December 2, 2014 / 1:21 AM / 5 years ago

OPEC Hibernates

NEW YORK (Reuters) - - Yesterday’s move by OPEC to leave its production limits unchanged at 30 million barrels per day reflected a failure by the cartel to act collectively to reduce oil production and boost prices. Oil prices will likely continue to drop on fears of oversupply. But while OPEC may go into hibernation, reports of its death are exaggerated.

A general view of the OPEC building and logo in Vienna , November 7, 2013. REUTERS/Leonhard Foeger

These are tough times for OPEC. Oil demand in the rich nations of the OECD is contracting, and the growth rate of oil demand in Asia’s growing market is slowing. At the same time, non-OPEC oil production is surging, led by the United States. As a result, the oil price has fallen more than 25 percent since June. And global demand for OPEC crude is expected to fall more than 1 million barrels per day next year.

Against this background, it is not surprising that OPEC countries share the same interest: retain market share and maximize revenue.

Twenty years ago, OPEC might have cut back supply to increase prices and keep revenues steady. OPEC could do that when it accounted for about 50 percent of global production for more than two decades. Today, OPEC accounts for one-third of the market and most oil supply growth is coming from North America. OPEC cohesion has been waning for some time, but is especially challenged in today’s environment.

Saudi Arabia is the world’s largest crude exporter and the only one that produces much less than it can, holding in reserve the ability to boost production to meet demand in times of shortage. Given its willingness to hold this “spare capacity,” many looked to the Saudis to cut production to support prices.

But the Saudis refused to cut production unless other major producers, both OPEC and non-OPEC, did so as well. Why should the Saudis bear all the pain of cutting production?

The prospects for such collective action were doomed from the start. Iran and Venezuela are facing a severe budgetary squeeze from falling prices, challenging their ability to meet social commitments that maintain political stability. Production in Libya is already sharply reduced due to domestic conflict. Iraq is looking at the growing Asian market and, like other OPEC members, working aggressively to capture market share in the region. Outside OPEC, Russia is extremely vulnerable to falling oil prices, particularly while facing economic pressure from western sanctions, so it is not willing to cut output.

Moreover, any move by OPEC to raise oil prices would make the economics of U.S. oil production look even more attractive, boosting U.S. output growth and further reducing OPEC’s market share.

It’s no wonder then that OPEC failed to reach agreement.

Some have speculated that Saudi Arabia desires a price collapse to undermine U.S. shale production, but while the growth rate of U.S. production may slow in the face of higher prices, most U.S. oil production will work at prices far below today’s level. Others argue that the United States and Saudi Arabia have teamed up to punish Russia and Iran, but the U.S. government does not control American producers and the Saudis are not much interested in coordinating with the fastest-growing producer in the market it has long dominated.

It is still possible that a further slide in oil prices could spur more of a sense of urgency and lead the Saudis to cut production, with or without participation from other countries. But it is more likely that, with OPEC in hibernation, forces of supply and demand will work to stabilize global oil markets.

Do not expect that OPEC’s hibernation is the start of a death knell, however. While there remains great uncertainty about how much more U.S. oil production will continue to grow, looking out past 2020 it is likely that the Middle East is going to need to raise production sharply to meet growing oil demand. The International Energy Agency has been highlighting the importance of Middle East supply in each of its last two annual outlooks, warning that without adequate investment today, oil markets could be very tight in the medium to longer term.

Moreover, recent geopolitical risk — from strife in Libya to sanctions against Iran — remind us how quickly the market can turn around. And presently only Saudi Arabia has the ability to quickly bring additional supplies online to offset a supply disruption, as it did after the Libya crisis, and keep prices from spiking.

For now, OPEC may go into hibernation because OPEC does not dominate the marginal barrel of oil on today’s market. But the nations of OPEC were blessed with vast riches. Be glad for American entrepreneurship that has transformed supply prospects in North America. Do not dismiss OPEC’s role in future supply and economic growth.

(Jason Bordoff and Carlos Pascual are, respectively, Founding Director and Fellow at Columbia University’s Center on Global Energy Policy. Mr. Bordoff previously served as a White House energy advisor to President Obama from 2009 to 2013. Mr. Pascual established and directed the State Department’s Energy Resources Bureau as Special Envoy and Coordinator for International Energy Affairs from 2011 to 2014)

Editing by Jessica Resnick-Ault and Jonathan Oatis

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