As ministers from the 12 members of the Organization of the Petroleum Exporting Countries (OPEC) prepare to fly to Vienna for their 166th meeting next week, the quiet consultations and soundings have already begun.

OPEC must decide whether and how to respond to the 30 percent decline in oil prices since the middle of June, in what may be the organisation’s toughest test in five years.

Slower oil demand growth and rising competition from non-OPEC suppliers, especially U.S. shale producers, pose a common threat to all the organisation’s members.

But formulating a common response will be hard because the slowdown in demand and the shale revolution have had a very different impact from member to member.

Saudi Arabia, Kuwait and the United Arab Emirates are producing and exporting close to their highest-ever levels of crude, according to the BP Statistical Review of World Energy.

All three countries have built large financial reserves so they could weather a prolonged period of lower prices without too much effect on their day-to-day government operations.

In contrast, production and exports from Iran, Iraq, Libya, Venezuela and Nigeria have been variously hit by war, sanctions, unrest, expropriations and mismanagement.

None of those countries has significant foreign exchange reserves and the drop in oil revenues will quickly feed through into reduced government spending and/or inflation.

The light oils being produced in the United States are not much of a direct threat to the heavier crude grades exported by Saudi Arabia and other Gulf countries.

But they compete directly with the very light oils exported by North and West African producers, including Libya, Nigeria and Angola.

Formulating a common response is made complicated because ministers are negotiating on two separate issues: (1) OPEC’s share of the world oil market versus non-OPEC producers; and (2) how OPEC’s share is allocated among its members.

Allocating production is the age-old problem for any cartel — OPEC is a cartel, whatever its members may say, and however incomplete its market coverage.

OPEC has struggled with these issues, on and off, since the early 1980s, so it is familiar territory for the ministers.

But sharing out the market is much easier when oil demand is growing rapidly and non-cartel supplies are flat or falling — a situation that describes much of the last decade.

It is much harder when demand is stagnating and non-OPEC output is surging — putting the organisation back into the difficult position in which it found itself 30 years ago.

To Cut, and If So, How Much

Ministers must decide whether to cut production, and if so by how much, and how to share out the reductions.

The first option is to do nothing, allowing lower prices to force a rebalancing between demand and supply: the best cure for low prices is low prices.

Prices might remain stuck at current levels, perhaps even head another $10 or $20 lower in the short term.

But eventually demand will pick up as moves towards energy efficiency take a back seat in consuming countries and incomes rise in emerging markets.

And supply growth will fall as shale producers cut back and new capital spending around the world is postponed or cancelled.

The market would tighten again over a 12- to 24-month period and prices begin to rise.

Saudi Arabia, Kuwait and Abu Dhabi could ride out a period of lower prices with comparative ease. But for the organisation’s other members, it would be much tougher.

The second option is to cut production, sacrificing market share in the hope of obtaining higher prices and higher revenues overall, and perhaps also speed the adjustment process.

But there is no guarantee production cuts would produce a big enough rise in prices to offset the fall in volumes. If prices rose too much, shale producers would be unlikely to cut back, and the necessary rebalancing might not take place at all.

Allocating Production Cuts

If the organisation does decide to cut, the question becomes how to share the reductions.

The producers that are best placed to cut their output (Saudi Arabia, Kuwait and Abu Dhabi) are also the ones with the least incentive to do so.

The countries that most need higher prices (Iran, Iraq, Libya, Nigeria and Venezuela) are the least able to afford to reduce their output.

Iran blames Saudi Arabia for taking advantage of U.S. sanctions to increase its market share at the expense of Iranian exports, and expects Saudi Arabia and its allies to shoulder the bulk of any cuts.

In fact, Saudi Arabia’s share of global oil exports has remained broadly flat. It is U.S. shale production (up 3 million barrels per day in the last five years) which has filled the gap left by sanctions, war and unrest across the Middle East.

If there are to be production cuts, Saudi Arabia will almost certainly insist all the organisation’s members participate. There is no reason for the kingdom to accept a significantly greater share of the cuts than its historic market share (http://link.reuters.com/suw43w).

Cuts totalling around 500,000 barrels per day (bpd) would be too small to make a significant difference to prices or market balances in the short term.

To have any impact, the organisation would need to find cutbacks amounting to at least 1 million bpd.

Based on Saudi Arabia’s historic share of OPEC production, which has been around 30 percent since the late 1990s, the kingdom might contribute 300,000 bpd — which could perhaps be stretched to as much as 500,000 bpd.

Close allies such as Kuwait and Abu Dhabi might contribute another 150,000 to 250,000 bpd between them based on their financial strength. That would leave the other members needing to find relatively small and symbolic cuts totalling around 300,000 to 400,000 bpd.

Production cuts would demonstrate that the organisation is not powerless to respond to the challenge posed by the shale revolution. But by propping up prices, production cuts also prop up non-OPEC suppliers who contribute nothing to the cutbacks.

