OPEC's lost decade

Ten years ago the global financial crisis exploded on Wall Street. The most violent and sustained economic eruption in living memory left no industry unharmed, energy included. Oil producers are still grappling with the debris thrown up by its shockwaves.

The damage was made worse because few oil policy makers saw it coming. In the summer of 2008, crude was trading at an eye-watering record $147/b. By the first week of September, OPEC was compelled to cut its production to defend prices even though a barrel was still trading above $100. A few days later, Lehman Brothers collapsed and the rest, as they say, is ancient history.

“Oil prices, by the middle of the year, soared to heights that were not only unimagined but, as well, unsustainable,” OPEC’s then secretary general Abdalla Salem El-Bari bemoaned in his official review of 2008. “Prices were to later come under unprecedented downward pressure as the financial crisis continued to sweep the world causing a contraction in global oil demand for the first time since 1983.”

By the end of that year, the cartel El-Badri headed had been forced into cutting a further 2.2 million b/d from its supplies, the biggest single output reduction in its 50-year history. Faced with a collapse in the value of oil as demand for their crude slumped, the group’s heavyweight Middle East producers had few other options if they wanted to keep their petrodollar-supported autocracies afloat.

Even then their response almost backfired. Two years later, political fires smoldering across the Middle East were partly kindled by the global economic downturn into a full blown inferno. These uprisings, which started as bread riots, became known as the Arab Spring. Attempts to manage oil markets in the wake of the crisis by striking a deal with Moscow also miscarried when the Kremlin backtracked on its promise to cut production.

These actions left OPEC – the controller of a third of the world’s oil supplies – open to blame for mismanaging the supply of the world’s most important resource. Some critics would even argue it had even played a role in starting the economic crisis in the first place for failing to act fast enough to reduce record-high oil prices.

Just a few months prior to Lehman’s juddering collapse, the group’s kingpin Saudi Arabia was being fiercely pressured by then US president George Bush and UK prime minister Gordon Brown to pump more oil as Americans were having to pay $4 per gallon for their gasoline. The Saudis trotted out their usual excuse and blamed greedy traders for causing an oil market bubble. Nevertheless, keen to avoid blame by their key Western allies they made a token gesture of adding an additional 220,000 barrels to daily supply. It was too little, too late.

Former Saudi oil minister Ali Naimi writes in his memoirs of the time: “We in Saudi Arabia realized that we would have to be the ones to break the oil market’s speculative fever”. Prices would eventually recover as a near $600 billion stimulus plan rolled out by the State Council of the People’s Republic of China triggered a commodities super cycle, which would see the world’s most populous country suck up ever increasing volumes of natural resources.

If the financial crisis came as a surprise to oil producers, its decade-long aftermath has showed them to be equally unprepared for the unexpected. The Federal Reserve’s actions to slash borrowing rates and flood the world’s largest economy and biggest consumer of oil with cheap money nurtured OPEC’s worst enemy. Extracting oil and gas from formations of tightly packed rocks in a process known as fracking had been around for years before record low interest rates made it possible for America’s so called “mom and pop” drillers to challenge the status quo of world energy.

In 2008, the US was producing a few drops under 5 million b/d of oil, with its domestic petroleum industry suffering years of decline and underinvestment. Next year, however, daily output is expected to near 12 million barrels after a decade of fracking, which has helped to turn America into an exporter of energy. Meanwhile, OPEC’s current daily production of around 32.9 million barrels is roughly where it was in the third quarter of 2008 before Lehman shut its doors.

None of this would have been possible without the flood of cheap debt pumped into the system following the financial crisis. According to research conducted by Amir Azar, a fellow at the Center on Global Energy Policy, net debt held by investment grade exploration and production companies in North America ballooned by 730% between 2005 and 2015.

“The real catalyst of the shale revolution was thus the 2008 financial crisis and the era of unprecedentedly low interest rates it ushered in, driven by the US Federal Reserve Bank’s monetary policy. American entrepreneurship, coupled with low-cost debt, created the conditions for a surge in production that ranks among the biggest oil booms in history,” wrote Azar.

This bond-fueled drilling bonanza eventually led to another downturn in oil prices, which started almost four years ago as global supply growth outstripped demand. OPEC is still dealing with it today. The group was forced into an unprecedented alliance with Russia and its allies to reduce supply by 1.8 million b/d to rebalance the market. Their pact is likely to be enshrined in a new charter when they meet for their final summit of the year in December.

Meanwhile, the industry as a whole has shrunk. In 2014, spending peaked at $900 billion. This year, the figure is expected to be closer to $500 billion.

A decade later and OPEC is still dealing with the aftershocks of the financial crisis.