OPEC will keep its production ceiling unchanged at 30 million barrels a day. This decision was reached on June the 5th, at the latest meeting in Vienna, after two days of meetings and proceedings during the 6th International Seminar. Oil was in Vienna to gather, first hand, impressions, reflections and comments about the role of OPEC and the effects of its decisions within the global energy community. Providing us with an insight into the latest decision of OPEC is Deborah Gordon, Director of Energy and Climate Program, Carnegie Endowment for International Peace.
The global oil market is in disequilibrium. OPEC’s continuous production stream - together with new alternative oils flowing from the United States, Canada, and else where - are flooding the market. Asia’s economic downturn and a sluggish global economy are constraining consumption and pushing supply and demand further out of balance. OPEC hopes that demand will soon recover and prices will rise. But no one knows where prices will ultimately settle - or if they will settle at all. With this backdrop, OPEC decided at its 167th meeting to stay the course, maintaining its 30 million barrel per day ceiling and urging member countries to adhere to it. OPEC is sending the market a signal that, even through the lean years, its members plan to remain open for business. The terms, however, are highly uncertain. OPEC - along with everyone else - has been baffled by the multitrillion-dollar reversal of fortune in the global oil market over the past year. Oil’s dynamic economic, political, technological, and societal circumstances often change without warning. The lack of transparency, barriers to entry and exit, incentives to profit from others’ losses, and mounting externalities can create blind spots.
It’s amid such opacity that OPEC has reaffirmed its position to maintain oil production. That OPEC took this tack is not entirely surprising. That the organization remained entirely intact is. Formed in 1960 with five founding members-Iran, Iraq, Kuwait, Saudi Arabia and Venezuela - and expanded to include Qatar, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador, and Angola, OPEC is often referred to as an oil cartel. However, this label may no longer apply. According to Brown University political scientist Jeff Colgan, "its members continue to have quite different interests and are unlikely to cooperate in any meaningful way." And experts dating back to the early 1980s have claimed that OPEC is an oligopoly with Saudi Arabia as the price leader and largest producer. While the relationship among its members is mystifying, OPEC has straightforward enough objectives. Its goals are to coordinate petroleum policies among member countries in order to stabilize prices for petroleum producers and efficiently manage the supply of petroleum to consuming nations while ensuring a fair return on capital.
How realistic are OPEC’s objectives amid today’s unprecedented market uncertainty?
- Coordinate policies among its members? Yes, at least for the moment.
- Stabilize prices for producers? Impossible. OPEC couldn’t prevent soaring prices last year or falling prices this year.
- Efficiently manage oil supplies? Dubious. OPEC isn’t acting rationally to reduce oil production in line with anemic demand.
- Ensure a fair return on capital? Unattainable. OPEC argues that current returns are inadequate. But tomorrow’s oils will likely cost more than $60 per barrel.
If OPEC can only achieve one of its stated objectives, namely coordination (an achievement in itself), does that call into question its very existence?
PAST AS PRELUDE?
It is not entirely clear what lessons OPEC can glean from more than five decades of experience in oil markets. But it’s worth briefly recounting them to see if history can serve as a guide. Perhaps OPEC’s greatest fear is an era of oil price volatility, pitting members against one another, creating rifts with non-OPEC producers, potentially destabilizing nations that depend on oil revenues, and confounding consumers. The ability to achieve price parity, however, may be more difficult than in the past. During the postwar period, through the 1950s and 1960s, oil prices hovered around $3 per barrel ($20 in real, inflation-adjusted terms). In recent history, there has never been a more stable period in oil markets. The 1970s marked unprecedented oil market upheavals. U.S. recessions dampened oil demand and oil-rich Texas removed its production limits, shifting the power to control prices to OPEC. Geopolitics roiled oil markets due to an Arab oil embargo, the Iranian Revolution, and the Iraq-Iran war. The 1980s saw plummeting oil prices. OPEC attempted to set production quotas to stabilize prices. When members exceeded quotas, Saudi Arabia assumed the role of swing producer, cutting its production. Tiring of economic self-sacrifice, the Saudis more than doubled production in 1986. Prices tumbled and remained weak through the decade. The 1990s brought more geopolitical strife. Oil prices spiked during the first Gulf War, but steadily declined to a recent all-time low by 1998. Japan’s stagnation, high oil inventories, and expansionary oil production policies precipitated this fall. OPEC’s rigid approach to weak prices was not considered very effective. By the 2000s, with the global economy humming and China booming, oil demand surged, driving up prices. By 2008, the oil market had hit an all-time high. And it’s this set of circumstances that caused an oil paradigm shift chocked full of market uncertainty.
