Crude Oil - The Cartel Takes a New Shape

Oil price decline
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OPEC, the international cartel of oil-producing nations, always has an important influence on the price of the energy commodity. The thirteen nations that comprise the cartel all have different interests at stake when they discuss production policy and sometimes those interests are at odds. Recently, there have been important changes in the leadership of the dominant oil producing nation in the cartel, and those changes are likely to affect the future of OPEC.

Crude Oil Fell, and OPEC Said Let it Go Down

When the price of oil began to fall from over $100 per barrel in June 2014, the cartel became the focus of producers and consumers of petroleum around the globe. Since OPEC member nations control more than half the world’s oil reserves, a production cut by the cartel would likely have been supportive to prices. However, when the group met in November 2014, they did not cut production. Instead, the group led by the world’s largest producer of oil Saudi Arabia told the world that lower prices were the result of new high-cost production, particularly shale production in North America. OPEC took the position that a lower oil price would make high-cost production uneconomic and result in a higher market share for the cartel membership. At the time of the meeting, the price had declined to around $75 per barrel, and it fell dramatically on that news.

Crude oil, which had been above $107 per barrel in June 2014, fell to lows of $42 in the wake of the meeting in early March of 2015.

OPEC meets twice each year, and the violent plunge in the price of oil led the world market to believe that the cartel might act at their next meeting. Many oil-producing nations within the cartel complained that their economies were falling apart under the weight of lower oil prices.

The price of crude oil rose to $62.58 in May 2015 and remained around the $60 level in anticipation of the gathering until the group got together once again before summer. When they announced no change in oil policy once again and reiterated their call for lower prices to force high-cost production from the market, the price fell to $37.75 per barrel on August 24.

With the fall meeting in October on the horizon, the price once again appreciated, but this time only to the $50 per barrel level. At the next meeting, OPEC ministers went one step further, pushed by the Saudis; they said that since other nations around the world did not have a production ceiling, there was no reason for members of the cartel to adhere to one. While the unofficial ceiling of production by the members of OPEC was at 30 million barrels per day, they were producing around 31-32 million at the time of the late 2015 meeting. In response to their position to build market share via lower prices, oil dropped once again, this time to $26.05 on February 11, 2016, the lowest price since 2003.

The Politics of Oil are Complicated

There are many factions within the world oil cartel complicating policy decisions. Saudi Arabia is the leader as they are the largest producer and have the other Gulf States such as Kuwait and the UAE as allies within the organization.

Iran is also an important member. The nuclear non-proliferation agreement with the West in late 2015 resulted in opening Iran to the West. For many years, the nation had been subject to sanctions, and now that this era was ending the Iranians stated that it was their right to increase oil production. At the same time, weaker member nations like Venezuela, Algeria, Nigeria, Angola, Ecuador and others put pressure on the stronger cartel members to cut production and shoulder the majority of those cuts. However, Saudi Arabia and other stronger nations refused to cooperate with the weaker members. The production cost for oil in Saudi Arabia is around $10 per barrel, the lowest in the world, giving the Saudis tremendous power in the world oil market.

In February 2015, when crude oil was trading close to the lows, a group of four nations representing diverse interests in the oil market met.

OPEC members Saudi Arabia, Venezuela, and Qatar attended the meeting. Qatar had often served as a mediator between the Saudis and Iranians who have a difficult relationship and had ended diplomatic relations in January 2016 for political and religious reasons unrelated to crude oil. At that meeting was the world’s second-largest producer of oil, Russia, a nation that is not a member of the cartel but a close ally of Iran. The group of four oil-producing nations discussed the potential for a production freeze at the January 2016 level. They organized a second meeting and scheduled it for mid-April of 2016 with invitations to most if not all cartel members and producing nations. Iran, Brazil, and Libya did not attend the meeting. As the meeting approached the price of crude oil rallied once again to above the $40 per barrel level.

