The Saudi Re-engineering of the Global Corporate Oil Board
Something interesting is happening now. Energy insiders and OPEC officials are saying publicly and privately that the days of OPEC managing the market is over, and it certainly seems that OPEC’s cohesion is breaking down. In truth, OPEC may already be a thing of the path, and Saudi Arabia appears to be in the midst of creating the next global corporate oil board.
For a long time now, since 1960 or, really, 1973, the countries comprising the Organization for Petroleum Exporting Countries (OPEC) have worked as a cartel to manipulate the world oil market by deciding together when to adjust production and by how much to influence prices. But something interesting is happening now. Energy insiders and OPEC officials are saying publicly and privately that the days of OPEC managing the market is over, and it certainly seems that OPEC’s cohesion is breaking down. Whether this is a temporary tangent or the beginnings of a major shift from OPEC custodianship is an interesting question because the things we need to evaluate what’s happening stand themselves to be affected by what’s happening.
The shale revolution brought on by hydraulic fracturing has over the last five years chipped away at OPEC’s ability to set prices because it has turned a number of large oil importing countries into oil exporting countries. Nevertheless, the vast majority of global reserves lie under the ground of OPEC countries and so many analysts caution reading too much into shale’s ability to undermine OPEC long-term. This is a critical consideration in understanding the long-term outlook of the oil market, but its something we won’t fully understand ahead of it playing itself out.
The cheap oil prices of 2014 and 2015 are making the issue all the more interesting because despite shale production’s ability to offset OPEC production, OPEC isn’t cutting production to maintain price stability. Rather, today’s main two OPEC producers, Saudi Arabia and Iraq, are charging ahead and producing far more than the world needs. There is a global oil glut and prices remain low.
The Iraqis need money to fund their battle against ISIS and demonstrate that the country has an economic backbone. Were it not for oil production, Iraq would be in total shambles and foreign investment would be stumbling over itself to flee. Saudi Arabia appears to be pumping away in order to limit rival Iran’s foreign policy now and its appeal to foreign energy investors in the future should an international agreement on its nuclear program pave the way for Iran’s economic opening.
Given the global oil glut and cheap retail prices putting high production cost sources at risk, it’s a very real question whether foreign oil companies, independent and national, stand to make much profit off Iranian oil or even if Iran helps them secure long-term supply.
At least this is explanation given for the Kingdom’s aggressive production. There is a more important long-term consideration, however, in the Saudi’s strategy, which is the outlook for shale. The Saudis are accustomed to managing the market through OPEC, but now that geopolitical considerations are driving short-term decision-making, they are realizing that because of shale production outside OPEC, OPEC is a weak mechanism for long-term market stabilization.
Therefore, the only way the Saudis succeed in maintaining a grip over the oil market in the long-term is leverage their advantage – their massive reserves – to exert leverage over shale producers whose governments do not have the right to dictate production decisions over their own resources. While their immediate message is to Iran, their most critical message is directed to America, Canada, China, and Russia whose shale production put Saudi Arabia’s oil monopoly at its most existential risk.
One could say OPEC is dysfunctional because the Saudis and Iraqis are going off on their own and throwing the other members under the bus. But in reality OPEC has lost its way because it is not achieving the only goal that makes it worthwhile to its most powerful member: it cannot control a shale-dominated market.
The Saudis have clearly been unable to give up their position as the CEO of the global oil market and are switching gears to re-arrange the corporate board. They have acknowledged that the shale producers have pushed aside previously important OPEC states, and that Iran stands to regain its influential position in the next five to ten years. Having faced this reality, the Kingdom is putting together its corporate strategy to bring these countries into the market managing process knowing that they cannot or will not cut their production unless something dramatic happens in the market. So step one: force a cut in shale production to render irrelevant Western governments’ inability to regulate production.
If successful, stockpiles will empty and could bring about the old, hated days of boom-and-bust cycles that cost the global economy a lot of money. The Kingdom is banking on strong market reactions that will curtail expensive shale production and allow the Saudis to re-establish the power of being the only swing producer in the market. At that point we will see whether the Saudis allow a re-establishment of OPEC as it once was.
If unsuccessful, if the Kingdom cannot outlast shale producers in this competition over who can withstand low prices for longer, the market will tighten up and prices will rise. This is a risky prospect for the Saudis who get their power from their market manager status. A void in that position will open the market up and we may finally get away from a cartel-minded market.
Either way, there is a lot of uncertainty in the market which means people are nervous, and rightfully so. A lot of Western money has been spent in a Saudi-controlled oil market, money that could be better used on other purposes. We’ve had a reprieve from the worst of it for the last few years, but it tough days may be ahead.