TURNING THE PAGE
In the summer of 2014, the oil market was soaring in the triple digits. A year later, oil is selling for nearly half that price. OPEC’s concerns over oil price uncertainty aside, there may be transformational changes coming to oil markets. As cheap, conventional resources dwindle, oils that fueled the twentieth century are giving way to an array of alternative oils. This is extending the age of oil. According to oil analyst Blake Clayton, author of Market Madness: A Century of Oil Panics, Crises, and Crashes, there is an assumption that "if [oil] has not been found yet, or cannot be extracted with today’s technology or at today’s prices" that it won’t ever exist. Yet we haven’t run out of oil and history has repeatedly refuted this claim. The twist in the story is that much of tomorrow’s oil won’t be as cheap as yesterday’s. Prices will rise to cover higher operational costs, mounting environmental externalities, increasing risks, and demanding economic rents. And the higher future oil prices rise, the more there is at stake for tomorrow’s marginal oil producer.
Saudi Arabia is OPEC’s de facto leader and largest producer, supplying approximately one-third of its oil. Whether its dominance will last, and whether the organization can be held together are burning questions. In the meantime, the Saudis and their stanch position appear to be the glue holding OPEC together. There are numerous explanations for the Saudi’s steadfast decision for OPEC to maintain production. The most honest is that OPEC doesn’t have the ability to engage in a price war. But there are other possible reasons. First, pumping oil while prices are low helps Europe, China, and others’ economies to recover, slowly rebooting demand. This could cement relationships with those buyers the Saudis need in the future. Second, maintaining production delivers an economic blow to Russia, Saudi Arabia’s real oil competitor. The Saudis may also be attempting to slow America’s fracking boom and Canada’s oil sands development, which are more price sensitive than their (and most OPEC nations’) production. By holding production relatively constant, the Saudis gain pertinent information on the marginal costs of North America’s unconventional oils. And last but not least, in pressing their position, the Saudis may be reminding OPEC members who’s really in charge when it comes to future realignments in oil markets. Backing down is not an option; they aren’t going to cut production. According to Saudi Arabia’s Oil Minister Ali al-Naimi in December, "[That’s a] position we will hold forever, not [just] 2015."
Despite support for the Saudis’ position from the Qataris, Kuwaitis and Emiratis, there may yet be a conflict brewing within OPEC. Iraq’s surging production and the possibility of Iran returning to its post-sanctions oil output with a successful nuclear deal could threaten Saudi Arabia’s influence and authority. Nigeria is grumbling. In February, Nigeria’s Oil Minister, Diezani Alison Madueke, complained, "almost all OPEC countries, except perhaps a few in the Arab bloc, are very uncomfortable." Venezuela is scheming. In April, Eulogio del Pino, the head of the state oil company PDVSA, proposed blending their extra-heavy oil with light Algerian and Angolan oil to compete against swelling North American supplies. Ecuador, OPEC’s smallest member, is bargaining. Its president, Rafael Correa is slashing budgets, reforming taxes, and borrowing from China. What leverage do the Nigerians, Venezuelans, and Ecuadorans really have to sway OPEC policy? They can attempt to protest or get creative. Or they can exit-which they are reluctant to do. It may be less that the Saudis have succeeded in retaining membership in trying times than there is nowhere for discontent members to go. Can the Saudis hold OPEC together? There are more questions than answers surrounding OPEC, its position, and tomorrow’s oil supplies. How will the oil sector reshape itself this time around? In reconfirming its decision to maintain oil output amid slow economic growth and increasing global oil supplies, can OPEC manage this sector’s growing risks? Will greater competition come from within OPEC or without?
