LONDON (Reuters) - By refusing to agree to deeper oil output cuts, Russia has done Saudi Arabia and OPEC a favour.
No matter how frustrating the refusal is in the short term, it is in the kingdom’s and the organisation’s long-term best interests.
Saudi Arabia’s strategy of cutting production to protect oil prices hasn’t worked, leaving the kingdom with both reduced market share and lower prices, the worst of both worlds.
In the past decade, the kingdom has orchestrated repeated output cuts by members of the Organization of the Petroleum Exporting Countries (OPEC) and more recently by an expanded group including Russia (OPEC+).
Over the same period, oil prices have drifted lower while Saudi Arabia and Russia have steadily conceded market share to non-OPEC producers, especially in the United States.
Perhaps the best way to illustrate the loss of market share is to compare the output of the world’s three largest producers over the last eight years.
By the fourth quarter of 2011, production had returned to a more normal level after the severe recession of 2008/09, so it can serve as a useful baseline for long-term comparisons.
Between October and December 2011, Saudi Arabia’s crude production averaged 9.7 million barrels per day (bpd), while Russia’s output was 10.4 million bpd and the United States produced 6.0 million bpd.
Eight years later, in the fourth quarter of 2019, Saudi output had increased less than 0.2 million bpd (2%), Russia’s output was up just over 0.2 million bpd (2%) but U.S. output had surged by 6.8 million bpd (114%).
The United States has overtaken both Russia and Saudi Arabia as the world’s largest crude oil producer (and the gap is even wider if production of condensates and natural gas liquids is taken into account).
PRICES vs VOLUMES
In the short term, Saudi Arabia, as the oil market’s swing producer, can exercise a degree of market power and choose between defending prices and protecting market share.
In the medium and long run, however, the development of alternative supplies outside the control of OPEC+ ensures the kingdom is a taker of market-determined prices, like everyone else.
“No one can set the price of oil – it’s up to Allah”, Saudi oil minister Ali al-Naimi admitted in a television interview in 2015. But that has not stopped Saudi Arabia and OPEC from repeatedly trying – and failing.
Production restraint by Saudi Arabia and its allies in OPEC and OPEC+ has instead thrown a repeated lifeline to U.S. shale producers, enabling them to survive through downturns and then return to growth afterwards.
For most of the last decade, the kingdom has prioritised short-term price defence, with predictable long-term consequences in terms of stagnating output, while U.S. shale surged.
The major exception was the period between the middle of 2014 and the end of 2016, when the kingdom switched to protecting market share and allowed prices to collapse.
The resulting price slump in 2014/15 is usually seen as a sign the volume-focused strategy failed, and it cost Naimi his job in 2016 (“Yamani legacy haunts the oil market”, Reuters, Dec. 9, 2019).
But it is more useful to see the slump of 2014/15 as an inevitable reaction to the previous period of high prices, which left the oil market facing a significant oversupply by mid-2014.
The ensuing slump was responsible for the only sustained downturn in U.S. shale production over the last decade, the only time Saudi Arabia stemmed the decline in its market share relative to the United States.
If prices had not been allowed to tumble, Saudi Arabia would have been forced to slash its output, and the market would still probably have moved into an enormous oversupply in 2015/16.
To understand why Saudi Arabia’s strategy has not worked, it is useful to compare growth in U.S. oil production with growth in global consumption since 2011.
U.S. oil producers captured all the increment in global consumption in 2014, 2018 and 2019, almost all incremental consumption in 2012, and nearly two-thirds of incremental consumption in 2013.
The only years when U.S. producers captured less than half of incremental consumption were in 2015, 2016 and 2017 – when U.S. oil production grew more slowly, or fell, in the wake of the price collapse.
U.S. shale producers have been the main beneficiaries of Saudi Arabia’s strategy of price restraint while the kingdom’s own market share has fallen and oil prices have drifted lower.
If the market is to rebalance following the coronavirus epidemic, which will have a severe impact on demand in the short term, it will require a period of slower production growth and faster consumption increases.
Lower prices remain the most effective way of enforcing the required changes by forcing deeper cuts in projected U.S. shale output while stimulating a modest increase in consumption around the world.
Reducing OPEC+ production to prevent an accumulation of oil inventories and a fall in prices would blunt the necessary price signal, ensuring the adjustment takes longer.
Deeper OPEC+ output cuts would help protect U.S. shale producers while reducing the stimulus for faster oil consumption growth. It is not clear how either would help Saudi Arabia, Russia or the rest of OPEC.
Russia’s refusal to agree to deeper production cuts is a decision to allow prices, rather than OPEC+, to rebalance the market. In the longer run, it is the right decision, for Saudi Arabia and OPEC as well as Russia.
John Kemp is a Reuters market analyst. The views expressed are his own.
Editing by Kirsten Donovan
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