Cutting oil production will not solve OPEC’s problems

Cutting oil production will not solve OPEC’s problems
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As oil prices continue to fall, OPEC faces a dilemma at its meeting in Vienna on 27 November. Members must decide between decreasing production that will support the oil prices but also consequently the US shale oil industry, and maintaining current levels of production that will lower oil prices at a potential cost for political stability.

The largest drop in oil prices in the past five years created a stir among the members of the prestigious energy club. At the moment OPEC controls 40% of the word’s oil production, with a daily production of around 30 million barrels. However, its market position is far from safe.

The surge in the US’ unconventional oil production, along with stagnating global demand, has caused an oil glut of 2 million barrels per day and a sudden slump in oil prices. Since June 2014, prices have dropped by 30% to less than $80 dollars per barrel of both Brent and WTI crude.

The drop obviously caught the oil producers by surprise, and OPEC members will have to decide whether to retain the current production levels or significantly cut output. Both choices carry major risks.

The significant cut of about 500 000 to 1 million barrels would inevitably bring oil prices close to their pre-June levels, but in the long term would not solve the fundamental problem of OPEC losing control of the global oil markets.

As a result of the shale revolution, the US is already pumping more than 8 million barrels of oil per day, compared to five million barrels in 2008. Consequently, the share of US crude oil imports from the OPEC members has already dropped to a 30 year low, and with the US oil production still on the rise and the crude oil export ban firmly in place, the OPEC’s market share in the US will continue to decline.

An expected increase in prices following potential cuts in OPEC production would give more incentive for US producers to enhance their production targets and start to bite into the cartel’s market share outside North America. The US has already re-started exports of Alaskan crude oil to South Korea and more US companies are circumventing the export ban by shipping a lightly processed oil condensate to Asia and Europe, which could soon reach 1 million barrels per day.

It will be equally difficult for OPEC oil ministers to agree on cuts on 27 November in Vienna. High oil prices benefited the budgets of oil exporters during the past decade, and the OPEC countries are no exception.

However, some countries are more dependent on oil incomes than others. Whereas the rich Gulf countries with high foreign currency reserves can sustain longer periods of low oil prices, countries like Libya, Venezuela, Iran or Nigeria cannot afford to lose their oil revenues, and will fight vigorously to cut OPEC’s overall production but with minimal cost to their own production quotas, which will put additional pressure on the organisation’s informal leader, Saudi Arabia.

The Gulf kingdom will be careful not to repeat its mistake in the 1980s when a decision to shrink production resulted in a prolonged period of low oil prices. In addition, the cuts, along with the price upsurge would only give advantage to US producers. This gives an indication that Riyadh will not react to the increased cut demands from its OPEC peers. With low production costs and a secure cash cushion, Saudi Arabia is still in a comfortable position to cautiously assess its future moves.

Regardless of the outcome of Thursday’s meeting, the oil markets are experiencing significant changes and all players will have to adapt to new circumstances. However, the immediate collateral victims of the prolonged oil price slump will be the countries that heavily depend on oil prices to patch their budget holes, which might have a disastrous effect on their fragile political stability.

About Author

Ante Batovic

Ante was previously a lecturer in International History at the University of Zadar where he specialised in Cold War and East European history. He was also a visiting fellow at the LSE IDEAS centre and the fellow of the Robert Schuman Foundation in the European Parliament. He holds a master’s degree in Global Politics from the London School of Economics and a PhD from the University of Zadar.