How OPEC Shook Off a Historic Crash to Successfully Stabilize Oil Markets

The global clout of OPEC, never one of the world’s most admired institutions, reached a nadir in April when a dispute between Saudi Arabia and Russia triggered a price war just as global oil demand was collapsing due to the coronavirus pandemic.

By Mark Finley, Jim Krane

Three months later, the cartel has re-emerged as a model of transnational cooperation and collective sacrifice, implementing historic

production cuts in an effort to stabilize prices. Oil markets have noticed. After cratering below $20 a barrel in April, Brent crude, the international benchmark price, has hovered between $42 and $45 so far this month, even as demand remains low due to coronavirus-related travel restrictions.

In cinematic terms, it’s as if “The Gang That Couldn’t Shoot Straight” transformed into “Ocean’s Eleven.” What happened?

First, Saudi Arabia, the cartel’s enforcer, wisely climbed down from its rash decision to increase oil production by 20 percent, which saw output temporarily reach a record-high 12 million barrels a day. Timely intervention from President Donald Trump in early April helped push Saudi Arabia, as well as the broader “OPEC+” grouping that includes Russia, to stop exacerbating the coronavirus-induced oil shock, which filled up global storage capacity and briefly sent U.S. oil futures into negative territory.

With that crisis averted, the OPEC+ countries quickly regained their footing, agreeing on the largest cooperative cuts to output the world has ever seen. Now, the 23 partner states are not just complying with their new quotas—they are over-complying, taking 10.3 million barrels of oil offline each day in June, rather than the agreed-upon level of 9.7 million.

The reason for this change involves a surprisingly ruthless enforcement of discipline by Saudi Arabia. Key policymakers in Riyadh, especially the oil minister, Prince Abdulaziz bin Salman, have begun demanding that OPEC+ members that cheat on their allocated quotas pay “compensation” for their transgressions through extra cuts in the future.

Initially, leaders in offending countries balked. In early July, Angola refused not only to make compensatory cuts, but also to stop cheating. But it reversed course just a few days later and agreed to comply with the scheduled cuts and with additional cutbacks later this year as punishment. Nigeria, another chronic cheater, has also pledged full compliance after its president, Muhammadu Buhari, received a call from Saudi Crown Prince Mohammed bin Salman in late June.

Even Iraq, the biggest quota scofflaw of them all, appears to have been won over by a mixed package of Saudi threats and incentives, the latter of which include the appointment of a new Saudi ambassador to Iraq and an investment in developing an Iraqi natural gas field. Relations between the two countries had been chilly until recently, due to Iraq’s close ties with Iran, Saudi Arabia’s main regional rival.

Meanwhile, Russia has also joined the enforcement team, pushing neighboring Kazakhstan, which also was producing above its quota, to atone with additional cuts.

Three months after its global clout reached a nadir, OPEC has re-emerged as a model of transnational cooperation and collective sacrifice.

A fragile equilibrium, upheld by reinvigorated cartel discipline, appears to have taken hold. But if it is to last, OPEC+ will have to overcome some steep obstacles, most importantly the coronavirus pandemic’s persistent drag on global oil demand. Many regions of the United States, the world’s largest oil consumer, are rethinking reopening plans and reverting back to lockdowns and travel restrictions amid a new spike in cases of COVID-19. The virus is also spreading rapidly in India and across Latin America, threatening to cancel out a demand revival in China and Europe.

This depressed demand means that even as prices recover, production volumes must remain low, damaging oil-producing countries’ export revenues. This is tough for most OPEC+ governments, which depend on oil to fund much or most of their budgets. The International Monetary Fund forecasts that oil revenues for Middle Eastern producers will drop by a whopping $270 billion in 2020—more than Saudi Aramco’s total earnings in 2018—an unthinkable amount of cash.

As a result, the IMF predicts an overall 7.3 percent contraction in GDP for the Middle East. The sharp fall in revenue will significantly hamper governments’ efforts to meet demands for new spending on social and health services amid the pandemic.

Of course, the pain isn’t spread uniformly. Three OPEC member states, Iran, Libya and Venezuela, have seen their oil production plummet by a combined 5 million barrels per day in recent years, mostly due to non-pandemic-related factors like U.S. sanctions, civil war or internal mismanagement. None of this is tallied in OPEC+’s official cuts, because the three are not party to the production-cutting agreement.

While Venezuela’s and Libya’s oil industries are in no position to bounce back in the short term, Iran’s is being held back solely by U.S. sanctions that much of the world opposes, including many U.S. allies and partners. Should Trump lose his reelection bid in November, a President Biden could take steps to ease those sanctions and even return to the Iran nuclear deal, which Trump unilaterally withdrew from in 2018.

Even wealthy Saudi Arabia faces tough times ahead. The IMF drastically revised its projection for 2020 Saudi GDP, predicting a 6.8 percent drop instead of the 2.3 percent contraction it envisaged in April. The kingdom has been scrambling to compensate for lost cash, taking the risky step in July of tripling its value-added tax from 5 percent to 15 percent, a move that could increase domestic discontent.

OPEC’s near-term success in market management also faces roadblocks from a potential revival of U.S. shale oil. Shale production is down 2 million barrels per day from the mid-March peak of 13.1 million. But with WTI prices, the main U.S. benchmark, mostly staying above $40 a barrel this month, production declines have shifted into reverse—at least temporarily, as shut-in production is brought back online. U.S. energy companies are not obliged to go along with OPEC+ production cuts, so the cartel will need to guard against future price increases that would bring shale back into the game.

OPEC+ plans to continue extending its current series of production cuts, which began in 2017, through next year and into 2022. With most analysts seeing the global market moving from surplus into deficit as production declines and demand recovers, OPEC+ announced earlier this month that it would stick with its previously agreed-upon plan to ease the original cuts of 9.7 million barrels per day to 7.7 million in August.

But even then, with the persistent possibility of another dip in global demand, Saudi Arabia and Russia were quick to caution that their additional production was not for export, but rather for domestic consumers dealing with a seasonal demand increase.

After all, they wouldn’t want markets to take it the wrong way.

Mark Finley is the fellow in energy and global oil at Rice University’s Baker Institute for Public Policy. He was previously the senior U.S. economist at BP. For 12 years, he led the production of the BP Statistical Review of World Energy, the world’s longest-running compilation of objective global energy data. Follow him on Twitter or LinkedIn.

Jim Krane is the Wallace S. Wilson fellow for energy studies at Rice University’s Baker Institute for Public Policy, and the author of the recent book, “Energy Kingdoms.” Follow him on Twitter @JimKrane.

Source: worldpoliticsreview.com

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