The Fuse

Market Intervention: The Cause of, and Solution to, All Oil Supply Challenges

by Leslie Hayward | June 21, 2018

Saudi Energy Minister Khalid al-Falih on Thursday made clear his intention to increase oil supply by 1 mbd coming out of this week’s OPEC meeting. Questions have shifted from the number that Saudi seeks to the viability of implementing this increase into the agreement despite opposition from Iran and other price hawks, and how the increase would be broken down between the various members of OPEC+.

But another question humming through Vienna this week is what is motivating the Saudis to boost supply and moderate prices. Analysts think some portion of Falih’s speech was geared toward President Trump, who has singled out OPEC as the culprit for rising gasoline prices.

Coincident with Trump’s attacks is the resurgent NOPEC bill, or No Oil Producing and Exporting Cartels Act, which sailed through the House Judiciary Committee last week. “This legislation makes the Organization of the Petroleum Exporting Countries (OPEC) subject to U.S. antitrust law by removing state immunity shields created by judicial precedent,” says the legislation’s webpage.

Analysts think some portion of Falih’s speech was geared toward President Trump, who has singled out OPEC as the culprit for rising gasoline prices.

Chairman Goodlatte commented, “The purpose of antitrust law is to protect consumers from behemoths in any industry that threaten competition and control prices. The fact that OPEC has not been held accountable for its cartel behavior makes a mockery of U.S. antitrust law, threatens the American economy, and has the potential to harm our national security. I applaud Representatives Chabot and Cicilline for their efforts to put an end to OPEC’s anticompetitive behavior and urge the House of Representatives to pass this legislation quickly.”

OPEC’s Trump challenge

While Presidents Bush and Obama were expected to veto previous iterations of NOPEC legislation, the bill’s chances “have never been better,” according to Bob McNally, President of the Rapidan Energy Group.

According to Bloomberg, the bill is a “fat-tail risk,” with low chances of passage but enormous implications, enabling the U.S. to sue the cartel for reparations for market manipulation.

To mitigate that risk, Saudi Arabia and Russia are now focusing their efforts on deflecting negative attention by boosting production to moderate prices now that the U.S. summer driving season is in full swing. For U.S. lawmakers, this may be enough to deflect attention and delay action of the bill, on the back of calls from Senators Chuck Schumer, Maria Cantwell, Bob Menendez, and Ed Markey to increase production.

Delayed reaction

Is asking OPEC to solve the problems it has created through its market intervention with more of the same the right approach? Let’s not forget how we got here.

OPEC itself is responsible for disrupting the investment cycle and eliminating the inventory overhang in record time. The tighter market conditions have been accelerated by unanticipated supply disruptions and exacerbated now by Venezuela’s rapidly declining production and the anticipated return of sanctions on Iran’s oil sector. Barclays analyst Michael Cohen points out that “though OPEC’s cuts are well suited to removing the inventory excess, the same actions have undermined market stability. If stable markets is what OPEC seeks, that certainty is more likely to result from allowing market mechanisms to work rather than keeping the market guessing about what the next six months will bring for the 2-3 months leading up to a meeting.”

The U.S. has remained complacent, watching OPEC intervene in the market, bolster prices to meet its own ends, exercise blatant market control by allocating quotas, unwind an inventory overhang, formalize its cooperation with Russia and consolidate its grip over global supply.

Other market observers anticipated the current situation as early as 2014. Gareth Lewis-Davies of BNP Paribas told CNBC in November of that year that OPEC had “disturbed” the recent cycle of production and investment. In late 2016 and early 2017, Adam Sieminski, former administrator of the EIA, commented that OPEC’s market intervention was a major factor contributing to a “Decade of disorder” in the oil markets in the 2020s. In March 2017, Ed Morse of Citi pointed out that OPEC had intervened to solve a problem that did not exist, instead accelerating a tightening in fundamentals and boost producer revenues, was mostly self-defeating and caused fundamentals to become “unbalanced.”

According to SAFE’s SVP of Policy, Jonathan Chanis, “OPEC’s efforts to keep the market undersupplied, its refusal to open most of its acreage to private oil companies, and its general lack of competency in balancing investment with demand have made the markets more volatile and less secure for energy consumers. The famous 1973 Foreign Affairs article heralding the impending oil supply crisis was titled: ‘This Time the Wolf Is Here.’ Well, it is slightly too early to say the wolf is once again at the door, but he is certainly circling the house.”

The U.S. has remained complacent, watching OPEC intervene in the market, bolster prices to meet its own ends, exercise blatant market control by allocating quotas, unwind an inventory overhang, formalize its cooperation with Russia and consolidate its grip over global supply. With prices having broken out of a comfortable range, U.S. policy makers are now asking OPEC to solve the problems it caused.

Now, OPEC faces one of its most daunting challenges yet—appeasing U.S. lawmakers, without appearing to be motivated by fear of Trump to do so, while keeping prices within a range that suits all their members. The challenge for American policymakers is even greater—how to break out of their dysfunctional relationship with OPEC, and oil, for good.

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