Almost a year ago, the Organization of the Petroleum Exporting Countries (OPEC) made a decision to keep crude oil production unaltered, raising doubts about the cartel’s role in the current oil market. This year, the organisation’s annual meeting, scheduled for 30 November, will probably lead to a policy shift, with the cartel reportedly looking to introduce some limits. Whatever the outcome, it does seem as though the effect of OPEC’s decisions on oil prices will be limited, as the global oil market moves towards supply-demand balance and oil becomes more expensive even without external intervention.
Cartel agrees to limit oil supply, but who will bear the brunt of the cuts?
In September 2016, OPEC reached an agreement in Algeria to curb oil production, by 700,000 barrels per day (bpd), for the first time since 2008. The agreement is expected to be finalised at the organisation’s annual meeting, which is due to take place in Vienna this November. In reaction to the rather unexpected decision made in Algeria, crude oil prices jumped by more than 6%. However, the agreement is not likely to have a long-term effect on crude oil prices. Moreover, it seems that the agreement is still actually a long way from being successfully implemented.
First and foremost, OPEC has agreed on the total amount of oil that has to be cut from production; yet, it is not clear how the reduction will be split among members. Considering that the cartel is made up of very different, and often competing, countries, including regional rivals Saudi Arabia and Iran, the task of sharing cuts is not likely to be smooth or easy. The details will be discussed at a series of meetings and are expected to be concluded by the time of the annual gathering in Vienna. Iran has already hit the brakes, stating that it will only consider production limits after it ramps up its own output to projected four million bpd and above. Another large oil producer, Iraq, on the other hand, has expressed dissatisfaction with the proposed quota system, insisting on basing production levels on self-reported figures, which are expected to be inflated and not reflect real production volumes. Both countries have refrained from attending the intermediate OPEC meeting in Istanbul in October.
Demonstration of significance
Even if OPEC members manage to put aside their differences and reach an agreement, there are a couple of other factors that raise doubts about the effectiveness of the decision. Firstly, it is not clear how willing OPEC countries will be to respect the agreement. Most of the cartel members heavily depend on oil revenues and therefore are likely to put internal gains above external obligations, as has happened in the past. Secondly, the reduction is actually very small. 700,000 bpd only makes up a tiny 2% fraction of the global crude oil supply, standing at roughly 33 million bpd. There are reasons to believe that the cartel’s oil production will contract slightly even without external limitations. A seasonal decline in demand will result in OPEC members reducing their oil production outputs in autumn anyway. In addition, some member countries are already experiencing oil production downturns. Oil facilities in Nigeria have suffered from attacks by local militant groups, while Venezuela’s production is rapidly contracting as a result of political instability in the country. In other words, OPEC is already about to produce less crude oil. In this situation, pledges of production cuts look more like a demonstration that the cartel is still capable of influencing the global oil market and prices, rather than a real initiative.
Fundamental market forces will play leading role in oil price growth
Whatever the outcome of the meeting in Vienna, global crude oil prices will continue to rise, but they will be determined by market forces rather than OPEC policies. The gap between oil supply and demand is decreasing, as the number of active oil rigs is declining globally. Current oil prices are still insufficient for any significant investment inflow, so supply will continue to contract, approaching growing demand and pushing prices up. Euromonitor International expects the Brent oil price, currently staying just below USD50 per barrel, to cross the USD60 mark by the end of 2017.