Can OPEC’s Output Cuts Stabilise Oil Prices?

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With the Organisation of Petroleum Exporting Countries (OPEC) controlling only about 30 per cent of the global crude oil market, coupled with the discordant voices among the members of the cartel, Ejiofor Alike posits that it is doubtful if OPEC’s output freeze will guarantee the recovery of prices

Though the Organisation of Petroleum Exporting Countries (OPEC) was established at the Baghdad Conference of September 10–14, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela, the cartel actually rose to international prominence in 1973 when the Arab members, declared an oil embargo against the United States.
After OPEC’s formation, the initial five founding members were later joined by nine other members- Qatar (1961); Indonesia (1962); Libya (1962); United Arab Emirates (1967); Algeria (1969); Nigeria (1971); Ecuador (1973); Angola (2007); and Gabon (1975).

In a development that was regarded in the global oil politics as the beginning of the rise and at the same time the fall of OPEC, the Arab members had in 1973 placed an oil embargo against the United States for supporting Israel in a war with Egypt.
Israel had in a six-day war of 1967 defeated Egypt, thus gaining control of territory four times its previous size.

While Egypt lost the Sinai Peninsula and the Gaza Strip; Jordan lost the West Bank and East Jerusalem, and Syria lost the strategic Golan Heights.
However, on October 6, 1973, Egyptian and Syrian forces launched a coordinated attack against Israel on ‘Yom Kippur,’ the holiest day in the Jewish calendar, in a bid to win back territory lost to Israel during the third Arab-Israeli war of 1967.

As Israelis were observing ‘Yom Kippur’, the country’s defence forces were taken by surprise, as Egyptian troops swept deep into the Sinai Peninsula, while Syria struggled to sack Israeli troops from the Golan Heights.

But with the assistance of the United States military, the Israeli forces routed the invading Egyptian Army and crossed the Suez Canal into Egypt and recaptured the Golan Heights, before a cease-fire was declared on October 25, 1973.

In retaliation, the Arab members of OPEC declared an oil embargo against the United States, and embarked on series of production cuts that tripled the prices of crude oil in the international market.
It was from that point that crude oil became a political tool and an instrument of war.
Though OPEC assumed an influential position in the global energy dynamics by this singular action, the development also marked the beginning of the fall of the cartel.

This action actually spelt doom for OPEC because having forced the United States economy into recession by this action, the US commenced search for alternative sources of energy supply.
Consequently, all the successive administrations of the United States beginning from presidents Gerald Ford to the present Barack Obama focused on energy independent to stop the country’s reliance on OPEC and its oil.

The result of the efforts of the United States towards the attainment of energy security is the Shale gas/oil, which has today crashed the price of conventional crude, driving the economies of most OPEC members into recession.
Having succeeded in extracting shale gas commercially, based on years of technological development, the United States is no longer dependent on OPEC’s oil, thanks to the lessons of the 1973 oil embargo.

Apart from the advancement in Shale gas, increased production of crude oil by non-OPEC members has also reduced OPEC’s market’s share as the cartel, which controlled 55 per cent of the world market in the 1970’s now controls less than 30 per cent.

Even the western countries that used to be traditional consumers now have billions barrels of crude oil in strategic reserves.
All these developments have placed OPEC’s strategic position in the global oil politics in jeopardy.

Current drop in oil prices
Even before OPEC was formed, crude oil as a commodity that is traded globally had seen several price cycles.
More recently, oil prices have seen booms from an average of $14 per barrel price in 1986 and $91 per barrel in 2008.

When Japan experienced the Fukushima nuclear disaster in 2011, the incident led to price rise.
On the other hand, the impact of shale gas, oversupply by non-OPEC, and the lifting of sanctions on Iran and Iraq have led to drop in prices.
As supply was increasing, demanding was decreasing due to what the outgoing Managing Director of Nigeria LNG Limited, Mr. Babs Omotowa described as weakened economies, tough environmental standards, automotive fuel efficiency, and surge of renewables, which led to up to 50 per cent reduction in fuel usage in some sectors.

From $115 per barrel in June 2014, crude oil price had crashed to $27 per barrel in January this year, before its current recovery around $48 per barrel.

While politics, speculation and oversupply played a role in crashing the prices, the underlying factor was that supply exceeded demand in the international market.

