pressures.
The Aramco move comes as political divisions and diverging economic agendas drive a wedge between OPEC’s key members, increasingly allowing market dynamics to take the driver’s seat in fueling price swings of crude oil.
Oil’s brief crash to below $30 per barrel earlier this year occurred largely because the U.S. oil and gas boom flooded the market and Saudi Arabia refused to scale back production again, choosing revenue through volume instead of preserving profit margins.
Oil’s relatively quick recovery to more than $50 per barrel in recent weeks wasn’t driven by OPEC’s production limits. Rather, analysts say, it was due to signs of improved economic growth in countries like China, fears of political instability in oil-producing nations like Venezuela and Nigeria and the Saudis’ single-handed and apparently successful campaign to drive prices so low that U.S. and Canadian producers would leave the market — and hopefully stay out even as prices drift up. The fallout has tipped 81 North American oil and gas companies into bankruptcy from the beginning of 2015 through May 31, 2016, according to law firm Haynes and Boone, which tracks the cases.
The recent uptick in prices has returned many companies to economic viability, but oil prices are unlikely to head much higher than $60 per barrel, according to most analysts.
There’s simply no reason to expect Saudi Arabia or Iran to turn off the oil spigot anytime soon.
Carlos Pascual, senior vice president of business information firm IHS and formerly the top energy official at the State Department, said in an interview that Saudi Arabia’s desire to maintain market share is heightened by its geopolitical dispute with Iran, which is bolstering production after striking a nuclear deal with the U.S. to escape sanctions.
“The marketplace — and, above and beyond other countries, Saudi Arabia — has emerged as the most important player affecting global oil supplies,” Pascual said.