The plan for OPEC and its allies to institutionalize a “Super OPEC” group may be formalized by the end of this year. The charter of the new organization is currently in draft form, and its goal is to strengthen the Vienna Group, an organization of 24 producers that is now restricting supply to lower inventory levels and increase prices.
If OPEC and its non-OPEC partners are able to form an official group, this action would have broad long-term impacts for global oil markets. Right now, the group is working to counter the price effect of U.S. shale growth. But as a result of underinvestment over the past few years, an expected shift in fundamentals that results in a supply gap would put the new producer group—which controls 55 percent of the world’s production capacity—in a position of greater strength.
If OPEC and its non-OPEC partners are able to form an official group, this action would have broad long-term impacts for global oil markets.
The development of so-called Super OPEC (there is no official name yet) into a formal group should not come as a surprise. Since the Vienna Group accord was struck in late 2016, which cut supply by 1.8 million barrels per day (Mbd), market participants have observed deeper integration. OPEC has made it known that it wants to institutionalize the collaboration between itself and non-OPEC oil producing states. The ability of the group to curb supply and increase prices over the past 14 months shows its outsized market power and why continued collaboration will likely be successful.
Russia has been talking to OPEC producers, particularly the Saudis, about restricting supply since early 2016, when prices hit their bottom. The tighter connection between the Saudis and Russia has been one of the most important developments in the oil markets over the past couple of years, as they produce more than 20 percent of the world’s crude.
‘Overbalance’ the market
OPEC’s argument that the Vienna Group serves as a vehicle for bringing stability and transparency to the market should not be taken at face value. On one hand, some analysts expect rapid growth of shale and lower-than-expected demand growth to precipitate a sharp drop in prices. On the other hand, sustained production cuts, continued strong demand, and supply shortfalls from geopolitical risks could prompt a supply deficit. Moreover, the 24 producers have yet to put together a cohesive plan to exit their current agreement or set an official price target. Saudi Energy Minister Khalid Al-Falih said that the group should continue to restrict supply through the entire year, even if it causes a supply shortage. “If we have to overbalance the market a little bit, then so be it,” he said. The alliance gives the Saudis not only more producers they can influence, but also the opportunity to spread responsibility for price volatility.
During its past two supply agreements, OPEC over cut, leading to tighter-than-anticipated markets and sharp prices rises.
During its past two supply agreements, OPEC over cut, leading to tighter-than-anticipated markets and sharp price rises. In 1998-99, the cartel made two rounds of cuts, successfully pushing the market higher and setting the stage for elevated prices throughout 2000s. In 2008, OPEC agreed to a massive 4.2 Mbd reduction. Oil prices rebounded over the next couple of years and consistently traded above $100 from 2011-14. Prices overshooting on the upside again is a stark possibility.
Alliance to last ‘forever’?
The irony of OPEC wanting to formalize the super group is that the cartel has, for the most part, met its goals of lower inventories and higher prices. Saudi Arabia and others, however, want to continue moving forward with cuts—in other words, success has not gone far enough. “My hope is for [the alliance] to last forever,” United Arab Emirates Energy Minister Suhail Al Mazrouei said in an interview with Bloomberg television. Collaboration can “prepare for any unforeseen surprises in the market, to avoid any glut or any shortage of supply.”
The irony of OPEC wanting to formalize the super group is that the cartel has, for the most part, met its goals of lower inventories and higher prices.
The stronger relationships among producers likely stem from the existential challenge posed by shale. Since the dramatic price fall of 2014, OPEC has struggled to handle the glut created by the rapid growth in U.S. output. At its November 2014 meeting, the group decided to produce at high levels in an effort to undermine higher-cost U.S. output. Although shale took a hit, OPEC producers saw their economies deteriorate amid low prices. In April 2016, soon after prices fell below $40, OPEC and Russia sought to freeze output, but the deal fell apart at the last minute. Later that year, however, after a string of meetings between OPEC producers, Russia, and others, they finally struck an agreement. Many market participants had expected the group’s action to fail: Higher prices from the cut would stimulate shale production and ultimately cause a sharp downward correction. But although shale has boomed and capped prices, OPEC was able to reduce the inventory overhang relatively quickly to increase the market above $60 per barrel.
Group’s market influence to increase
OPEC countries, which hold approximately 80 percent of the world’s proven crude oil reserves and make up more than a third of the world’s current supply, are expanding their reach and will likely invite more producers to join the super group. OPEC’s market share has always been a major determinant for its pricing power. Super OPEC, should it become institutionalized, will increase the cartel’s influence—and ultimately its market share—for years and decades to come, particularly when shale reaches its peak and declines. Although they have been caught off guard by U.S. growth, OPEC members and their non-OPEC partners have successfully regrouped and will likely be well positioned when fundamentals eventually tighten even more.