Discipline & deviation: Opec action to keep oil prices at reasonable levels

At an online meeting over the weekend, the Organization of Petroleum Exporting Countries (Opec) plus associates like Russia — known as Opec+ — agreed to step up the rate of oil production. In June, output will be increased by over 400,000 barrels a day, according to the grouping. This is a second consecutive month that it has done this, and it takes the amount by which daily production will increase over the April-June quarter to almost a million barrels. Brent crude oil futures were already dipping to nearly $61 a barrel before this announcement, and prices might go below $60 once traders have had a chance to digest this news. The question that many policymakers will ask is whether this is a temporary shift, a partial unwinding of decisions over recent years to cut output, or whether the cartel has now shifted to targeting a different price range altogether.

 

The prime mover of this increase is Saudi Arabia, and it has apparently been quite clear about its motivations. Delegates to the Opec+ meeting have been reported (in the media) to have said that Saudi Arabia had warned “overproducing” members of the cartel that further “cheating” would not be tolerated, and that there might be additional production increases unless they fell in line. This seems to be directed at Kazakhstan and Iraq, in particular. In Kazakhstan, a massive facility run by multinational Chevron is largely responsible for this overproduction — and Almaty claims it has no control over its output. However, the fact is that the cartel has always relied on its members’ cooperation and control of domestic oil output — and that there is absolutely no way to compel them to strictly follow agreed-upon quotas for their individual production. Cheating has been endemic in the past — between 1995 and 2007, Qatar alone overproduced by about 18.5 per cent every year. Countries such as Algeria have been even more egregious violators. The only discipline that Saudi Arabia can apply to keep the cartel running is the fact that it has vast amounts of spare capacity for extraction, more than the other members — and thus it can, if necessary, penalise them collectively by dropping prices substantially. It has done so at least twice over the past decade.

 

This analysis concludes that lower prices would be the case only until Kazakhstan, Iraq, and the others learn their lesson and reduce overproduction. At that point, the Saudis would return to targeting the $100-a-barrel range from the current tolerance of $60-70 a barrel. But there are other considerations in play as well. American President Donald Trump is due to visit Saudi Arabia later this month, and has called for increased output so that prices at the pump in the United States (US) decline. Where the President comes down on Opec+ production — high, to control consumer prices, or low, to benefit shale oil producers in the US — will matter. Riyadh will also worry about whether other large producers, including Iran and Venezuela, will shortly come back online. While the preponderance of evidence remains that this is just another episode of discipline to enforce compliance, there are good reasons also to consider that $100-a-barrel oil may not be in Saudi Arabia’s interests. Lower oil prices will obviously benefit a large importer like India. It will help in reducing the current account deficit at a time of high global uncertainty. It will also reduce the inflation rate if the price benefit is passed on to the consumers.