Investing & Day Trading Education:  Day Trading Academy

The Long Global Reign Of OPEC Comes To An End

125px-Flag_of_OPEC.svgAt the meeting in Vienna, Austria earlier this month much to the chagrin of a number of the membership in OPEC (Organization of Petroleum Exporting Countries). it was decided that limits on output for oil would be abandoned at this point. For awhile it looked like the old limit of 30 million barrels a day would simply be increased by 1.5 million, in order to ratify what was actually already reality.

Total exports of crude from member nations was closer to 31.5 million barrels than 30 million for months. A negotiated increase as was the habit in the past among the countries in OPEC, failed to materialize. With no agreement actually reached, it now permits each country to produce and then export as much oil as they wish.

Organization of the Petroleum Exporting Countries

Organization of the Petroleum Exporting Countries

There is already a surplus of 2 million barrels of crude in the global supply. As a result Brent crude the world benchmark, has dropped to the lowest price level since February 2009. In the United States WTI (West Texas Intermediate) is already selling regularly below $40 USD (United States dollar). As the global economy continues to slow down and production of crude increases worldwide, the price for oil will continue to drop.

OPEC was founded in 1960 by five countries which included Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Qatar would join in 1961, followed by Indonesia and Libya in 1962. The United Arab Emirates would join the organization in 1967 and Algeria in 1969. In the next decade, Nigeria would decide to be part of OPEC in 1971, then came Ecuador in 1973 and Gabon in 1975. Angola would be the last new member joining as late as 2007.

From December 1992 to October 2007, Ecuador had decided to suspend its membership. Gabon left the group in 1995 and Indonesia suspended its membership in January 2009, which will now be reactivated next month. So beginning in 2016, OPEC will have 13 countries within its ranks again. The membership may be expanding, but the influence of the group as a whole is in full retreat.

Weekly reports on crude oil inventories or total stockpiles in storage facilities like these tanks have a strong bearing on oil prices

Weekly reports on crude oil inventories or total stockpiles in storage facilities like these tanks have a strong bearing on oil prices

Prices for crude have dropped by 50% since June of 2014. The industry as a whole is in the deepest downturn since the 1990s. Earnings are down for energy companies that were making record profits just a few years ago. Most big oil firms have idled almost two thirds of their rigs as prices have dropped.

As a group these corporations are making deep investments cuts in exploration and production, as global oil inventories continue to rise. Worldwide, more than 200,000 workers in the sector have lost their jobs.

The losses have now spread to the related industries of oil which include the manufacture of oil drilling equipment as well as other goods involved in the production of oil. The glut in crude originally benefited shippers, as buyers moved to replenish inventories at lower prices. However, now that stocks are full, it is getting more difficult to find additional storage space. This will now translate to lower overall demand and a decline in shipping.

The present market in crude is the result of a number of ongoing global changes. On the demand side, the economies of Europe and those in the emerging world have slowed considerably, thus reducing demand for oil. In Europe particularly, energy efficiency in vehicles and in households has increased dramatically.

Wind, solar, and biomass are three emerging renewable sources of energy

Wind, solar, and biomass are three emerging renewable sources of energy

Alternative sources for power have become a major focus of many countries within the region. The race for renewable energy especially in solar and wind has made major strides, with Germany taking the lead. Higher investments in alternative sources of energy by government decree, have become mainstream in many countries across the continent of Europe.

OPEC now controls just 40% of world production of crude oil. There has been some big changes to the industry within the last decade. One of the biggest events to the oil market, is the return of the United States as a major producer.

American production has nearly doubled over the last six years, dramatically reducing the need for imports from the more volatile areas of the world like the Middle East. It has forced traditional suppliers like Algeria, Nigeria and Saudi Arabia to find new customers elsewhere. To date, this has been mostly in oil hungry East Asia.

Athabasca oil sands

              Athabasca oil sands

Canadian output because of the rising production in the tar sands of Alberta, has virtually made North America energy independent. Despite the civil war in Iraq, production has not slackened there since most of the oil fields are located in the southern part of the country, largely untouched by the forces of ISIS (Islamic State of Iraq and Syria). Russian production is also being maintained, regardless of the financial and economic problems the country is now experiencing.

However if oil prices continue to drop, it will force the least efficient producers to cut production. This would include the fracking that is largely responsible for the spurt in American production and the exploitation of the tar sands in Canada.

This new production in North America is one of the reasons that output from Saudi Arabia has been rising. The Saudis would like regain some of the market share that has been lost in the region, by forcing some of their competitors out of business.

The United States, Canada and a number of other countries that have found new ways to develop their oil resources, are not alone in taking a major hit in the energy sector. Brazil and Russia have both become quite dependent on oil revenues, to balance their national budgets and to keep their economies growing.

Even nations within OPEC are suffering. Algeria, Ecuador, Iran, Nigeria and Venezuela all need world oil prices to be much higher than they are now, in order to keep their economies afloat. These nations have been pressing the cartel to cut production, as a way to firm up prices. The problem is the major producers in the Middle East like Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates refuse to do so.

