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Time for action from Opec

Saudi Arabia’s oil minister says Opec will take “any possible action” to stabilise the market. The group should cut, now

The plan to recover market share, force rival producers out of business and wait for prices to bounce back has failed and is creating the conditions for a damaging price spike later this decade.

Another boom, forced by the supply gaps that will emerge from the colossal withdrawal of upstream spending, might sound tempting for producers struggling with sub-$50-a-barrel Brent. But it would be a disaster for the industry, giving the decisive push for alternative energy sources and signalling oil’s eventual obsolescence.

To avoid this, Opec and any other producer it can cajole into action—Russia, for a start—should act now.

This means not just a freeze in production at high levels; and not just tweaks or trims. It means cuts. Quotas, independent verification—the whole shebang. Opec should do it as quickly as possible.

Free-marketeers would hate this. American drivers burning through gallons of cheap gasoline would bleat. Donald Trump might say outrageous things about the Middle East. Some nasty regimes would get more money. So be it.

The past 22 months, since Riyadh’s fateful November 2014 decision to “take its hands off the tiller” (in the words of one senior advisor), show that without Opec’s attention the market is a wild place.

The slump has crippled oil heartlands, from Alberta to the Orinoco, the North Sea to the Bakken.

Even the Gulf’s economies are struggling. In Libya, Nigeria, Venezuela and Iraq, the price collapse has exposed structural failures, deepened conflict and threatens destruction.

For consumers, the magical impact of falling oil prices, which in the past buoyed big consumer economies’ GDP, has faded, overtaken by bigger macroeconomic forces and the legacy of the global financial crisis. The cheap-oil demand surge is over.

Consumption rose by 1.9m b/d in 2015, but this year it will grow by 1.4m b/d and in 2017 by just 1.2m b/d, says the International Energy Agency.

If sob stories from other producers won’t persuade Opec, the market’s behaviour should. Many forecasters, including those within the group, were confident that the so-called “rebalancing” would be well underway by now.

Instead, Opec and other producers have continued to pour oil onto a weak market. Despite the drop in US output, record-high output numbers from Saudi Arabia, a surge of production from post-sanctions Iran, growth in Iraq and the resilience of Russia’s oil sector, mean the world remains amply supplied.

Superfluous reserves

OECD crude oil stocks remain well above their five-year average, even if the global glut is gradually shifting to products. The loss of Libyan and Nigerian output has been ignored. The decline of American tight oil production has reached its nadir, and well-productivity is sharply higher. When Ali al-Naimi, the architect of this policy, talked of forcing “inefficient” producers out of production in December 2014, he didn’t expect them simply to become more efficient.

Opec met 32.9% of the market’s demand in November 2014. In July, the number was 34.7%. That’s a meagre gain for a policy that has cost it billions of dollars in lost revenue, ruined some members’ economies and, by blowing apart upstream spending plans, is creating the conditions for a destructive price surge in the coming years.

So now is the time to reverse course. Saudi Arabia, keen under new oil minister Khalid al-Falih to revitalise Opec, should abandon Naimi’s policy, recognising that cuts to raise oil prices will benefit the entire sector, including itself.

Obstacles to a deal are plenty, not least mistrust between Riyadh and Moscow. Any deal would have to acknowledge Iran’s capacity target of 4m b/d, implying still more capacity growth. But a quota that accepted Tehran’s plans yet settled on limiting its production to current levels could be workable, especially if Saudi Arabia used its historically high current production as a baseline from which to make the bulk of the group’s cuts.

Opec would have to accept that a rising price would bring more tight oil on stream and cost the group some custom. But that’s what would happen when the mysterious rebalancing actually appears anyway. So why prolong the pain?

Cuts need only be temporary. The deferrals and cancellations of deep-water, oil sands and other pricey-but-high-yielding projects will eventually bring a supply crunch: even if demand grows sedately the world will still need 10m–12m b/d of more oil in 10 years’ time. So a dip in market share would only last until the conveyor belt of projects sanctioned in recent years ends.

In short, enough is enough. Neither consumers nor producers, neither Opec nor its rivals, neither Saudi Arabia nor Iran has more to gain from the slump—but much more to lose if it drags on.

It was only when the European Central Bank’s chairman, Mario Draghi, said in 2012 that he would “do whatever it takes” that the eurozone’s crisis started to ease. The oil world’s equivalent, Saudi oil minister Falih, said on 11 August that Opec could take “any possible action” to stabilise the market. It ought to be the Draghi moment. Opec should now get back to business: no cheap talk, no freezes, but strategic cuts that bring relief and confidence back to the world’s oil industry before it is too late.

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