The Reality of OPEC’s Oil Cut Extension
What does this mean for Saudi, Russian, and American oil exporters?
By Elena Castillo Guijarro.
This weekend the Organization of the Petroleum Exporting Countries (OPEC) met to discuss the deal that cuts oil supply by around 1.8 million barrels per day (bpd) in an effort to boost oil prices. The oil cuts have successfully reduced global oil surplus since the beginning of 2017 although remain at 140 million barrels above the five-year average. The important strategic question one should be asking is should oil cuts continue and who benefits from these measures?
During the meeting, most of the members and its allies were in favor of extending oil cuts to benefit from high prices; however, Russia expressed the possibility of an early exit finish of the cuts in oil production to prevent the market from overheating and if not. Russia also showed interest is planning a schedule of how the cuts will end so it can guide privately-owned Russian oil companies and their foreign partners about future output. Even though Russia’s demands were reasonable, OPEC members faced a dilemma. OPEC could jointly continue the successful policy to stabilize the surplus by meeting market expectations or preventing U.S. Shale oil, a non OPEC member, from benefitting from low prices. It was no surprise that demonstrating unity and compromise was a priority for OPEC since dropping their world market share to non-OPEC rivals seemed a better option than losing market stability.
In spite of of the members’ struggles at home including Iraq’s Kurdistan risk to oil exports shaken by tensions with Baghdad, Libya’s conflict with militias, disruptions in Nigeria’s production, Venezuela’s crisis, the USA’s intentions to issue financial sanctions on Iran and Saudi Arabia’s rising political risk, with Russia’s support, OPEC agreed to extend oil cuts until the end of 2018 and include Libya and Nigeria, which had been previously exempt from the oil cut due to unrest and lower than normal production.
Before the agreement was reached, oil prices had been rising above $60 per barrel. For Russia, the extension of the oil cuts for the whole of 2018 could prompt a spike in crude production in the United States, which is not participating in the deal. In fact, shortly after OPEC and Russia made the announcement, according to the Global Crude Oil Benchmarks, prices rose by 0.5% to $63 per barrel and are expected to rise up to $70 per barrel if there were to be a any major oil supply disruptions. In the short term, this means that OPEC members will be losing additional market shares to U.S. Shale’ yet, OPEC prefers losing market share to American producers than market failures such as surpluses. The problem is that if producers in the U.S. increased production over the next few months then by the time OPEC end the oil cuts this would translate in the collapse of prices.
Countries like Russia want to avoid the market to flip into a deficit so that prices don’t rally too fast and rival U.S. shale firms don’t boost output even further. It is true that Russia would benefit more from lower prices to balance its budget, but OPEC’s leader Saudi Arabia has the last word. Why would the Arab country be interested in extending the oil cuts? Because Saudis are preparing a stock market listing next year for Oil company Aramco and thus would benefit from pricier crude. OPEC members should now be concerned in preparing for the end of oil cuts, state governments need to provide guidance to its private and state energy companies to prepare for the chances of price volatility. Russia in particular needs a clear plan than most OPEC members because its economic policy is very complex with a floating exchange rate that fluctuates with the price of oil.
In the next regular meeting, OPEC has agreed to examine their progress and plan and exit strategy done gradually so it doesn’t provoke a shock in the market. This will be done by reviewing the market situation and whether to keep the same level of cut or gradually decrease or increase it.
Why does this matter? Well, the U.S. is on the way of becoming a global force in global oil and and gas markets. According to the International Energy Agency by 2025 oil production in the US will equal that achieved by Saudi Arabia and natural gas will surpass that of Russia. Since the US is not part of OPEC, lower prices are helping to support oil demand, even though the world is and still be heavily dependent on oil coming from the OPEC countries.
The U.S. is looking to ensure its consumers for the coming years, which explains why the Secretary of State Rex Tillerson declared two days ago, on the same day that OPEC met, that the US was vowed to help Europe oppose Moscow’s aggression and “wean off Russian oil”. American President Donald Trump not only considers withdrawing its support from Iran’s Nuclear Deal, which would place inconvenient economic sanctions on, but also placing heavier sanctions on Russia, too. In turn, Iran would be economically isolated and Russia unable to benefit from its oil revenues. As a result, the U.S. would be in a superior position in the world oil market.