Due to its advancement in Shale gas production, the United States, which used to import 40 per cent of Nigeria’s crude oil, had at a point imported zero per cent as a result of increased production of Shale gas, coupled with the country’s abundant conventional oil.
The implication is that OPEC and its oil are no longer as powerful as they used to be in the 1970’s and Western economies have also become less vulnerable.

Apart from Shale and other willing substitutes, which keep oil producers in check and prices low, non-OPEC members have also increased crude oil production, thus offsetting any output cuts by OPEC.

What this means that if Saudi Arabia decides to cut production, Mexico, Russia and Canada will quickly increase production to bridge the supply gap.

Discordant voices
Apart from the external challenges against OPEC, the rows among the members have also hampered efforts to ensure price recovery.

While Algeria, Nigeria and other poorer countries had insisted on output cuts to stabilise prices, Saudi Arabia and its Gulf allies opposed the move on the grounds that they would lose market share to Shale gas producers and non-OPEC if they cut supply to the market.

Rather than curb output, Saudi Arabia had initially flooded the market, thus driving the prices further down in a bid to force the high cost Shale producers out of the market.
Iran had also opposed the output cuts, insisting that it would raise production to the pre-sanction level before joining the talks on output freeze.
At their April meeting, OPEC failed to agree a clear strategy as Iran insisted on raising its own production.

Tensions between the Sunni-led kingdom and the Shi’ite Islamic Republic had frustrated efforts at several previous OPEC meetings, including in December 2015.
The failure of the group to agree on formal output target for the first time in years in December 2015 led to the slump in prices to an all-time low of $27 per barrel in January 2016.

Reconciliatory moves
With the price crash taking its tolls on the economies of Saudi and her Gulf neighbours, the new Saudi Energy Minister Khalid al-Falih had indicated that Riyadh wanted to be more conciliatory, while his Iranian peer, Bijan Zanganeh kept his criticism of Riyadh to an unusual minimum.
Though the market recorded 15 per cent recovery of crude oil price since the beginning of August, there are no strong indications that OPEC’s output freeze in their next month’s meeting would stabilise prices due to signs that disrupted production in Nigeria, Iraq and Libya would be ramped up.

Iran is however sending positive signals that it may support joint action to prop up the oil market.
But speaking at a recent conference organised by energy reporters in Lagos, Nigeria’s Minister of State for Petroleum, Dr. Ibe Kachikwu had hinted that the proposed talks on output cuts by the OPEC would have limited influence on the prices as the cartel controls only about 30 per cent of the global oil output.

“OPEC controls only 30 per cent. So, even if we shut down, it will have limited impact because the 70 per cent producers are more powerful. Only a handshake between OPEC and Non-OPEC can solve the involving by inviting Russia, Mexico and the United States,” he said.
“Are we cutting volumes? I don’t see that happening. Will that meeting help lift the price? Well yes if we succeed in having conversations with Russia, the USA and Mexico. If there is a handshake with individuals across the aisle that would be the beginning,” kachikwu added.
OPEC has stabilised oil prices in the past but it is doubtful if its decision would be as effective as it was in the past unless with the collaboration of non-OPEC.

According to the United States’ Energy Information Administration (EIA), oil production from countries outside the OPEC currently represents about 60 per cent of world oil production.
However, actual supply in the market is less than 30 per cent because of conflicts in member countries.
Key centres of non-OPEC production include North America, regions of the former Soviet Union, and the North Sea.

In contrast to OPEC oil production, which is subject to central coordination, EIA said non-OPEC producers could independent decisions about oil production.
Also, in contrast to OPEC, where oil production is mostly in the hands of national oil companies (NOCs), it is the contention of EIA that international or investor-owned oil companies (IOCs) perform most of the production activities in non-OPEC countries.

“IOCs seek primarily to increase shareholder value and make investment decisions based on economic factors. While some NOCs operate in a similar manner as IOCs, many have additional objectives such as providing employment, infrastructure, or revenue that impact their country in a broader sense. As a result, non-OPEC investment, and thus future supply capability, tends to respond more readily to changes strictly in market conditions. Producers in non-OPEC countries are generally regarded as price takers, that is, they respond to market prices rather than attempt to influence prices by managing production. As a result, non-OPEC producers tend to produce at or near full capacity and so have little spare capacity. Other things being equal, lower levels of non-OPEC supply tend to put upward pressure on prices by decreasing total global supply and increasing the “call on OPEC.” The greater the call on OPEC, the greater is its likely ability to influence prices,” EIA explained.
Events of the next few months will test the relevance of OPEC in today’s global oil market.