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Why OPEC Can’t Win The Oil Price War

Why OPEC Can’t Win The Oil Price War

As the oil price war unfolds it becomes easier to understand the outcome. There is ongoing speculation about the motives of the main players. Is it a battle between OPEC and US shale? Or a battle by the USA and Saudi Arabia against Russia and Iran? I lean quite strongly towards a market driven version of the former and believe that OPEC (i.e. Saudi Arabia) cannot win against the USA. Low oil prices are a major benefit to the US economy and US citizens, a disaster for OPEC and Saudi Arabia. Figure 1 shows how halving oil prices slashes export revenues for the exporting countries while halving the cost of oil imports to the USA.

Figure 1 Oil export and import figures based on BP 2014 for the year 2013. Values based on constant U.S$ 2014. The average oil price in 2014 was $110, shown in blue. Had the oil price been $50 in that year, the value of oil exports to the exporting countries would have halved (red). On the other hand, the cost of oil imports to the USA would also have halved. One man’s poison is another man’s candy.

Methodology

The methodology employed is very simple and some may argue too simple, but it serves to demonstrate a few points. I have used BP oil production and consumption data, average annual oil price data and World Bank GDP data, all for 2013 to calculate the value of production, exports / imports compared with GDP. Exports are simply the difference between production and consumption. I’m aware of the limitations here. Related:Why French Military Action In Syria Doesn’t Affect Oil Prices

Figure 2 shows the value of oil production to the various economies expressed as % of GDP.

Figure 2 The oil price averaged $110 in 2013. The value of production, therefore, is barrels per day * 365 * 110. For Saudi Arabia 11.393 Mbpd * 365 * 110 = $457 billion. With GDP reported as $748 billion, oil production works out as 61% of GDP.

Consequences

The main point I want to make is that oil production is 2.4% of US GDP. The US has the biggest oil industry in the world and yet it has rather small importance to the economy as a whole. The fall in the value of oil production to $50 may turn out to be catastrophic for some OPEC countries, it barely affects USA GDP at all and bestows major benefits via lower energy costs and a positive impact on the trade balance. The gigantic size of the US economy compared with the other players is shown in Figure 3. Related: OPEC’s Bad Bet By The Numbers

Figure 3 In green is actual GDP when oil was $110 / bbl. In blue is a notional GDP if oil had been $50 / bbl. It’s difficult to see what is going on with the OPEC states, so they are reproduced separately in Figure 4.

Figure 4 The same data as shown in Figure 3, but for OPEC countries only. The drop from $110 to $50 is particularly painful for the Gulf States. While they may be the most wealthy, they are also being hit the hardest. Kuwait with a possible 39% drop in GDP, Saudi Arabia 33%. These numbers could be quite far out but indicate the scale of the consequences (Figure 5). Related: Saudis Planning For A War Of Attrition In Europe With Russia’s Oil Industry

Figure 5 Had oil traded at $50 in 2013, this chart illustrates the drop in GDP that oil exporting countries may have experienced.

To Sum Up

Cheap oil is a major benefit to the US economy. Cheap oil reduces the cost of US oil imports and is good for the trade balance. The lost value of indigenous oil production in the US is of little consequence to its gigantic economy. In summary, cheap oil is really, really good for America and Americans.

In contrast, oil production is the major part of OPEC GDP, especially the Gulf States that have rather undiversified economies. The drop to $50 is a disaster for them. With WTI flirting with near term lows (on $40.73), the time of reckoning is nigh for the oil price. Things could be about to become a lot worse. It is very difficult to understand the OPEC strategy unless there is in fact a hidden political agenda. A production cut of 2 Mbpd (shared with Russia) would see the price and all their economies bounce. Sticking to the current course will see 2016 turn out to be much worse than 2015 for oil producers while the consumers party.

Heads the USA wins. Tails Saudi Arabia loses.

By Euan Mearns

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  • Raj Manglani on November 18 2015 said:
    OPEC will now never be able to control the oil price. As soon as there is any shortage, prices will rise and bring back Shale forcing the price down again to below 50. If that is OK with OPEC, they can continue their "market share" strategy to their own detriment. OPEC are cutting off their nose to spite their face.
  • Michael on November 18 2015 said:
    I disagree with this analysis.

    OPEC is not competing with the USA. Thats a very simplistic way to look at it and certainly not how a business would approach this matter.

    They are trying to compete with Shale, which happens to be in the USA. Thats the difference. The USA economy strengthening is good business for them (more people and business buying oil). Increased bankruptcies from uncompetitive shale industries is also good for them.

    Both of these are currently being achieved.

    I do agree that this not a long term strategy, but if they can squeeze the shale industry out as much as possible by flooding the market. Then when prices do return to the norm there will be less market share loss, simply because there is less competition.
  • amvet on November 19 2015 said:
    I agree that the low oil price is political. I think that Russia, Iran, and Venezuela are the targets.
  • James on November 19 2015 said:
    I agree with Michael. This analysis suggests it's purely OPEC vs the entire USA, when in reality OPEC are only competing with Shale oil industry in the USA. Saying that the USA is not affected and in fact benefits from low oil prices is not relevant. The fact is that low oil prices do affect shale oil and making oil production not financially viable for them is all they are aiming to do.
  • Seth on November 19 2015 said:
    Shale is a big reason the price of oil is so low and shale has placed a permanent price ceiling, which is beneficial to the U.S. and other oil-importing nations. It's delusional to believe that OPEC will be able to squeeze shale out of the market simply because there are plays in the Permian profitable at $30 or less per barrel and shale extraction across the board is getting much cheaper with better approaches, technologies, and equipment.

    Lowering the price is like sending shale drillers the gym to work out and get stronger. In a race to the bottom, shale has her foot on the backs of Russia, Venezuela, and Saudi Arabia.
  • kent on November 19 2015 said:
    o11Price

    i guess no one cares about the operators all over Texas and Oklahoma

    who are going broke. Evidently you think it is good for business. I don't.
  • Roy on December 01 2015 said:
    These are economic realities, aren't they Euan and hard to ignore on the world's stage. Perhaps because the Saudi's are so oil-centric for their GDP, they took their eye off the ball in going for market share over profits and economic investment.

    You're spot on that they will pay for it. The US industry is contracting in the less profitable areas, growing in the Permian, and will expand overall when it can again, and it will get better at the game of stop and go as we go forward. Of course, the shrills in Paris are screaming louder than before about imagined catastrophes. We in the oil patch will continue to innovate and diversify into new fuels.

    As Seth stated, certain countries will be hurt more than others. Venezuela is getting scary.

    It's a great article, you had a couple of dissenters but they weren't able to make a convincing point.
  • Joe Knight on January 19 2016 said:
    I agree with the conclusions of the author. I would like to add that in Jan alone the USA has exported 1 million barrels of oil to France. OPEC (SA) has indeed shot itself in the foot this time. The US has a price trigger in place now and a plan "B" should OPEC ever try to blackmail us (USA) again. The shale boom has been a God send for the west and we should use it to our advantage. We need to partner with Canada and Mexico to form the North American Energy Alliance , (NAEA) to compete directly with OPEC and never again allow them control over our economies. We would be wise to finish the keystone pipeline as well. Saudi Arabia will someday run out of oil. They will hasten that day by over producing if they aren't careful.

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