Opec's final throw?

Cartel's deal shows it has lost control over the crude oil market

On Monday, prices for Brent crude oil passed $55 a barrel to trade at a new 16-month high on growing expectations that the oil market will tighten. Last week, in a landmark and long-expected deal, the members of the Organisation of Petroleum Exporting Countries, or Opec, agreed to control crude oil production. Opec members agreed to cut oil production from their present level of 33.8 million barrels per day to 32.5 million barrels per day, a decrease of 1.3 million barrels a day. This was accompanied by action expected from some major non-Opec producers, including Russia, which may reach a further 600,000 barrels per day of cuts. The news that Opec has finally got its act together for an agreement energised the markets; the gains on Monday for crude oil mean that Brent prices are 19 per cent higher than they were last Wednesday, when Opec reached its agreement. Yet, all is not well for Opec; a return to the crude oil prices that were de rigueur before 2014 is unlikely, for multiple reasons. 

For one, this cut is itself not as great as it appears. Saudi Arabia, the prime mover behind Opec, has increased output by one million barrels a day since 2014 and is proposing now to cut back that increase by just half. Russia, the major non-Opec supplier that is a party to the agreement, might cut back production by 300,000 barrels a day, but that will still mean it is pumping more than it did earlier this year, leave alone in 2014. Iran, exiting from sanctions, has also increased production by one million barrels a day; to secure a deal, Saudi Arabia had to allow its great geopolitical rival to retain this gain. Thus, the cutbacks simply are not on the scale needed to send prices back anywhere close to pre-2014 levels. It is worth noting that crude oil prices need to be in the $80-100 range for many indebted and free-spending oil exporters to break even and keep various international and domestic commitments. This deal will not get them there.

In fact, rather than announcing the return of Opec, this deal may prefigure its exit. Already, the cartel only controls about a third of global oil output. Imposing internal discipline on its members was never easy, with rampant cheating with regard to oil production numbers, but doing so is doubly difficult now, thanks to various geopolitical tensions. And worst of all for Opec, this two-year self-imposed oil glut has been revealed to be futile in one major respect. If the intention was to drive the United States’ nascent shale oil industry into the ground, then the period of cheap oil failed. Instead, there continues to be a hard limit, imposed by the variable cost of shale oil, on how high Opec can hope to take prices. That limit has, in fact, become tighter in the past years; some shale oil producers in the US needed prices of $70 a barrel to be competitive in 2014, but have shed costs in the two years since and might now be competitive at prices as low as $55 a barrel. In other words, Opec has less control over crude oil prices now than it did in 2014 and, four decades after it shook the world, it may have finally been rendered irrelevant.