OPEC enters a price war with the US for market share

Oil prices are currently at the center of every discussion: The prices seem to be on a never-ending decline: The Brent ended the week at 61.85$ a barrel. This is going to have a worldwide effect: US, Russia, the Middle East… every one will be affected by this free-fall.

The OPEC (Organization of the Petroleum Exporting Countries) is composed of 12 members such as Saudi Arabia, UAE, Iran Qatar or Venezuela. It’s mission is to « coordinate and unify the petroleum policies of its Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry. »[1]

The OPEC produces 40% of the world’s oil: it thus has an important impact on the world’s oil prices. As stated in its mission, the OPEC has always tried to regulate the prices, by cutting back its production when the prices were too low, and on the contrary by increasing their production when the prices reached high peaks.

However, the OPEC faces competition since the mid-2000s and the explosion of the world’s oil demand mainly due to the development of China. The oil production was lagging behind, in this way the prices escalated well over 100$ a barrel between 2011 and 2014.

 

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Fig 1: Crude Oil brent price

With such prices, it became profitable to extract oil from difficult-to-drill places. In the US, it is referred to the Shale Oil Boom. Shale Oil requires complex extracting methods such as fracking or horizontal drilling, which are a lot more expensive than the traditional techniques employed by the OPEC members. Since then, the US crude oil’s production has kept rising, to 9.12 million barrels a day in the first week of December, a peak only reached once before, in 1986.

december 10 cotd

Fig 2: US Weekly Crude Oil Production

As the US production increased, so did the Russian and Canadian production. This led to a major boost in the global oil production since approximately 4 years. But why are the prices only plunging now? In order to understand this, we need to focus on Libya, Iran and Iraq, all OPEC members. Libya was in a civil war, Iran was subject to sanctions from the EU and the US, which affected its exports, while Iraq was in a disastrous situation. The oil production in these regions was consequently lowered, but with the US production rising, the market wasn’t really affected. The problem is that since the end of the third quarter, these complications began to lighten. Libya saw its production get right back on track, with significant quantities of oil being pumped back again. Add to this a lowering demand from Asia and Europe and you get a decline in prices. This is not particularly surprising. But the reaction, or more correctly the passivity of the OPEC towards this situation is. As we said before, normally the OPEC tries to regulate its production in order to maintain stability in the prices. But at its general meeting in Vienna on the 27 of November, the OPEC, heavily influenced by Saudi Arabia, decided to retain its production at 30 million barrels per day, thus letting the prices fall lower. This might seem incoherent with their mission. But if we look back in the 1980s, when the prices dropped, Saudi Arabia reacted accordingly and cut back their production. In the end the barrel continued to drop, and Saudi Arabia only lost market share.

With the growing competition, the OPEC wants to avoid the reproduction of this situation. The OPEC is expected to lose 5% of its market share by 2018. By letting the price fall, they might force the US companies, largely dependent of the costly shale oil to cut back their production or get out of business. This is why we can easily state that the OPEC entered a price war with the US for market share.

These global oil politics will have some serious consequences. By choosing not to react the OPEC exposes some of its members at risks. Every country has a different break-even price to respect its budget.

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Fig 3: OPEC median budgetary breakeven price

 Iran is the most exposed member: After years of recession, the Iranian economy just started to get better. The IMF had projected before the decline of oil prices, a 1.5% growth this year and a 2.3% growth for next year. Due to western sanctions, Iran needs the prices to be over 100$ a barrel. With the free-fall of prices, Iran will be forced to seek revenues elsewhere.

If we look at the effects on non-OPEC countries, these might be as problematic, not to say worse. Russia, which is already facing economic difficulties as a result of the Ukrainian crisis, is headed for more trouble as oil accounts for approximately 45% of Russia’s revenues.

Concerning the US, they are exposed, as the shale oil is very expensive to produce. A low price of the barrel is likely to have repercussion sooner on the US companies than on the rest of the world.

 This war of prices is extremely risky for both parties engaged: The OPEC and USA. It will also have dramatic repercussions on countries not directly involved in this conflict. It is also important to know that while prices are now plummeting, they could rise again instantly if the situation in Iraq, Libya or Nigeria became critical.

Who will win this war of market share and who will fall? Can Saudi Arabia let the prices lower without harming the other members of the OPEC? Will the US try to safeguard its market share at any cost? Only TIME will tell…

Marc Zaidan

Sources:

Cover image: http://i.huffpost.com/gen/821702/thumbs/o-PENNSYLVANIA-GAS-DRILLING-LAWS-ACT-13-facebook.jpg

[1] http://www.opec.org/opec_web/en/about_us/23.htm

[Fig 1]:  http://www.nasdaq.com/markets/crude-oil-brent.aspx?timeframe=4y

[Fig 2]: http://uk.businessinsider.com/chart-of-the-year-again-december-10-2014-12?nr_email_referer=1&utm_source=Sailthru&utm_medium=email&utm_term=Markets%20Chart%20Of%20The%20Day&utm_campaign=Post%20Blast%20%28moneygame%29%3A%20The%20Oil%20Crash%20Has%20Done%20Nothing%20To%20Slow%20The%20American%20Shale%20Boom&utm_content=COTD?r=US

[Fig 3]: http://www.realclearenergy.org/charticles/2012/10/22/opec_median_budgetary_break-even_price_106748.html

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