There’s no debating that oil is risky business-economically for investors, operationally for industry, geopolitically for nations, socially for communities, and environmentally for the earth. But is it getting riskier? Two major concerns from different spheres, both private (speculation) and public (climate change), are barreling down on OPEC and oil markets. Together these unpriced externalities impose significant premiums on oil markets that are estimated to cost as much as a barrel of oil itself, or possibly more. On a private front, speculation may be driving oil markets more than supply and demand. According to OPEC Secretary General Abdalla Salem El-Badri, in an April bulletin commentary, actual market fundamentals may not be solely responsible for plummeting oil prices. Instead, he stressed that speculators-"phantoms of energy markets"-have played a meaningful role in the fall. Dealing in "paper barrels," where the player never takes physical possession of actual barrels has futures markets trading an order of magnitude more virtual barrels than the market can supply. Moreover, speculators routinely arbitrage oil, purchasing low priced crude and holding it in storage, until they can recoup handsome profits. Oil volatility is becoming a new asset class for investors. OPEC’s Monthly Oil Market Report observed last September while prices were falling that "hedge funds and other money managers chose to reduce their net long positions in Brent and WTI futures trading by a hefty 73 percent and 45 percent, respectively, exerting even more downward pressure on prices." Oil volatility is thought to have jumped to its highest level since the financial crisis. OPEC is concerned that speculation will ultimately destabilize markets.
From a societal perspective, the externalities associated with oil are large and increasing. It is unclear how seriously OPEC and its western competitors take their social license to operate. The upcoming climate talks in Paris could offer a meaningful reminder. And the reminder may be necessary. Apparently, when an audience of over 300 delegates gathered this June at OPEC’s International Energy Seminar was asked in a show of hands whether they believed a binding agreement to limit global warming would result, no one raised their hand. Saudi Arabia could assume a leadership role, however. Their oil minister reportedly continues to warn about the "dangers of the industry failing to act to help to limit global warming." So too could the EU oil industry-Royal Dutch Shell, Total, Eni, BG Group, BP, and Statoil. Ahead of OPEC’s seminar, they collectively called for a "binding global system to govern carbon pricing." And Shell’s CEO, Ben van Beurden, proclaimed that the global energy system needs to undergo "a transition from the traditional model based on oil and coal to a progressively cleaner, less carbon-intensive model." Inspiring words from OPEC and non-OPEC producers. But are they actionable? High oil prices spurred new oil supplies. Low oil prices will likely spur growing oil demands. Both run the risk of increasing the oil sector’s climate footprint.
As conventional oil dwindles, producers and refiners will have to learn how to handle a new array of alternative oils. These resources are very different from the conventional oils OPEC produces, and from each other. For example, Alberta’s oil sands and North Dakota’s light tight oil have little in common except that they can be turned into marketable petroleum products-and even there they differ. In a recent report, Know Your Oil, the Carnegie Endowment for International Peace, Stanford University, and the University of Calgary estimate that there is an 80 percent difference in total life-cycle greenhouse gas emissions between the highest and lowest-emitting oil in a sample of 30 global oils. That difference in only 5 percent of the world’s current production is surprisingly large-and large enough to matter. What’s more, prospective unconventional oils modeled using Carnegie’s Oil-Climate Index are expected to expand that emissions range further. The large and variable climate footprint of oil speaks to the issue of stranded assets that suffer from unanticipated or premature write-downs, devaluations, or conversion to liabilities. Significant oil assets will almost certainly be stranded. There are estimated to be at least ten times more fossil fuel reserves slated for future exploitation than is compatible with the 2 degree Centigrade climate target-the safety limit agreed to by the world’s nations.
THE EVOLUTION OF OPEC
OPEC is being challenged on many fronts. Its future is not guaranteed. In order to survive, the organization may need to innovate, regroup, restructure, and renew its mission. Important questions remain. Will OPEC nations like Saudi Arabia diversify their economies away from oil? Can OPEC provide a larger tent and would that improve market function? Can OPEC burnish its image through greater integration and transparency in the global system? Can oil revenues bring national and regional stability? How will the world’s major oil consumers-China, India, and others-figure into the equation? Full disclosure from here on out-or as close to that as is possible for OPEC-will likely be necessary for the organization’s very survival. Petroleum exporters-OPEC and all others-will need to compete more openly in the global marketplace. According to Oxford Institute for Energy Studies founder, Robert Mabro, in The Oil Price Crisis of 1998, it’s a "fallacy to believe that withholding information on production, investments or stocks improves the producer’s [market] position. Transparency pays much higher dividends." It will benefit OPEC to be creative and candid about its plans to evolve. Motivations for OPEC to evolve could advance on many different fronts: economic rivalry from other oil producers, threats from unconventional oil resources, geopolitical tensions and regional strife, technological breakthroughs on oil alternatives, societal concerns stemming from climate change, or unforeseen risks. Come December 4th, OPEC will meet again about production levels. The odds are high for keeping the status quo if you take the Saudis at their word. The odds are small otherwise for adopting a radical shift. Either way, OPEC has some serious thinking to do. And it’s best for all involved if OPEC thinks out loud.