The Strategist

Will OPEC be destroyed?

11/13/2018 - 14:57

The oil market is waiting for global shocks. The Organization of Petroleum Exporting Countries (OPEC) may cease to exist. Saudi Arabia has long been playing its own game, and key decisions are made de facto without taking into account views of the majority of other cartel members. The United States is also calling to disband the organization.

A serious reshuffle is waiting for existing order in the world oil market. The Organization of Petroleum Exporting Countries - OPEC - may soon become a thing of the past, giving way to other strategic alliances and agreements. Oil producing countries are trying not to talk openly about this, but there has already been a split in the ranks of the cartel members.

One of the key OPEC participants - Saudi Arabia - seriously considers prospects for existence outside this format. The King Abdullah Petroleum Studies and Research Center (KAPSARC), a major analytical center funded from the treasury of the kingdom), is conducting a study on how the possible disintegration of OPEC will affect the country and the oil market as a whole.

On Sunday, November 11, on the sidelines of the ministerial meeting of the OPEC + Transaction Monitoring Committee, the Kingdom’s Energy Minister Khaled al-Faleh very vaguely answered the question of whether Saudi Arabia is really considering the OPEC dissolution scenario.

“Research centers love to explore, and we will not deprive them of this opportunity. We asked them to study all possible scenarios, but I am convinced that the oil world needs responsible producers who will regulate the market in good faith. Let's give them some thought. I think that this professional research will show that the cooperation of responsible producers, which reduces excessive volatility, is good for the market,” he said.

According to the authors of the study, the reason for dissolution of OPEC could be achievement of peak demand for oil and its subsequent decline.

Different post-OPEC scenarios are considered. The first - competition for the falling market between the largest oil producers will become fiercer after the dissolution of OPEC. Second, Saudi Arabia assumes the functions of a regulator, trying to maintain stability on the market itself, adjusting its oil production volumes.

The fact that the center is doing this work was confirmed by the head of KAPSARC, Adam Sieminski. However, he assured that this is a regular research that should not be considered as a signal of intention of the Saudi authorities to leave the cartel.

Sources of the WSJ also assure that the country’s leaders do not plan to terminate OPEC membership. However, it will allow taking into account criticism of the unification by US President Donald Trump, who often blames the cartel for overpricing.

Rumors that OPEC, in its present form, has outlived itself and does not solve anything have been heard a long time ago. In recent years, OPEC has not made any de facto serious decisions on market regulation. At the same time, experts are increasingly talking about a split in the ranks of the cartel members.

For example, in June, before the next meeting in the OPEC + format (cartel members plus countries that joined the agreement to reduce production in 2016), alliance members could not come to a compromise on increasing production, terms and volumes for each of the parties.

As a result, a formal, vague and very general agreement was adopted, which, as Bloomberg noted, was “concocted according to the long tradition of the cartel, which was supposed to increase production, without saying which countries would increase it or by how much”.

At the same time, Iran, the third largest OPEC member in terms of production, was dissatisfied with the decision of the cartel, since it actually gave the green light to the United States’ sanctions against the republic. However, they refused to take into account the political component in OPEC.

Another major player - Venezuela - has lost its position. Its production against the background of sanctions from the United States and the general economic downturn in the country fell below the historical minimum. In such a situation it is difficult to influence something. Libya is still torn apart by internal confrontations after the overthrow of Muammar Gaddafi, which catastrophically affects its level of production. Iraq is interested in maximum development of its own exports and, at every opportunity, tries to bargain for itself additional quotas.

Many African countries have not ensured timely investments in production against the background of the recent fall in oil prices, as a result of which their production volumes are also falling.

The point is not only that Riyadh is the leader in terms of production and reserves among cartel members, but also that the Saudis have low production costs and real opportunities to regulate production volumes. At the same time, the kingdom is a traditional ally of the United States, which is one of the key importers and the leader in the extraction of oil.

Not only internal disagreements, but also US actions are now threatening OPEC. The House of Representatives is considering the No Oil Producing and Exporting Cartels Act (NOPEC) bill proposing to give the US authorities the right to challenge OPEC actions in court as violations of antitrust laws and attempts to manipulate energy prices.

The draft law has already been posted on Twitter. And in his book, released in 2011, Trump called the members of OPEC “oil bandits” and stressed that the cartel’s actions openly violate a law that prohibits such arrangements, essentially a price conspiracy on a global scale.

If the law is passed, the US authorities will be able to arrest the accounts and assets of OPEC members that fall under the jurisdiction of Washington. Given that the Saudis and other Middle Eastern oil monarchies in North America have hundreds of billions of dollars, NOPEC will destroy the cartel.

This will not destroy the oil market, but will make it extremely turbulent and unpredictable. Such a situation is in the hands of only stock speculators, but the world economy can dismantle the “market clips” into a deep knockout.