“Nobody wants a price war scenario.”
Internal squabbles within OPEC caused a tremor of industry concern in July and briefly unsettled global oil markets.
A lingering concern was whether the cartel and its producing allies could maintain discipline and create an ongoing supply balance without negative effects on the oil industry or the world’s economies.
“Oil markets are likely to remain volatile until there is clarity on OPEC+ production policy,” observed the International Energy Agency in its July Oil Market Report. “And volatility does not help ensure orderly and secure energy transitions – nor is it in the interest of either producers or consumers.”
OPEC+ scored a major victory when it orchestrated an oil-supply reduction agreement to offset reduced demand during the worldwide COVID-19 pandemic, according to Mark Finley, fellow in energy and global oil at Rice University’s Baker Institute for Public Policy.
The OPEC+ group consists of OPEC’s 13 members plus 10 other oil-producing countries, including Russia. It does not include the United States.
“We are in the middle of a period, or coming out of a period, when they have successfully pulled off the biggest organized production cut in the history of the petroleum industry,” Finley noted.
That cutback took up to 10 million barrels of oil per day out of the world market.
“They said this agreement in April of 2020 is going to remain in effect and here’s how we’re going to moderate it, and it’s going to remain in effect until April 2022,” Finley noted.
“They have been spectacularly successful,” he said.
Dissension in the Ranks
But when Saudi Arabia led OPEC in a proposal to extend that production-curtailment framework to the end of 2022, in addition to increasing overall oil production quotas in monthly installments of 400,000 bpd, the plan was derailed by the United Arab Emirates.
The UAE “have been pretty much obeying their production quotas but also adding new production capacity,” Finley said, which became the basis for a demanded quota increase.
That disagreement took many industry observers by surprise, partly because it involved a rare public dispute between the UAE and Saudi Arabia, and partly because of its timing.
“It was a little surprising to me that the Saudis and Emiratis picked this as the time to have this fight, frankly, because it was something that wasn’t going to happen for another nine months,” Finley said.
Instead of taking a nine-month period to negotiate, “both sides dug-in and they were willing to walk away from an increase in production, which the market needs,” he added.
The IEA reported, “the possibility of a market-share battle, even if remote, is hanging over markets, as is the potential for high fuel prices to stoke inflation and damage a fragile economic recovery.”
Finley estimated that U.S. gasoline prices had increased about 90 cents a gallon, on average, in 2021.
“If you take 90 cents a gallon and extend that over a full year, that’s $120 billion out of the pocketbooks of American consumers,” he said.
Prisoner’s Dilemma
After negotiation, OPEC and its allies agreed to raise the UAE’s quota limit and to increase output by 400,000 bpd each month from August 2021. Questions about OPEC’s internal discipline remained, however.
Managing a huge production cutback during the pandemic took significant discipline from OPEC+, Finley said, in a cartel not always known for observing its own quotas. U.S. shale oil producers have also shown good discipline recently, he noted.
Finley, a senior fellow of the Association for Energy Economics, was formerly senior U.S. economist at BP, where he led production of the BP Statistical Review of World Energy for 12 years. Prior to joining BP, he was an analyst and manager for the U.S. Central Intelligence Agency.
He called OPEC quota enforcement “a classic prisoner’s dilemma”: If everyone observes agreed-to behavior, everyone does reasonably well. But if someone seeks self-advantage, that person does much better while everyone else does worse.
“I would argue you see exactly the same story playing out in shale right now. If any individual company snuck a few more rigs and a few more barrels out there they would make money twice, from the higher production and from today’s higher prices. But if everybody did it, prices would collapse,” Finley said.
Getting Ahead of Market Changes
Will the UAE’s quota increase embolden other OPEC members to demand future adjustments?
Russia has become an important part of the OPEC+ consortium, but it was widely believed to be exceeding its quota limits by at least 100,000 bpd.
Russian President Vladimir “Putin wrote his master’s thesis on using oil and gas to increase Russia’s political influence. It’s an ingrained part of Russia’s political strategy,” Finley observed.
“The Russians have in the past been very clear it’s part of their objective that it’s very important oil prices don’t get so high that it brings shale back into the market,” he said.
Adding a cooperating list of allies to the OPEC group has widened the cartel’s influence, but has made agreement and conciliation even trickier.
“By recruiting a bigger group of countries, that basically increases the share of the world’s oil production that’s under management,” Finley said.
“The challenge is, there are many more countries you have to manage output and expectations for,” he added.
Placating multiple producing countries and fending off a challenge from shale oil aren’t the only looming problems for OPEC. Finley said the “800-pound gorilla is climate change policy.” That might be a motivating factor in the UAE accelerating capacity expansion and Saudi Arabia talking about doing the same.
“One of the ways to think about that is saying, ‘We’re going to bring oil up out of the ground before climate change policy decimates oil demand,’” Finley said.
“That doesn’t necessarily mean OPEC producers lose, because they are the low-cost producers. They can happily produce if oil prices are half of what they are now,” he said -- providing the biggest oil exporters can successfully diversify their economies.
Economic diversification is a serious challenge for the largest producers. Saudi Arabia launched a Vision 2030 plan to promote industrialization and direct investment toward non-oil sectors of its economy.
“Even if you can live with lower oil prices, you need a more diversified economy that’s not so dependent on oil and gas prices,” Finley noted.
“These countries are in a mortal race to diversify their economies,” he said. “They have a long-lived oil asset base and they need to be less dependent on oil and gas today.”
Climate action and competition from shale oil are changing the global playing field for OPEC, which continues to pursue a mission of balancing output and demand.
And oil markets continue to react to OPEC’s pronouncements, as well as its struggles. World oil prices declined sharply following the OPEC+ production-increase announcement in July.
“Cartels are really good at managing short-term perturbations in the market. What a cartel can’t do is manage permanent change in the market,” Finley noted.
“Those are things that will reduce the cartel’s importance, but it doesn’t mean they won’t be relevant,” he said.
Although internal conflict has always characterized OPEC to some degree, “I and most people suspect they will find a way to manage it,” Finley said.
“People have been writing OPEC’s obituary for 60 years – they celebrated their 60th anniversary last year. They’ve set formal production quotas for about 40 years,” he observed.
OPEC’s member countries and allies seldom seem to be on exactly the same page at the same time. That has led to a perpetual, push-pull balancing act for the cartel, and especially for Saudi Arabia.
“Nobody wants a price war scenario,” Finley noted, adding that “it could still happen.”
“Yes, it does matter,” he said, “and it bears watching to see how they handle this.”