Free-riding has always been the organisation’s biggest problem. In the past, it was Britain, Norway, Mexico and Russia that benefited most. Now it would be U.S. shale players.

If prices do bounce and non-OPEC supply growth continues unabated, OPEC could be forced to cut again in 12-18 months, and face the prospect of a permanent loss of market share.

OPEC must determine the best joint path for its output, prices and the output of non-members. This is fiendishly difficult, given the large uncertainties around the demand outlook and the sensitivity of U.S. shale producers to falling prices.

So there are no good options for oil ministers in Vienna next week — only a choice between poor alternatives in the hope of finding the least-bad one.

And there is no guarantee that they can reach an agreement at all.

– See more at: http://www.rigzone.com/news/oil_gas/a/135940/Kemp_OPECs_Options_None_of_Them_Good/?all=HG2#sthash.YXSl0kty.dpuf

13 Comments on "OPEC’s Options (None of Them Good)"

Makati1 on Mon, 17th Nov 2014 7:04 pm 



They are not stupid. They know that US fraking is a blip in the oil radar, not permanent. All other ‘alternate’ sources (Arctic & deep sea) are very expensive and still years away from producing competitive amounts of oil, if ever.

Their decision, to my thinking, is whether to drop the price lower, long enough to bankrupt the high cost oil producers (fraking & tar sands) or to go back to $100+ oil. After all, China and the East are their future customers, not the West.

There are as many theories of why the price is low as there are writers about the subject(Many). It happened too fast to be from declining demand, so there is some outside (political) cause. Maybe we will never know…unless someone leaks.

keith on Mon, 17th Nov 2014 7:22 pm 



They will never bankrupt the tar sands. It’s been subsidized by the Canadian federal government since the 60’s.

keith on Mon, 17th Nov 2014 7:22 pm 



sad but true

Northwest Resident on Mon, 17th Nov 2014 7:45 pm 



Makati1 — “It happened too fast to be from declining demand…”

But all commodity prices are sinking in tandem with oil. It is hard for me to believe it is a manipulated event.

The rising dollar probably accounts for a portion of the declining worldwide commodities prices — or so I read on what I considered an informed site. But definitely not all of the price decline.

Like you, I’ve read a dozen or so speculative theories on why oil is sinking in price so fast, none of them seem convincing to me at all.

The most likely cause is just lack of demand — consumers and businesses are on the tail end of a $100 per barrel extended period of time and they’re busted.

Major corporations are borrowing money at low interest to buy back their own stock rather than invest in future projects — that’s a dead giveaway that they don’t BELIEVE there is a future worth implementing projects for.

Another viable reason for falling prices is lack of credit. With QE ended, maybe banks and lenders realize the free ride is over and they’re not willing to part with money that isn’t practically given to them free of charge to spread around however they see fit.

Makati1 on Mon, 17th Nov 2014 7:48 pm 



keith, the Canadian government is not in the best shape either. Canada’s national debt is already approaching 90% (IMF). How long can they support a losing enterprise?

If the US fraking also goes down, it will cut off the need for tar sands as the previous consumers will be looking for food and shelter, not gasoline. I hope you have not bet it all on the tar sands providing your future income.

MSN fanboy on Mon, 17th Nov 2014 7:59 pm 



Im sure they will just print the money, that’s been the plan sine 08 and its working.

Speculawyer on Mon, 17th Nov 2014 10:47 pm 



OPEC is a paper tiger. At most, they’ll declare a lower production quota for their members . . . and then most of the members will cheat rendering it all nothing but mere posturing.

Kenz300 on Tue, 18th Nov 2014 12:08 am 



“Prices might remain stuck at current levels, perhaps even head another $10 or $20 lower in the short term. But eventually demand will pick up as moves towards energy efficiency take a back seat in consuming countries and incomes rise in emerging markets. And supply growth will fall as shale producers cut back and new capital spending around the world is postponed or cancelled.

The market would tighten again over a 12- to 24-month period and prices begin to rise.”

———————

Enjoy the lower prices while they last.

Risky oil plays will be shut down. Some marginal companies will go bankrupt. Oil supply growth will slow and prices will begin to rise once again. Lower prices will be a boost to the world economy and that will add to growing demand..

In the short run prices will be lower. In the long run prices will be higher….. much higher.

Perk Earl on Tue, 18th Nov 2014 9:49 pm 



“In the short run prices will be lower. In the long run prices will be higher….. much higher.”

I think you’re off there, Kenz. The only way the world economy could afford 100+ oil was to inject huge amounts of stimulus, and in fact still are in Japan and the EU. Price fell for a variety of reasons, but will it go higher later. Sure, it can go back up some, but much higher? Not in my opinion. I think the new price ceiling is somewhere between 90-95, above which decreasing demand drops price back down.

Incidentally, oil price seems to have found a groove from which it’s now fluctuating within a small range. I don’t see a lot of movement from here in the near future up or down. Just going to hang there for a while and we’ll see how much this lower price spurs economic activity worldwide.

