Going into the November 27, 2014 OPEC meeting in Vienna, many seasoned market watchers and some OPEC members expected the group to cut output and lift prices, which had fallen from $115 per barrel in June to $77 per barrel just before the meeting. It was assumed that OPEC’s largest producer by far, Saudi Arabia, would save the day. It politely declined.
Prices tumbled into January falling as low as $45. OPEC will meet again this week on June 5 but this time the mood is much different. Attendees are expecting a short, uneventful meeting, with no cuts or quota agreements. Brent is cheaper now (at $65 per barrel) than it was before the November meeting, but—for Saudi Arabia and OPEC—the market landscape looks too familiar to take a chance.
Late last year, OPEC was unusually powerless, non-OPEC production trends were rising steadily, and the size of the market glut meant quick fixes could not be counted on. Leading up to the meeting very little attention was paid to the constraints of most OPEC members, especially the major producers. Of course OPEC should have done something to lift prices. That’s what it was designed to do.
So why didn’t it act then? Why won’t it act on June 5?
The simple answer is that very few can do anything. Saudi Arabia entered the November meeting with production at about 9.7 million barrels per day (mbd). It was willing to consider cuts, so long as it would not have to act alone. Cutting some with the help of the UAE and Kuwait may have been an option but not a very good one. Three members, representing roughly half of OPEC’s daily output, would have been asked to bail out the other nine members—and their competition.
OPEC was uniquely powerless then and it remains so today.
OPEC was uniquely powerless then and it remains so today. Iraq, OPEC’s second largest producer, cannot afford to cut production while fighting a costly war against ISIS. Iran is equally resistant because it expects oil sanctions to be lifted this year. The only other major OPEC producer that might have room to cut, albeit not much, is Venezuela. But fellow members have good reason to doubt Venezuela’s commitment. Going into November, the country did not report official data for months and its economic crisis has only deepened since then.
The six remaining OPEC members all produce significantly less and none are prepared to cut because their output is naturally declining or because their financial situations dictate against it. Nigeria, Angola, Algeria, Qatar, and Ecuador simply cannot contribute. Total chaos in Libya means it will pump whatever it can—but it can’t make any promises.
In fact, U.S. production continues to rise, in spite of lower prices and falling rig counts.
Popular estimates hold that the market remains oversupplied by about 1.5-2 mbd. Assuming a cut of that size would “balance” the market today, the natural next question is: For how long? With U.S. oil production surging and Russian output hanging around post-Soviet highs, the Saudis had little reason to believe that a few OPEC members could stem the tide of non-OPEC oil in late 2014. Market fundamentals haven’t changed significantly since then. In fact, U.S. production continues to rise, in spite of lower prices and falling rig counts.
In a March 4 speech, Saudi Oil Minister Ali al-Naimi made it clear that “it is not the role of Saudi Arabia, or certain other OPEC nations, to subsidize higher cost producers by ceding market share.” Saudi Arabia isn’t doing favors for its competition, nor is it flooding the market. Production and exports were steady in 2014. Saudi production climbed to a record 10.31 mbd earlier this year thanks to increased demand in China, India and South Korea. Exports to the U.S. have also recovered recently.
Iranian and Russian officials love this argument because it absolves them of any responsibility.
There’s another theory for Saudi inaction: Riyadh drove down prices to hurt Iran and Russia, countries that back the Assad regime in Syria, which the Saudis wish to see toppled. Iranian and Russian officials love this argument because it absolves them of any responsibility. Iran and Russia are not bystanders in the market; they could buoy prices by cutting output along with OPEC. However, neither is willing to do so. (Conspiracy theorists haven’t offered a good explanation for why Riyadh would believe Moscow and Tehran are uniquely vulnerable now, when both regimes have endured price collapses before.)
It is true Saudi Arabia has cut production significantly in the past. It did so in concert with OPEC, when demand fell off dramatically during recessions in the ‘80s, ‘90s and late 2000s. As the sole swing producer with spare capacity it also raised production quickly in times of crisis. But Saudi Arabia’s apprehensions about cuts were telegraphed well in advance.
As early as December 2013, an unnamed Saudi official ruled out unilateral cuts to balance the market. “Saudi Arabia is done with its role as swing producer,” the official told Dow Jones on December 12, 2013. “It is not Saudi Arabia’s role anymore to adjust output to protect the market or balance [it]. It is the [responsibility of] OPEC.” The unrelenting surge in non-OPEC production, driven mostly by U.S. shale, prompted the Saudis to take this logic a step further in 2014. They want non-OPEC producers to share the pain.
It’s easy to imagine a scenario in which a few OPEC members make cuts, only to be asked to do it again and again.
It’s easy to imagine a scenario in which a few OPEC members make cuts, only to be asked to do it again and again. Saudi Arabia saw it happen in the early 1980s, when it slashed output by 75 percent—to below 2.5 mbd—while other OPEC members cheated. Instead of trying to balance the market for a limited time, the Saudis are betting that low prices will force high-cost producers to dial back. They’re also convinced that cheaper oil can lift demand over the long-term, making room for everyone in a crowded market.
“From my perspective, demand is gradually rising, global economic growth seems more robust and the oil price is stabilizing,” Naimi said in March. When Saudi officials say there is room for everyone in the market, they aren’t being disingenuous—they’re being optimistic. After years of supply growth outpacing demand growth, the Saudis are waiting for demand to catch up, while OPEC has no choice but to wait with them.