Is there method behind OPEC’s apparent madness?

Having shown considerable discipline, over the last 5 years, in maintaining production cuts to shore up global oil prices, this year has seen a complete reversal of this strategy. The first step was to restore the 1.6m barrels per day (bpd) of previously halted production and release this onto global markets.

Then in October, the cartel went even further with the announcement that it would actually be increasing oil production by another 150,000 bpd. All of this despite the world being awash with new crude from the likes of Guyana, Brazil and the USA.

Why would OPEC deliberately open the flood gates and create a price war, when the economies of member states can barely breakeven when prices are at $100 per barrel, let alone the kind of predictions that are currently being forecast (sub $60)? Has OPEC lost its mind like a headless chicken turkey, or is there method behind the madness?

“THE CHEATERS AND CHANCERS DAMAGE THE CARTEL’S REPUTATION.”

The answer is no; OPEC has not gone totally mad, and there is some logic behind these moves. Generating a price war drives internal discipline amongst members. The likes of Saudi Arabia, UAE and Kuwait are deliberately looking to punish the “production cheaters” and the “production chancers” within OPEC’s membership.

The “production cheaters” are those countries that do not / did not join in the collective sacrifice of other members when production cuts were introduced. Instead, they seized the opportunity to maximise production and enjoy high volumes at high prices, whilst everyone else was pulling back from the marketplace. The “production chancers” (those members with expensive production costs and who can thus only survive when oil prices are high) were also able to continue extracting oil from fields, that really should no longer be producing.

To the Machiavellian minds at the top of the OPEC pyramid (Saudi et al), the cheaters and chancers damage the cartel’s reputation, and to encourage natural attrition amongst these weaker members aligns well with the organisation’s long-term aim of market control.

The external factors of a price war also play to OPEC’s longer-term strategic position. OPEC producers are sitting on vast reserves of crude that they definitely want to tap into over the next 100 years. The worst situation for OPEC is that these reserves become stranded (i.e., the oil stays underground) and to prevent this from happening, OPEC needs to maintain the attractiveness of oil as a low-price energy source.

Periodically, low prices are required to maintain the price advantage of oil over alternative forms of energy and in a world of rapidly cheapening alternative energy (batteries, solar panels etc.), this is an important tactical goal for OPEC. The unattractive truth is that a worsening global climate is of secondary importance to the economic self-interest of OPEC, and whilst cartel members want high prices because of the immediate riches generated, a low oil price can also be beneficial because that will ensure underground assets do not become stranded.

The most obvious impact of a price war is on OPEC’s competition. By deliberately sinking the market, massive pressure is immediately put on the US shale oil producers. Shale has much higher exploration costs than OPEC production, and the American industry has benefitted greatly from the constraint shown by OPEC members over the last 5 years.

At the same time that the cartel was removing oil from the market (as part of their cuts programme), the USA was simply stepping into the fray and increasing production from 10m bpd in 2020 to 13.5m bpd today. No surprise then, that the US shalers are clearly first in OPEC’s firing line. When prices tanked in 2014, the US shale industry went into melt-down with well-capping, project cancellations and bankruptcies, and this is clearly what the cartel is hoping for this time around.

They would also have reason to be hopeful in this area as most producers remain heavily indebted, partly as a result of reacting with such gung-ho enthusiasm to Trump’s “drill, baby drill” mantra. And increased production from the shale patch only adds to the problem of over-supply, whilst at the same time it is Trump’s tariff programme that has weakened demand and helped cause the over-supply problem in the first place.

“A WORSENING GLOBAL CLIMATE IS OF SECONDARY IMPORTANCETO THE ECONOMIC SELF INTEREST OF OPEC.”

The stage is set then for a fascinating few months ahead. The US President has staked his reputation on taming inflation and, therefore, OPEC’s tactics of glutting the market should in theory be welcomed, as “gas” (i.e., gasoline) prices will drop for US consumers. However, at the same time, Trump is a huge champion of home-grown oil producers, and they categorically do not want oil prices to fall.

Furthermore, the last time we saw a price crash, employment levels plummeted in the largely Trump supporting areas of the American shale patch, which won’t translate well into electoral support. No doubt, the President will come up with the usual verbal gymnastics to glorify the situation, but behind the scenes, the Administration must be hoping that any drops in the oil price are relatively short-lived. On this point, there may be more alignment with OPEC policy than one might initially think.

There is no getting away from the fiscal imperative that exists within OPEC member states for high oil prices, so a deliberate strategy to push oil prices down can surely only last for a few months. Enough time to damage OPEC cheaters, chancers and competitors, but before any real damage is done to the long-term economies of OPEC Member States.

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