The end of OPEC as we know it?

The end of OPEC as we know it?

Saudi Arabia’s decision to reduce its dependency on oil is the final acknowledgment that the Kingdom’s global swing producer role is nearing its end. The decision will have long-standing consequences for OPEC and oil markets.

The past two years have not been easy for OPEC; the low oil prices that hit the markets in June 2014 have had a disastrous impact on its members’ budgets, and created difficulties for the oil industry in general. The current crisis is not a mere reflection of supply and demand volatility, but of a structural shift that came with the U.S shale revolution. The rise of American non-conventional oil production caught the world by surprise, and quickly transformed OPEC-dominated oil markets.

Not your father’s oil glut

The process is comparable only to the North Sea discoveries that caused a similar oil glut in the 1980s. However, both the circumstances and OPEC’s reaction are slightly different this time. Unlike 30 years ago, and probably having the 1980’s experience in mind, OPEC and Saudi Arabia decided not to reduce production, but instead sought to focus on preserving their market share.

The logic behind the move was that high-cost producers, primarily the U.S shale sector, would not be able to survive the period of low oil prices for long. The logic proved to be correct, but Riyadh hugely underestimated the resilience of the U.S oil industry.

Two years into the crisis, the U.S shale sector is going through a difficult period of restructuring, with 59 oil companies already having filed for bankruptcy. However, production has fallen only slightly so far, due to improved productivity and deep cost cutting. The decreasing trend will continue and probably accelerate however, which will eventually contribute to global supply and demand rebalancing, and an increase in oil prices, perhaps as early as 2017.

But despite current woes, the U.S shale sector has strong prospects. The development of a new shale play, although in price comparable to offshore projects, takes less than a year, and North American shale has the shortest payback time of all global oil developments. In such circumstances, the U.S oil industry will have the ability to quickly restart production once demand and prices pick up.

The future of OPEC

The key victim of the current oil slump would be deepwater offshore projects, which take seven years on average to develop. According to the consultancy IHS, discoveries of new oil reserves have dropped to their lowest level for more than 60 years, and if the new discoveries rate does not improve, the world might experience a shortfall of around 4.5 million barrels per day by 2035.

What does this mean for the future of OPEC and oil markets? Although its members would individually remain important players in global oil markets, in essence the cartel has lost its privileged ability to control global oil prices. This will undoubtedly weaken its cohesion, and potentially affect the political dynamics in the Middle East.

In geopolitical terminology, with the ascent of U.S shale, the world of oil has shifted from unipolarity, dominated by OPEC, towards multipolarity, where Saudi Arabia, the U.S and Russia, along with other smaller producers, compete for market share.

In the short-to-medium term, such a scenario will eventually prop oil prices as oil production would continue to fall. Even so, with increased competition, it is hard to expect that prices will reach pre-2014 levels any time soon. In the long-run the lack of an organised effort to control prices might bring further volatility to oil markets. In addition, the global move towards a decarbonised economy will put more pressure on oil producers.

One positive thing that might come out of these trends is the realisation among oil dependant economies that diversification is key for the future economic sustainability in the low-price oil environment. Saudi Arabia is in a good position to successfully achieve this. But the majority of cartel’s members will have to go through a painful period of transition.

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.