Northwest Resident on Wed, 19th Nov 2014 12:33 am 



Perk — What you’re saying makes sense and might very well come to pass. My guess though is that oil prices have found a “new normal” somewhere around $75 per barrel. I don’t think the global economy can handle more than that at this late stage of the game. We see all commodities falling in price. We see big drops in retail buying. We see Japan going full desperation mode as “unexpected” recession hits, and they are sure to drag the rest of Asia down with them. Riots in Italy. EU falling apart. Global debt so ponderous and unsustainable that you can practically hear BAU groaning under the weight. The grand illusion of American oil independence and BAU forever crashing and burning along with the unraveling shale Ponzi scheme. There isn’t any more fight left in the global economy, not enough energy or raw natural resources to mount another sustained period of economic growth, not even a little spurt. They can raise the price of oil a little, maybe, but I doubt by much and not for long. I obviously don’t know what’s going to happen, but it feels like we’re going to ride this $75-or-so per barrel plateau for a while, then take another rough ride down to the next lower price as demand destruction goes full retard and painfully visible deflation kicks in. That’s a really grim outlook, but I think a realistic one.

Perk Earl on Wed, 19th Nov 2014 2:22 am 



You may be right NWR, and we’ll just have to see what happens to oil price from here. My thought was price has dropped substantially (25-30%) in a relatively short period of time, and therefore could have some bounce back. Even ice in the arctic rebounded after 2012’s new record minimum, and of course will later probably go to a lower minimum.

If 75 bucks a barrel is the max. at this point then good gracious we are precariously close to calamity, because many of the exporters economies including Russia that have relied so heavily on these recent years of high oil price profits, are going to tank.

A year or so ago I was on Gail’s site and many posters were talking about when oil price goes too high and things get crazy and that was the thinking by many peak oilers, that high prices was where we were going and that was the danger. I countered that idea with the suggestion that dropping oil price was the nightmare scenario, because future oil supply would be threatened due to less drilling and non-conventional and we end up drawing down conventional, dropping from peak.

It’s late and my sentences are running on a bit, but you get the drift – we are now in that nightmare scenario. Unless a higher price can be established fairly quickly major damage is going to occur to future oil supply and the world economy.

The automatron followers of MSM newsbite propaganda think we’ve hit the motherload. The US has so much oil we’re really hitting OPEC hard now, and what a joy it is to pay so little in comparison to what it was before. When the reality is we’re in a new world now in which low oil price will kill the golden BAU goose.

Well, you know all this stuff. Anyway, we’ll have to compare notes later as to what happens to oil price. It’s getting surreal though – this situation the world is grinding towards is going to blow it’s stack at some point.

Davy on Wed, 19th Nov 2014 5:25 am 



I equate the economy and oil in a direct way. A car finds value from gas and gas finds utility from a car. The car is the economy for analogy purposes. My point is there is no way to decouple the two.

We are due for a correction that follows a normal business cycle. Currently with financial repression and artificial liquidity it is debatable what a new business cycle will resemble. We are no longer in a historical reference zone because of the amount of repression and the length of application. This is also a globalized world like never before. It is in effect a surreal world or a hybrid world with the old and new. A dangerous world because we are in uncharted waters. Dangerous also because liquid fuels are suffering compression both with quantity and quality of energy delivery to economy.

We know oil prices will modulate between a range. It appears the economy and the oil sector are in a range compression. There is a range these two codependent variables must maintain to operate efficiently. That range is no longer healthy. Unhealthy points to lower growth. Lower growth points to lower economic activity.

Oil supply and demand is growth driven. Oil supply and price is depletion influenced. We know depletion is in effect. Oil price must go up to account for depletion. It appears the economy has oil price limits and we were likely near these limits recently. When a resource is near limits the price can vary widely.

Oil prices can damage the global interconnected economy. Oil prices must be maintained in the higher range to support supply growth. The economy has shown a limit to oil prices. The economy has also demonstrated it cannot grow when oil supply is not growing. Healthy economic dynamics says oil prices cannot go much higher than recent prices. These dynamics also say supply cannot go much lower than current supply. We are in a compressed range currently that short term could have dangerous price and supply swings. Dangerous swings can damage the oil sector and or the economy.

My conclusion is short term price volatility but longer term lower relative prices with lower economic activity do to an economic demand supply compression environment. The economy and oil sector are not healthy nor point to future health so prices will likely never reach a longer term extended high.

Yet, we know whatever price oil settles to its relative price will remain high due to its intrinsic worth. IOW even if the economy suffers a deflated crash or hyper-inflated collapse oil will remain a value within a range of economic conditions. The above is a doomer view. A corn view says long term growth can maintain price supply relationship. I know of no way to reconcile these two views.

Mike999 on Wed, 19th Nov 2014 10:13 am 



There is no new development of Canadian Tar Sands already, before this move. Now, no new tar sand fields will be developed as they’re uneconomic.

The lower the price of oil on the world market the lower the profit, and marketshare of Canadian tar sands.