OPEC is terrible at Poker

The price of oil continues it’s downward tumble, down over 60% in the past 12 months. Oil is currently flirting with a new $20 handle, bouncing around in the low 30’s. Analysts are updating their price targets, with some even calling for prices to dip below $20 into the teens.

OPEC, who in the past has used their power in the oil markets to set prices, has a stated objective to push out high cost producers in the oil market.

Most analysts agree the high cost producers OPEC is targeting are US frackers and Canadian oil sand producers. Unfortunately for OPEC they have proven to be scrappy producers — finding ways to reduce production cost and borrowing costs to stay in business and pump oil. In fact oil production hit a record in the US in 2015 at an average of 8.7 million b/d, and is projected by the EIA to be to the same in 2016.

To OPEC’s credit, original production quota’s for US crude in 2015 were as high as 9.4 million b/d, so dropping to 8.7 million b/d did remove 700,000 b/d of production. But in the context of a 60% fall in oil prices over 12 months one would have hoped for more.

So what gives?

OPEC is failing with their market communication strategy.

As an avid poker fan (and market watcher) I know the value of deception. And for some reason OPEC doesn’t seem to realize they are in a high stakes game of poker. Letting your opponent know your plan in advance is a sure way to let your opponent plan for the future.

American frackers and Canadian producers have hung on OPECs every word. When OPEC says they are temporarily flooding the market to push out high cost producers -> high cost producers listen, and plan. If you are a high cost producer and believe you can tough it out for the next 12 months and then you’ll see higher oil prices, why not tough it out? Go to your bank, get a loan extension, cut back costs, find ways to produce the same oil for cheaper, and maybe even burn a little cash. Oil is a big investment game. It’s a long term game. And the participants know the rewards of being the last man standing when prices inevitably march higher with an OPEC guarantee.

The outcome? High cost producers stay in the game and production continues to be higher than one would have thought at lower prices. This extends the time needed to push out high cost producers and the size of the decline. And it even starts to put internal pressure on OPEC!

For internal discord in OPEC you don’t have to look far. The Nigerian oil minister coming out recently arguing that their may be room for a meeting to discuss oil prices before the scheduled OPEC meeting this summer. Immediately afterwards the oil minister from UAE said no such meeting was needed. He believes that prices would recover in the next 18 months after the current market pressure pushes out high cost producers.

So what to do?

OPEC should take a lesson from that other all powerful institution in the financial markets, the FED, and learn a thing or two about communication strategy.

When you want to bully the market to do exactly what you want — in this case remove excess supply — then you commit, commit aggressively, and advertise it like crazy. And of course punish anyone who thinks they can outlast your (almost) limitless liquidity in the market.

The OPEC prescription:

1. Set production targets for oil globally — basically identify how much supply you want removed and say you’ll keep prices low until this supply is cut.
2. Remove any and all language specifying an exit strategy. Don’t say, “in about 12 to 18 months”, don’t say “soon”. Instead say, “We are gonna keep the pain on until it breaks, forever if necessary”. This out to clear out any investment interest in the space.
3. Tell everyone over and over. Tell producers. Tell consumers. Tell banks. Tell trading partners. Tell anyone who will listen that they are an idiot for funding new oil projects or existing oil projects who you deem to be high cost suppliers. Make it your business to tell other people fighting you is a losing game.
4. Start immediately with the OPEC prescription. The longer you wait, the more it hurts your own producers.

Aggressive? Yes. But better than dragging out an over supplied oil market and inducing more bad investments and loans in a sector of our economy that even the largest producers see as over saturated. Who knows, maybe some of those oil investors will turn to the sunnier pastures of renewable energy? One can always dream!