Maintaining oil production levels could backfire for the oil producers group
The decision by Opec on 5 June to maintain its current oil production level of 30 million barrels a day (b/d) was unusual only in that it was announced with a smile rather than a grimace.
Opecs continued relevance in the global oil market has been repeatedly questioned in recent months and its last few meetings have been marred by heated arguments and accusations of foul play. The oil producers group needed to put up a united front and that is exactly what was presented in Vienna.
Reaching a consensus was the only possible outcome when Saudi Arabia said it had no intention of dropping its production below 10 million b/d, so it made more sense for all parties to say it was a joint decision.
Traditionally, Opec has been able to flex its collective muscles by turning off the taps and reeling production back to influence oil prices. This new strategy is, therefore, unchartered territory for the group.
On the back foot
Some argue that allowing the market to set the price is a dangerous game to play. It also could indicate that despite the glad-handing, backslapping and mutual admiration in Vienna, the recent surge in non-Opec supply has the group on the run.
Maintaining high oil production seems like a counter-intuitive move for Opec, an organisation famed for putting the brakes on production as soon as the going gets tough.
The big game changer has been the large increase in North American unconventional oil. The shale oil revolution has rattled Opec and is the underlying driver for the current strategy. Shale oil is expensive to produce and it took the strained geopolitical situation in the Middle East that came after the 2011 Arab Uprisings to act as a tailwind for the oil price and allow US producers to flourish.
Any diversification of supply always spells bad news for cartels, but aside from Libya and Iran, the rest of the Opec members were making too much money to notice what was happening in the US.
There are several advantages held by the Middle Easts major producers, not least low production costs, coupled with the fact Opec holds 74 per cent of conventional oil reserves.
Saudi Arabia, traditionally the worlds swing producer, has set Opecs current strategy as it believes that continuing to sell large volumes of low-cost oil to long-term customers is the safest way to safeguard market share.
Other Opec members have not shared that view up to last weeks meeting. Now, it seems that either everyone is in total agreement, or that the smaller exporters have been left with no choice but to toe the line.
It is a good move and it makes the most sense at this time, says Sadad al-Husseini, former head of exploration and production at Saudi Aramco. Demand is picking up, so why not capture that demand surge by making room for Iran and Iraq instead of fighting?
Output from Iran and Iraq is expected to increase in the coming months.
Irans Oil Minister Bijan Zangeneh has spelled out the Islamic Republics plan to increase production by as much as 500,000 b/d within a month of international sanctions being lifted following a deal on the country curbing its nuclear programme.
This would rise to 1 million b/d within six months before hitting pre-2008 production levels of 4 million b/d shortly after. Iran is reported to have produced 2.8 million b/d in May.
Despite Tehran earlier accusing Saudi Arabia of using oil as a weapon to punish Iran by purposefully keeping oil prices low, relations between the regions two largest power players were not as strained at the recent Opec meeting as at previous gatherings.
Tehran is now so desperate for cash that it is expected to offer up 35 million barrels of crude for immediate sale before the ink even dries on the nuclear agreement with world powers, the P5+1.
This would certainly depress an already oversupplied market and it is fair to assume much of that oil would be offered to Asian refiners at a bargain price, the very customers Aramco has been courting for the past 12 months.
How Opec will manage to accommodate this small tidal wave of crude will be interesting as will how Iran plans to elbow its way into an already crowded market. There are, however, still doubts as to whether Iran could ramp up to 4 million b/d with more realistic figures of 3.5 million b/d being cited by many.
Baghdad has also said that it has no intention of curbing its drive to ramp up oil production. If Libya can sort out its domestic troubles, then it will also want to restore production to pre-civil war levels of 1.5 million b/d from the current output of about 500,000 b/d.
Oil prices are already looking precarious at $60 a barrel and any substantial production increase could send them into freefall.
The entente cordial enjoyed by Opec members at the recent meeting may well stem from finally understanding that for any cartel to work, it has to act in a way that is beneficial to all. The one positive from hugely increasing Opec production would be that the US shale oil sector would take a battering if oil prices dropped below $50 a barrel for a prolonged period.
Shale oil was always subsidised oil It was never sustainable and is never going to be cheap
Sadad al-Husseini, Saudi Aramco
The average cost of production for shale oil is about $55 a barrel. If oil prices were to fall below $50, many of the hundreds of small independent producers could be sent under within the next 18 months. This would buy the major oil producers a year or so of time to get their fiscal budgets aligned to cope with lower-priced oil.
[US shale oil] is a case of the tail wagging the dog and it has certainly been overstated and over-exaggerated, says Al-Husseini. Why should Opec be frightened of 4 million b/d of very expensive oil when it produces 30 million b/d of very cheap oil?
What seemed to be firmly off the agenda at the Vienna meeting was how leaving the taps on to flood the world with oil would affect smaller-producing Opec member states that do not have the advantage of low-cost oil. Production costs in some countries are almost on a par with shale oil and consequently new field developments under 200,000 b/d will look extremely risky in some of the regions more fragile economies.
Even in the Middle East, producers such as Qatar have a lot of smaller yield mature fields that require huge sums to rehabilitate. A prolonged bout of lower oil prices would make many smaller fields completely unviable.
Another problem is that US shale oil is proving to be more difficult to suppress than many thought last year when Riyadh implemented its high production strategy as a means to bury it.
Shale oil producers only have shareholders to appease and many of the venture capitalists investing in the US market are happy to take breakeven prices or low returns on investment for the first few years to gain first-mover status. The real money is in future operations when the technological breakthroughs lower operating costs to match conventional oil production.
Shale oil was always subsidised oil, made possible by cheap dollars and high oil prices, Al-Husseini says. It was never sustainable and is never going to be cheap.
Aside from the challenges facing US shale producers and the smaller Opec members, national oil companies (NOCs) from the Middle Easts large oil-exporting nations also have their own problems.
Not only are they expected to rake in billions of dollars of export revenues for cash-hungry governments, they are also expected to provide citizens, power generators and industry alike with hugely subsidised hydrocarbons.
All Middle East oil-producing nations, with the exception of Kuwait, have budget breakeven prices above $50 a barrel.
On top of this insatiable demand for money and resources, NOCs are also charged with the task of maintaining their respective upstream oil and gas assets being operated at close to maximum capacity. Not an easy task.
Opec still controls 30 per cent of global oil supply and is the biggest force in the energy world. However, there are cracks beginning to show in the organisations facade and there is no clear solution as to how they can be fixed.
Despite the smiles of Opec officials, they know that low oil prices are bad for all producers, not just the US. By the same token, they know that if $70-plus oil returns the US shale oil producers will be back in business, which will be bad news for Opec.
Saudi Arabias strategy to smash the competition by flooding the market is fine for the worlds largest oil exporter with $700bn of foreign cash reserves. The real question is whether this strategy is good for the rest of Opecs members, which are far less financially stable.
If the strategy works, it could return Opec to its former dominant position, able to control the global oil market and win it even more market share. If not, it could lead to the break up of the oil industrys oldest interest group.
$49.4 a barrel Kuwait
$64.1 a barrel Qatar
$68.1 a barrel Iraq
$73.8 a barrel UAE
$87.2 a barrel Saudi Arabia
$95.9 a barrel Oman
$99.8 a barrel Bahrain
$105.2 a barrel Russia
$119.2 a barrel Algeria
$117.5 a barrel Venezuela
$107.4 a barrel Iran
$122.7 a barrel Nigeria
$124.8 a barrel Libya
Source: Reuters survey
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