OPEC boxes itself into a corner: Fuel for Thought

Heavyweight oil producer group OPEC stepped into the ring with young upstart US shale back in November 2014 and delivered its best shot. Led by prizefighter Saudi Arabia, it decided not to cut output in hopes of arresting the slide in prices, but, in an attempt to floor the relatively high-cost producer, declared it would defend its ground.

Fast forward 13 months and unconventional crude supply is down but not out. And OPEC, whose membership has been split down the middle by a policy aimed at clawing back market share from what has proved to be a resilient opponent, must be wondering whether it has all been worth it — especially after having read the International Energy Agency’s latest medium-term forecasts.

The IEA expects US light tight oil output to start recovering in 2018 after a 600,000 b/d decline in 2016 and a further 200,000 b/d drop next year. It sees US light tight oil reaching 5 million b/d by 2021, up from 4.23 million b/d in 2015 as oil prices recover and technology continues to improve.

Indeed, OPEC is now in a predicament of its own making. It and Saudi Arabia have regularly stipulated over the past 13 months that OPEC will not cut output unilaterally but is willing to work with independent producers towards a stable market. But no one has shown willing to cut production and the talk now is of an output freeze, as proposed by non-OPEC Russia, Saudi Arabia and two other OPEC members, Venezuela and Qatar.

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OPEC Secretary General Abdalla el-Badri suggested in Houston last week that the proposed freeze could be a first step in the effort to deal with a global supply glut.

But Saudi Arabian oil minister Ali Naimi pretty much dismissed any potential for future output cuts, telling the same conference audience that a coordinated production cut would be essentially pointless.

“There is no sense in wasting our time seeking production cuts,” Naimi said, adding that OPEC and non-OPEC producers would likely “not deliver” if asked to cut production.

Naimi was confident that major producers would join a pact to freeze production at January levels.

US shale producers having their “Rocky” moment

But, understandably, there is some disgruntlement within OPEC’s ranks about the mechanics of a freeze, which would see producers hold output at the January level. This would mean Saudi Arabia continuing to pump in excess of 10 million b/d and Russia at the all-time high of 10.88 million b/d.

Not surprisingly, Iran is unwilling to play ball, with oil minister Bijan Zanganeh last week saying it was “a joke” that countries pumping more than10 million b/d should expect Iran to freeze its production at the low level imposed by the sanctions.

But OPEC’s challenges don’t just lie in breaking the impasse and getting its own members and non-OPEC producers on board. They lie with the fact that any agreement — whether a freeze or an output cut — may not have the desired longer-term outcome, because restraining supply could allow shale producers to ramp up production and offset any supply cap.

This risk was highlighted by the IEA: “While oil prices should start to rise gradually once the market begins rebalancing, the availability of resources that can be easily and quickly tapped will limit the scope of rallies – at least in the near term.”

Oil companies have become far more efficient in fracking unconventional wells over the last decade and should continue to raise productivity, but probably need prices quite a bit higher than $30 a barrel to boost activity, shale experts have said.

The IEA sees the supply glut continuing into 2017, heaping more pain onto crude producers on both sides of this battle.

There is unlikely to be any clear winner from ongoing low prices, which have been bobbing along close to 12-year lows.

But did OPEC have a real alternative to its market share policy? Possibly not. And with no sign of a coordinated pact among producers to reduce production, leaving the business of supply management to market may still be the only realistic option — even if that means continuing and deepening pain for the oil producing community as a whole.

Also, does OPEC have the resolve? For OPEC, read Saudi Arabia, and, to judge from Naimi’s remarks in Houston last week, there is no sign that the kingdom is for turning. Indeed, Naimi said Riyadh could survive $20/barrel oil. In December 2014, he said OPEC would not cut, even if prices went to $20/b. As the great US baseball player Yogi Berra once said, it’s déjà vu all over again. — Paul Hickin in London