OPEC’s pyrrhic market share victory: Fuel for Thought

OPEC’s decision to defend its market share by opting for freewheeling crude oil production appears to be working.

It was only a few months ago the International Energy Agency said the market was “drowning in oil” and prices plummeted to less than $30/b. Fast forward to July and the IEA said there had been an “extraordinary transformation” from a major surplus in the first quarter to near-balance in the second.

Non-OPEC production remains on course to fall 900,000 b/d this year before staging a modest recovery in 2017, according to the IEA.

Meanwhile, OPEC production hit an eight-year high in June, helped by Iran’s post-sanctions return being better than most analysts expected. Couple that with Iraq’s substantial rise in 2015 and the IEA commenting that “low-cost Middle Eastern OPEC countries have seen output rise steadily in recent years” and not only is OPEC defending its market share, it’s slowly increasing it.

So far, so good.

However, there are a number of flaws to the plan.

First, it has only delayed the inevitable. US shale producers are becoming more flexible and prices around $50/b start to make it economic for some to increase output.

Second, even the better placed OPEC members have felt the squeeze — evidenced by the mooted privatizations from Kuwait and Saudi Arabia to generate extra cash for depleted government coffers. At the thin end of the wedge there are cash-strapped countries like Venezuela who led the charge for an output freeze, only for the proposal to be scrapped at the 11th hour.

Third, OPEC may well have a shared goal but that is often driven by Saudi Arabia and it doesn’t mean individual members are fully committed: they do say a camel is a horse designed by a committee.

Indeed, while many talk of OPEC defending its market share, what about the jostling for market share within the group itself?

Saudi Arabia has made it clear it does not want to cede ground to Iran and Iran has made it clear it wants its pre-sanctions market share back. Nigerian outages and Venezuela’s decline have helped keep a check on OPEC’s runaway production which was 32.73 million b/d according to S&P Global Platts June survey. But what happens when they recover?

Whether this market share strategy proves to be a success depends on the key part of OPEC’s mission statement: to “coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets.”

Saudi oil minister Khalid al-Falih recently spoke of $50-$100/b oil as a fair target range that would bring stable flows and profits.

And therein lies the rub. Left to its own devices, markets correct themselves but not before chronic over- and under-shooting. The return of shale may help keep a lid on prices and erode OPEC’s market share. Then again, all the investments and spending that have been shelved in the past couple of years could mean a massive shortfall further down the line and prompt a spike
in prices.

Radical suggestion: A return to quotas?

There appears an answer to a more stable market and a cohesive OPEC: quotas.

The Iranian oil minister was the first to advocate their return at the June OPEC meeting, which OPEC abandoned in 2011.

Outgoing OPEC Secretary General Abdalla al-Badri suggested an output ceiling could be discussed at the organization’s next ministerial meeting, which is scheduled for November 30. Maybe the fractious group needs this token step — which it scrapped only late last year — before committing to some sort of real control with quotas later on.

But whether some kind of cap can be delivered is easier said than done.

Saudi Arabia has not changed its output policy and, if anything, has made indications that OPEC should have a smaller role in managing the market.

Imposing a ceiling the market would not respect was no way for the producer group to demonstrate its value, Falih said after emerging from his first OPEC ministerial meeting.

“OPEC has tried to target prices, tried quotas and tried more recently letting the market do it alone,” he said. “With each one we have found failures. Perhaps balancing a little bit of each [is the solution]. We need more consensus around the mechanism we use.”

Clearly OPEC needs a new strategy and one that allows it to co-exist with shale, Russia and big oil.

OPEC’s market share has remained over 40% for the past 20 years and it will not want to return to the bad old days of the mid-1980s when it hit a nadir of just over 25%. Especially since the now 14-member group controls more than 70% of the world’s proved crude oil reserves.

Source: http://blogs.platts.com/

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