On April 17, 2016, in Doha, Qatar, the Saudis took the position that unless all nations agreed to cooperate with a production freeze they would not. With a refusal from the Iranians to cooperate, the talks fell apart with no result. This time, in the aftermath of the meeting, the price of crude oil did not fall. It remained between $40-$45 per barrel throughout April and into early May. At first, a strike of oil workers in Kuwait on the day following the meeting caused an immediate disruption in supplies. However, news that U.S. production finally fell below 9 million barrels per day gave support to the Saudi insistence to build market share, and the price did not fall as a result of the decline in North American shale production. At the June 2 OPEC meeting, the policy of no freeze and no output caps remained in force. Crude oil had appreciated to the $50 level at the time of the cartel’s gathering and remains strong after marking a change from the three previous official meetings.

Huge Changes in Saudi Arabia Mean Huge Changes in OPEC

Saudi Arabia has taken a tough and consistent position regarding all other oil production in the world. They believe that a lower price will eventually build their market share of the world oil markets and the share of other OPEC members. A new Saudi government took the throne in early 2015 with the death of King Abdullah. The new monarch, King Salman, has put Prince Mohammed bin Salman (MbS) in charge of the Saudi economy. As a response to lower oil revenues, the government cut back on social services and raised domestic energy prices. Prince MbS outlined his ideas for the future of a Saudi economy that was independent of the price of oil in late April 2016 in his “Vision 2030”. He called for the creation of a sovereign wealth fund of $2-3 trillion. The nation will sell up to a 5% of its state oil company Aramco via an initial public offering in the stock market. The Saudi government and monarchy will use that money to invest, diversifying their economic future away from crude oil. The vision for the future of the monarchy included vast social changes.

At the beginning of May, in a further sign of economic changes within the Kingdom, King Salman announced a change in the succession plans to the younger generation. He appointed he nephew 55-year old Mohammed bin Nayef crown prince, the next in line to the throne. At the same time, he promoted his son, Mohammed bin Salman (MbS) as second in line to the throne or deputy crown prince. The son of the King has been in charge of the military and economic changes in the nation. At the same time, he replaced the 80-year old Saudi oil minister, Ali al-Naimi with Khalid A. Al-Falih, the current chairman of Aramco. Al al-Naimi has been a fixture on the international oil scene for decades, and his departure marks a huge change in policy toward OPEC and the world. These moves virtually guaranty a continuation of the Saudi oil policy of no production cuts or freezes unless all producers agree to one.

The evolution within Saudi Arabia marks an important change for the world’s oil cartel. The Saudis live in a troubled and violent area of the world where their many enemies would like to see an end to the monarchy in the nation that is home to the two holiest sites in Islam, Mecca, and Medina. The U.S. agreement with Iran, an arch-enemy of the Saudis, has caused the Saudi government to find ways to forge stronger ties with allies around the world. One of the strategic reasons for lower oil prices could be to force less U.S. production and more dependence on Saudi oil reserves. U.S. protection of the Saudi Kingdom due to their position as the world’s number one producer of the energy commodity with massive reserves would then become a necessity for the United States. The actions of the Saudis in response to a falling oil price and the changes in the structure of their government are likely to change and consolidate Saudi power within OPEC.

The Middle East is the most politically turbulent area in the world, but more than half of the world’s oil reserves sit in this region. The Saudis appear to be doing everything they can to diversify away from dependence on the oil price for revenue flows, consolidate their power in the region by constructing alliances based on their natural resource reserves, and shelter themselves from those who wish to see a change in Saudi leadership in the region. When the most powerful member and leader of the cartel undergo important changes within its leadership and government, the cartel is likely to take a new shape, if it continues to exist at all in the future.

The price of any commodity ultimately depends on supply and demand. However, supply and demand change according to price and the Saudi government seems to be working to control the oil market mechanism as they are the world’s top producer. As of the latest OPEC meeting the Saudi strategy appears to be working and the price of oil was around $50 per barrel.