What history tells us about OPEC+ and how oil prices may evolve
One may safely assume that Saudi Arabia and Russia have tasked some of their best people to review the options for OPEC+, the love-hate alliance of OPEC and Russia. Similarly, one may assume that some of the learnings from the past have burned themselves into the memories of the senior policy makers in both countries.
This may inform us as to what we may expect in the days to come.
In the following I summarize what the learnings were.
Pre-1986: Saudi-Arabia can’t alone carry the burden of market management
The market share of OPEC increased steady year by year up to 1978. By then the OPEC-production reached 30 million barrels per day. Now OPEC had the ability to restrain volume and raise prices. The prices increased, way above their long-term trend.
However, as one would expect, the market responded, albeit slowly. An immense shift away from oil as a base for power generation was triggered. Once and for all, forever, the oil industry lost the power generation industry as one of its main outlets. Furthermore, new upstream resources were unlocked, notably the OECD-offshore industry. A pattern had been set.
Consequently, OPEC had to slash its volume year by year, down to about 15 million barrels per day to keep prices up. Saudi oil production was reduced from 10,3 million barrels per day in 1980 to 3,6 in 1985.
In 1986 volumes were again increased and prices fell.
A decade was though needed to restore even only half of the OPEC market-share loss.
Up to 2012: Be careful as to what you ask for
The full cost of producing oil from unconventional reservoirs in the US vastly exceeds the production cost in most OPEC-countries. The density of the rock in some US provinces match the density of a gravestone. Still, with new technologies, dense drilling, injection of water at pressures as from explosions, the rock can be blown in fragments, fracked, and the oil released.
All knew such reservoirs contained oil. A period with high prices was though needed to mobilize the capital, build the experience and retain the talent needed to move down the learning curve. The high prices of 2008 and again 2010-2013 was what made the development happen.
Again, a period of high prices backfired and led to vast losses for the oil producers.
2014: All will bleed if one tries to outcompete US shale
Some US fields require an oil price of 35 USD per barrel to be profitable, some 40, some 45 and so on. Anyway, so far US investors have been willing to allocate vast amounts of capital into a graveyard of capital returns. But the resilience is immense.
The collapse of the oil prices in 2014 dampened the growth, but US production only fell by less that half a million barrels from 2015 to 2016.
While the cost to the OPEC was immense. Thus, I believe all in OPEC, if they carry the OPEC-hat, will advice against an attempt to outcompete US shale.
October-2014: Sometimes noise may serve a purpose
I remember attending the Oil & Money conference October 29th, 2014 as a speaker. A spokesman from one of the largest producers of the world though had a more interesting speech. He announced a ramp-up of production. He said his home country couldn´t and wouldn´t carry the responsibility of managing the prices to the benefit of the large Western oil companies.
After his speech, an interesting incidence occurred. The Head of Strategy and M&A of a large Western oil company, stepped forward, and basically asked; “How can you do this to us?”.
“You need to understand the problems you cause us if you create uncertainty. That will place our project returns at risk and will become an impediment for our large projects,” the strategist continued.
“Exactly,” said the representative with a smile.
2015 and 2016: Macroeconomics matter
OPEC and Russia need whatever revenue they can get. Oil & Gas represented about 45% of the Russian exports in 2017. It ran a surplus of about 3% on its current account. Hence, a 25% drop in oil prices places it solidly in the red. The comparable Saudi figures were 65% and, again, 3%.
January 2020: OPEC already under pressure
US-shale production increased by about 1 million barrels per day from January 2019 to January 2020. Other non-OPEC as Canada and Norway added volumes, with Norway being the second largest grower globally after the US. The core OPEC-countries cut by about 1,5 million barrels per day. Russia contributed with a small cut, about 0,1 million barrels per day.
Then, along came the Corona-virus and a mild winter in most OECD-countries. Now, demand was down by about 3 million barrels per day.
1998 and 2008: Success and failure in addressing a crisis
The OPEC-response to the 1998 Asian crisis was slow and non-decisive. Oil prices fell to 10 USD per barrel. In contrast, as the crisis hit in 2008 OPEC acted more forcefully.
“The decision was straightforward,” said Saudi Oil Minister Ali al-Naimi after OPEC met October 24th, 2008, to slash production by 1,5 million barrels per day. One month and nine days after the Lehman collapse.
With all the pieces of the puzzle on the table the puzzle can be completed
Rationality steers oil and gas. However, the short-term price elasticity of demand and supply is very modest. Vast price movements are needed to clear markets. This explains the volatility, at every occasion, when prices deviate from the OPEC-defined corridor. Outside the corridor, prices may go immensely high or low.
The range of the corridor appears pretty clear, as is the volume allocation needed to stay in the corridor. For us kids that have messed it all up, its easy to see what the adults must do to bring it all back in good order.
This time even more is at stake and as the main cause is a shock from the outside the basis for an agreement may be less complex to find.