Raising the specter of a global financial crisis, members of the Organization of the Petroleum Exporting Countries (OPEC) appear poised for a new approach in dealing with oil-producing nations outside of the cartel.
Or at least, one that’s different from the tactic taken last year. Looking to flex its global muscle as the predominant oil producer in the world, OPEC leader Saudi Arabia refused to cut its production and after Chinese demand waned, the move proved to the global economy the Keynesian theory that oversupply makes for discounted prices. Within 10 months, oil sold per barrel for less than half its previous price.
OPEC’s potential about-face is evident in the regular bulletin the organization provides. The July-August 2015 missive leads with a piece called, “Cooperation Holds the Key to Oil’s Future.”
“International crude oil prices in July suffered their largest monthly decline since Lehman Brothers collapsed in the United States in 2008, marking the onset of the global financial crisis,” the bulletin said. “Today’s continuing pressure on prices, brought about by higher crude production, coupled with market speculation, remains a cause for concern for OPEC and its members – indeed, for all stakeholders in the industry.”
That’s hardly the kind of rhetoric that drove analysts in November 2014 to say that OPEC had thrown down the gauntlet to U.S. shale producers and that Saudi’s decision not to cut its market share would become a survival of the fittest between Saudi’s vast Gwahar reserves and the U.S. shale revolution.
Rather, continuing the language in the Aug. 31 bulletin, the organization said it stands ready to talk to all other producers.
“But this has to be on a level playing field. OPEC will protect its own interests,” the organization said. “Cooperation is and will always remain the key to oil’s future and that is why dialogue among the main stakeholders is so important going forward.”
What’s more, OPEC said, “There is no quick fix, but if there is a willingness to face the oil industry’s challenges together, then the prospects for the future have to be a lot better than what everyone involved in the industry has been experiencing over the past nine months or so. Only time will tell.”
Dave Pursell, managing director and head of securities at Tudor Pickering Holt & Co. in Houston told Rigzone it’s a “fool’s game” to predict what OPEC will do, but the bulletin released today did show that Saudi Arabia is considering its options, particularly when it comes to “growing fears that, under the current low-price scenario, investment in future capacity additions will continue to be shelved or cancelled altogether.”
If prices stay lower for longer, and demand becomes greater, even OPEC may not be able to keep up with future incremental capacity.
Pursell said the worst is, capacity is reduced and oil shoots up to $140 per barrel, that’s not sustainable.
“You’re crimping demand badly and in the longer term, you start to encourage alternative fuels and you re-encourage investment in non-OPEC countries. If you get a price level high enough to cover their costs – then you have excess capacity to bring on supply to the market.”
Other countries within OPEC are worried about price stabilization, and Russia and Venezuela have requested an extraordinary meeting to deal with the situation.
Pursell said that frankly, the number one rule of OPEC, Pursell said, is that it doesn’t matter what anybody says except Saudi Arabia.
“You can take that to the bank,” he said. “Russia and Venezuela can talk, but unless Saudi wants an exceptional meeting, there’s not going to be one.
A GAME OF MONOPOLY
Kenneth Medlock III, senior director for the Center for Energy Studies at Rice University’s Baker Institute for Public Policy, said you can use an approach called the Stackelberg leader/follower model – the idea that OPEC is a dominant firm that can effectively exercise monopoly power in a market, but there are other firms that also produce competitively. They are the competitive fringe. Once a lot of new supply comes onto the market – like shale – it get cheaper.
“That means the fringe is becoming more elastic. What that tells you is that OPEC should act or respond to that new reality exactly as they have been. It’s a completely economic situation,” he told Rigzone. “In Saudi Arabia, they do a lot of very deep thinking about energy markets and they model things very intensively and they use that to construct a five, 10 and 15 year plan, much like energy companies do here. They’re just in a different position. They’re the low cost producer, so they can act differently.”
But be that as it may, Bloomberg reported Aug. 31 that Saudi Arabian stocks had capped off the month with the worst totals in seven years, just as Brent, with its own yo-yo pricing, resumed a decline. Also telling, some of those “fringe competitors” that Medlock described, are meeting to discuss steps to stabilize prices during a visit to China in September.
However, with new leadership in the kingdom, “There really is more of a commercial emphasis on developing Saudi Arabia’s oil and that’s largely because it’s going to help generate revenue for the government, social programs and other needs in a much more efficient way,” Medlock said. “Because of that, I think they will be very response to what global demand is doing, what other suppliers are doing, and what their assessment of other suppliers’ cost structures are, which is kind of what we think about when we think about Exxon Mobil, or Chevron or Shell.”
A LOT CAN CHANGE IN A YEAR
The thing about Saudi’s refusal last November to cut its market share by say, 5 percent, is that prices for their own oil went into the tank, too. Although oil might not command $100 per barrel, it would be a lot closer to $90 per barrel than the $40 to $50 per barrel we see today, John Hofmeister, former president of Shell Oil Co. and founder of Citizens for Affordable Energy Inc., said.
“The Saudis were not cooperative at the OPEC meeting a year ago,” he said. “This is a new year, a new meeting. It’s a little early to predict what they may do. A lot depends on how badly they have hurt themselves with the low oil price. We saw recently that they’re going to the bond market for $20 billion, and that they’re funding with bonds because they are taking real money out of their sovereign fund to keep things going in the country because of the low oil price. This is costing Saudi Arabia a lot of money.”
Hofmeister added that simply, “OPEC cannot tolerate prices at this level, and I don’t think this can continue for much longer before certain OPEC countries simply cry uncle and agree to a more disciplined approach to oil production. I think there would be an effort to work cooperatively and in harmony, rather than go it alone. The Saudis are clearly the leaders of OPEC, and I don’t think they want to give up their leadership position. But I don’t think the OPEC countries can stand much more of this flirting with a total collapse of the oil price.”