OPEC’s ‘need’ to maintain $100/B-plus sowed the seeds of recent oil price falls. What happens next?
Oil prices have been falling. From 2011 to June 2014 the OPEC basket consistently averaged around $107/B. However, from a price of $108/B in June, the price has fallen steadily to $79/B so far in November, a fall of 27% in five months (see p28). This fall should not have surprised. Its cause is explained by “OPEC’s Dilemma” (Paul Stevens & Matthew Hulbert, Oil Prices: Energy Investment, Political Stability in the Exporting Countries and OPEC’s Dilemma. Chatham House Briefing Paper, October 2012). Since the Arab uprisings of 2011, Arab producers have needed higher revenues to assuage their populations with jobs and subsidies. This requires higher oil prices that have been achieved but these lead to demand destruction and increased non-OPEC supply. Such a weak market is unsustainable. Prices must fall and they have.
The current question is what happens next? There is much speculation over the 27 November OPEC meeting as to whether OPEC will formally cut production in an attempt to reverse falling prices. This depends largely upon the extent to which the fall has been deliberately engineered by Saudi Arabia and for what reasons. It is here that conspiracy theorists are having a field day. There are two main schools. Both agree that Saudi Arabia would welcome lower prices that will damage Iraq and Iran. Although lower prices also hurt Saudi revenue, the country has a considerable financial cushion. Neither Iraq nor Iran has any financial cushion. The schools then diverge. One school argues the US has encouraged the Saudis, given lower prices hurt Russia in the context of Ukraine. The other school argues lower prices damage the US – and thus a significant competing source of oil – since they inhibit the shale revolution that (allegedly) depends on high prices to keep it going. This school points to the fact that Saudi Arabia’s ruling House of Saud has been distinctly cool in relations with Washington, since the fall of former Egyptian president Husni Mubarak in early 2011; events in Syria and the prospects of an Iranian nuclear deal have compounded the strain.
The truth of the situation is hard to fathom. Since prices began to fall this summer, the Saudi response has been to cut sales to the market – 300,000 b/d in August; 300,000 b/d in September; plus (to the annoyance of Kuwait) the unilateral closure of the Neutral Zone Khafji field on “environmental grounds” losing another 320,000 b/d. However, at the same time, they have been cutting prices leading to speculation about a “price war”. All this uncertainty is not helped because mixed messages, many of them “anonymous”, are emerging from the Saudi oil sector that normally speaks with a clear unambiguous voice. This is reinforced by the suggestion that the oil sector, as with other sectors, is trying to position itself for a change of leadership when the Al Saud are forced to jump a generation in the succession.
However, motives may lie in the bitter experience of Saudi Arabia when the markets were similar in 1980-86 following the oil shocks of the 1970s with demand destruction rife and non-OPEC booming. Then, as now, they cut production to defend prices. However, this resulted in dramatic loss of market share. Production of 10.27mn b/d in 1980 fell to 2.5mn b/d by mid-1985. This time however, it is likely they are also seeking to defend market share. Something they failed to do in the early 1980s. If such “lesson learning” is indeed part of the story, OPEC may agree a formal cut as Saudi Arabia insists on the sharing of pain.
A further uncertainty should be flagged. November 24 is the deadline for negotiations on Iran’s nuclear program. If a deal is struck (or at least talks muddle on) this implies greater oil supply adding to price weakness. However, if they fail, this would likely revive a geo-political premium on prices with Tehran making mischief, notably in Iraq, that could affect Iraqi exports giving further strength to prices.