Global oil traders are excited about OPEC’s provisional agreement to cut production levels to between 32.5 million barrels a day and 33 million barrels a day. Oil prices jumped around 6% following the September 28 announcement, while energy-related stocks registered a similar boost. Unfortunately, it’s doubtful that any agreement will be implemented and, if it is, that it will hold for long.
This pessimistic analysis is rooted in the nature of the oil cartel itself. First, the power of the Organization of the Petroleum Exporting Countries has been mythologized since its brief success in 1973, when it replaced the Seven Sisters oil companies’ cartel as the most powerful actor in the oil market. However, since then OPEC has invariably failed to act as a coordinated group beyond the very short term.
Second, all cartels are subject to cheating. One member cheating by a little does not undermine the power of the group. But if the majority cheat, then the quotas become irrelevant — this is what has happened in the past with OPEC.
Third, the agreement is at the “headline” level. The devilish details involve getting countries to agree on individual quotas. Quotas for OPEC members have only been in place for one month since October 2007 — that was in November-December 2008. Much has changed since 2007 in terms of production, and it will be nigh on impossible to get agreement. Furthermore, Iran and possibly Iraq will be unwilling to cut their output, while Libya is producing significantly below the level of its 2007 quota and could actually increase output in the short term.
Fourth, Saudi Arabia has previously played the role of “swing producer,” whereby it would cut its production to allow other members to maintain their output levels. However, the Saudis got badly burned by this policy in the 1980s. Now the country is concerned with maintaining or increasing market share rather than with cutting production levels.
Consequently, Riyadh is concerned that if OPEC cuts production and raises oil prices it would merely encourage the relatively agile high-cost unconventional oil suppliers — such as US shale oil producers — to re-enter the market and/or boost production, reducing OPEC’s market share in general and the Saudis’ in particular.
In short, expect oil prices to fall over the next few weeks as markets look beyond the rhetoric.
Dr. Warwick Knowles is the Deputy Chief Economist on D&B’s Global Data, Insight & Analytics team. Based in Marlow, UK, he covers global issues and the Middle East and North Africa for D&B Macro Market/Country Insight Products. Previously he taught Middle East politics and political economy for almost a decade at both Newcastle and Durham Universities and has published widely on regional issues and the hydrocarbon sector.