OPEC Still Doesn’t Get It

One should not underestimate OPEC as an organization. In 2016, the 14 member countries of OPEC produced nearly 43% of the world’s oil. The cartel also controls 71.5% of the world’s oil reserves. OPEC remains tremendously influential in the global oil market. 

But OPEC often has a hard time getting its act together. The group could have much more control than they do, but OPEC members have competing interests. They frequently cheat on production quotas. They differ on strategy. All of these factors keep them from being as effective as they could be.

Sometimes they miscalculate, as they did in 2014 by thinking they could bankrupt the U.S. shale oil industry. I considered that a Trillion Dollar Miscalculation. They underestimated the resilience of U.S. shale oil producers. Of course, some producers did go bankrupt. The number of rigs drilling for oil plummeted. U.S. oil production declined as oil prices plunged to below $30/bbl. But most producers slashed costs and remained afloat. 

Two years after embarking on that strategy to defend market share, OPEC raised the white flag as members struggled under the burden of low prices. They would have to coexist with shale oil producers that were increasingly competing directly with them in the global oil market.

But they still don’t seem to understand something fundamentally simple about the oil industry in the U.S. This week Reuters reported OPEC Secretary General urges U.S. shale oil producers to help cap global supply.:

OPEC’s Secretary General Mohammed Barkindo on Tuesday called on U.S. shale oil producers to help curtail global oil supply, warning extraordinary measures might be needed next year to sustain the rebalanced market in the medium to long term.

“We urge our friends, in the shale basins of North America to take this shared responsibility with all seriousness it deserves, as one of the key lessons learnt from the current unique supply-driven cycle,” said Barkindo.

Shale Producers Are Not A Cartel

The comments from the Secretary General seem to demonstrate a fundamental ignorance about the U.S. oil industry. The U.S. produced 13.4% of the world’s oil last year, but there are thousands of companies — each acting in its self-interest and based on individual expectations for future prices — responsible for U.S. oil production.

Each of these producers acting individually can only impact a fraction of a percentage of the world oil market. ExxonMobil (NYSE: XOM), the largest publicly traded international oil company, produced 2.1 million barrels per day (BPD) of oil in 2016. They could cut their oil production by 20%, and it would reduce global oil output by less than 0.5%.  

Without significant collusion, U.S. oil producers just can’t impact the global oil balance in the way OPEC seems to think they can. Yes, by increasing production, they have added to the oil glut, but there is no mechanism by which they can (legally) restrict production to benefit all producers. That’s a function of the collective decisions of those thousands of oil producers, based on their outlook for oil prices.   

That’s a different situation than with OPEC. It is possible for OPEC to agree to collectively cut a million barrels a day of production (which would be about 2.5% of the group’s 2016 production), but virtually impossible (and in fact illegal) for U.S. producers to collude in the same fashion.

OPEC’s No-Win Strategy

The rationale OPEC gave when embarking on the price war in 2014 was that it wasn’t fair that their production restraint was helping prop up the highest-cost producers (i.e., marginal shale oil producers). 

This is a valid argument. In most businesses, high-cost producers tend to get squeezed out of the market. OPEC was, in fact, propping up these producers by restraining production and helping maintain elevated oil prices. 

But fair or not, there were real consequences to OPEC members in embarking upon that strategy. They squeezed a few high-cost producers out of the market, but oil prices have dropped by more than 50% from the first half of 2014.  

In reality, OPEC is probably just hedging its bets. In its newly released monthly report, the cartel has again raised its demand forecast for 2018. That is the third consecutive upward revision in OPEC’s 2018 demand forecast. The report even raised the possibility of a global supply deficit in 2018 unless oil output is increased.

Self-serving? Yes, but probably accurate. And U.S. shale oil producers stand to benefit.

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