The OPEC headquarters in Vienna

The OPEC headquarters in Vienna

Venezuela needs global prices of crude to be double what they are now, in order to have any hope in bringing order to the present financial chaos that exists in their domestic economy. Over 90% of the national revenue derived from exports, originate from oil. The Venezuelan representative at the recent meeting of OPEC, was asking for $88.00 USD a barrel as the price goal.

Russia needs oil be about $96.00 USD a barrel in order for the 8 million barrels a day that are exported daily, to meet the needs of the government. The central government relies on oil for about 50% of the national budget.

The Iranian regime needs prices even higher. In order to balance their books, oil needs to be over $100.00 USD a barrel. Their industry only becomes truly profitable when prices reach $135.00 USD a barrel.

Some nations in the region like Iraq, need to increase production to pay for the cost of an going war. As the international trade sanctions on Iran end, production there is also expected to increase by hundreds of thousands of barrels a day.

OPEC Conference at Swissotel, Quito, Ecuador, December 2010

OPEC Conference at Swissotel, Quito, Ecuador, December 2010

Saudi Arabia has been pumping at full throttle, in order to maintain their market share in world markets. They claim if they would cut production which would increase global prices, it would mostly benefit competitors. Although this is true, Saudi Arabia has a number of other goals in keeping the supplies of crude abundant and cheap. They are able to produce oil at $30.00 USD a barrel, although long term oil prices need to be between $83.00 USD and $84.00 USD to balance national expenditures.

The government of Saudi Arabia has decided to use oil as a weapon in pursuing foreign policy goals. Mainly in combating the rising influence of both Iran and Russia in the region. Lower prices for crude keep these nations unable to expand their power to its full potential in the Middle East. Lower oil prices did help to bring down the Soviet Union in the 1980s. It is an historic example, that the government of Saudi Arabia has studied carefully. The Saudis are also hoping to put more pressure on the Iranian regime, to limit its support for rebels in Yemen and the governments of Iraq and Syria.

OPEC net oil export revenues for 1972–2007

OPEC net oil export revenues for 1972–2007

It is likely that the Saudis will continue this policy, at least until there is a return of more American and Western military forces to the region. A larger presence by the United States and Europe,would make the royal family of Saudi Arabia feel far more secure in an increasingly dangerous neighborhood.

There will of course, be a financial cost to Saudi Arabia and its allies in the region. It is estimated that they collectively, have lost a total of $300 billion USD this year alone. The huge foreign exchange reserves of these nations, built up over the years of abundance, will see them through the short term.

A big problem arises however, if the price remains low for a longer period of time. Most of the countries in the Gulf have governments that have been able to stay in power, because of the compromise reached with their citizenry. That is the people have exchanged material well being and prosperity, for lack of a voice in the political arena. This arrangement will be under threat, if the monarchies of the Persian Gulf begin to run short of funds.

Graph of top oil-producing countries, showing drop in Iran's production

Graph of top oil-producing countries, showing drop in Iran’s production

Saudi Arabia and its allies in the region are taking another gamble as well. Since there are no longer any production limits, what is the purpose for OPEC? This is far removed from the era where OPEC was able to threaten and undermine the global economy and influence policy makers in Western Europe, China, Japan and the United States.

The oil embargo begun in October 1973, when OAPEC (Organization of Arab Petroleum Exporting Countries) plus Egypt and Syria, decided to reduce crude sales to the supporters of Israel during a local war. It caused global prices of oil to skyrocket. The price went from $3.00 USD a barrel to $12.00 USD internationally and were significantly higher in the United States, by March of 1974 when the embargo finally ended. This was later to become known as the first oil shock.

The second oil shock would arrive in 1979. As a result of the Iranian Revolution, world supplies of crude were reduced by a mere 4%. Even though there was sufficient supplies, it created a widespread panic. Prices jumped to $39.50 per barrel over the next 12 months. It created long lines at gas stations in both the United States and Europe. As with the first shock, the nations in OPEC were able to reap record profits.

Saudi Arabia remains the largest exporter within OPEC. Their contribution at 9.7 million barrels, is near 1/3 of the total output from the group. This alone gives them the power to attempt to forge a agreement or derail one, depending on what they deem to be in the interest of their economy and foreign policy.

Line at a gas station in Maryland, United States, June 15, 1979

Line at a gas station in Maryland, United States, June 15, 1979

Over the years OPEC has seen its total contribution to world oil production drop, but output from this cartel remains crucial to overall global supplies. With the world awash in oil and global production still rising, prices will continue their decent.

A number of governments presently in power, may not survive this latest bust in energy prices. Venezuela, is a primary example of this. It will be difficult in the future to reassemble a consensus within OPEC, to reassign quotas and production limits to member states of this almost now defunct cartel.

Too many nations within the organization now have interests that are in divergence, to maintain an accord to satisfy the majority. In failing to reach an agreement on production, OPEC has largely lost its reason for existence. The 42 year reign that this energy cartel has held over the world economy, is now largely over. A future shock in the interruption of global supplies is inevitable, but it will be hard to convince individual members nations of OPEC, to cut production under those circumstances. It will also be difficult to increase output, since most of them are already in full production mode.

Post a Comment

Your email address will not be published. Required fields are marked *

Call Now ButtonCall Now