Since the co-option of Russia at the end of 2016, OPEC has appeared resplendent, but it remains a far from perfect cartel with no real destination in sight.
Although it is acting robustly to rein in supply, which, in tandem with a brighter outlook for US-Chinese trade relations, have buoyed the oil price, its problems are just if not more acute today than at any time in the past.
OPEC has always struggled when there has been a surge in non-OPEC output, but this time round it is not just a new oil province that has opened up but a new category of oil reserve – Light Tight Oil, known more colloquially as shale oil.
However, since the last major challenge, the world has moved from fear of peak oil supply to peak oil demand. The supply of petroleum liquids is a function of price, rather than the gradual exhaustion of a finite resource, but demand cannot grow indefinitely unless the environmental costs can also be addressed.
This is a new paradigm for OPEC as it faces its largest non-OPEC volumetric challenge to date. It raises a question that reveals the organisation’s fundamental vulnerability – if it cannot grow in production terms while the oil market is expanding, how will it fare in a market that eventually starts to shrink?
Although not formally a member, Russia now looks like a permanent fixture within OPEC’s newly-broadened institutional architecture. On paper, this a huge expansion of the organisation’s reach. Even if the minor non-OPEC producers that have accompanied Russia are ignored, OPEC plus Russia control 54.7% of world crude supply, based on 2017 figures, a huge leap from OPEC’s 42.6%.
However, Russia’s new-found affection for OPEC -- an organisation it kept at arms length for decades -- was a capitulation. It has three primary drivers.
- First, after years of growth to record post-Soviet levels, Russian crude output is expected to flatten. The cost of cooperation with OPEC in terms of output curbs is therefore relatively low and may in future years be met simply by natural decline.
- Second, like OPEC members, Moscow is heavily dependent on hydrocarbon revenues to balance the books. It needs OPEC to function, a prospect which Riyadh’s experimentation with a market share strategy threatened. At the point at which Moscow decided to cooperate, the price of standing aside had grown significantly.
- Third, Moscow saw a new opportunity to use cooperation with OPEC as a pillar in its emerging role as a Middle Eastern power broker. The US retreat from the region, based on the new found energy security provided by shale oil, left a vacuum, which Moscow was willing to fill.
While Western interventions in Iraq and Libya left anarchy in their wake, Russia demonstrably turned the balance of power in Syria, ensuring the survival of a long-term ally. Riyadh and Moscow have been active in building closer relations, and Russia’s oil companies have made strategic investments in Iraq, including the Kurdish autonomous region.
Expansion but no growth
However, as a proportion of total world liquids supply, a measure which includes biofuels and derivatives from coal and gas, OPEC’s crude oil output has slipped from 41.3% in 2008 to 37.2% in 2018. The US Energy Information Administration forecasts this share will fall even further to 35% by 2020, reflecting rising US output and weakening demand growth.
The underlying reality is that – Russian cooperation notwithstanding -- OPEC’s market share is shrinking when shale oil and alternative fuels and modes of transport are taken into account. As such, it remains very much on the defensive.
US shale might move into long-term decline in the mid-2020s before the next big growth story gains momentum, shifting power back towards OPEC. Oil demand continues to rise globally, despite the emergence of new non-oil forms of transport, but demand growth is unquestionably being nibbled away at the edges. Peak oil demand appears inevitable at some point, even if its timing remains uncertain.
Free market thinking portrays the cartel as holding a market to ransom, but in OPEC’s case it is the other way around because its members are countries not companies. The cartel is hostage to the oil market.
This is because of its members’ overwhelming dependence on oil revenues as a proportion of government income. OPEC can expand its membership, but it cannot grow its share of the oil market in real terms while it pursues a policy designed to promote the price stability on which its revenues rely.
It cannot overcome the free-rider problem, which today comprises not just new non-OPEC crude supply, but all forms of low carbon transport.
As a result, OPEC policy remains reactive and ultimately self-defeating.
Many of its members do have long-term strategies, but these -- tellingly -- all focus not on gaining more effective control of the oil market, but the economic diversification which will free them from the oil market.
Russia’s decision to cooperate with OPEC was recognition that it suffers from the same lack of economic diversification and inability to innovate in the new growing areas of technology where China, in contrast, is proving so strong.
At best OPEC-plus-Russia can deliver its members a period of stability, which could equally be characterised as stagnation. This, as in the past, will be extended as much by its own internal disruptions as its policy decisions. The 21st Century challenge for the oil industry is peak oil demand, the answer to which is neither a 20th Century cartel nor Moscow’s Middle Eastern adventurism.