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Will OPEC Really Risk An Oil Price Crash?

As OPEC and partners are…

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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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How Long Can OPEC Maintain Its Current Strategy?

The six-month clock is up. OPEC is convening this week in Vienna, as it does every six months, to discuss and decide on how the group will coordinate.

The November 2014 meeting was one of the most widely covered in years. After leaving its collective output quota unchanged for several consecutive meetings in a row, much of the world watched for a major policy change. The glut of oil had led to a crash in prices, falling from well over $100 per barrel, down to the $70 range. As it had in the past, surely the cartel would pull the production lever downwards, switching off a million barrels per day or so in order to stop the bleeding?

That decision never came. In a move that shocked the oil markets, and enraged many of OPEC’s own members, production levels were not touched. Saudi Arabia looked into the history books and realized what happened the last time they cut production during a glut. In the 1980’s, prices did not recover, and Saudi Arabia merely lost market share and revenues. Related: Top 4 Oil Companies For Dividend Investors

Not eager to make the same mistake, this time they went full speed ahead, fighting for every piece of the market it could capture. Saudi Arabia has even boosted production by 700,000 barrels per day since then, increasing output to 10.3 million barrels per day as of April 2015.

As it quickly became clear, Saudi Arabia hoped to force out higher-cost producers (i.e. US shale) and maintain market share, allowing prices to eventually adjust upwards on the backs of others.

So what should we expect from OPEC’s upcoming meeting on June 5? More of the same. Having made the decision to fight it out, there is almost no reason to back off now. US shale producers have hung on longer than many anticipated. OPEC has inflicted a lot of damage across the US shale patch, but it hasn’t yet struck the deathblow that it had wanted. Related: Could The New Silk Road End Old Geopolitical Tensions?

Rig counts have fallen by 1,000 (more than 50 percent) since October 2014, production has largely come to halt (although not really declined), and fewer wells are being drilled. Importantly, a few smaller companies have gone bankrupt, and others are struggling under mountains of debt. That portends a larger adjustment in the months ahead, but for now, the market is in limbo.

OPEC’s strategy could still work, but will need more time. That points to a stay-the-course approach heading into the June meeting and beyond.

Still, it is not clear how long OPEC members can hold out. Many are not as well endowed as Saudi Arabia, nor do they have the massive rainy day fund that Riyadh does. Several members – most notably Venezuela and Iran – loudly called for a cut in output last time around. Their arguments didn’t win over Saudi Arabia in November, and they won’t again in June, but at some point the pressure could mount.

The Wall Street Journal reported in May that OPEC is starting to come to grips with the possibility that oil prices could remain below $100 per barrel well into the next decade, a troubling prospect for oil-producing countries that had become used to the super profits associated with three-digit oil prices, and many have budgets that only breakeven in that range. Related: A New Giant Among Oil Traders

An internal OPEC report sees oil prices at $76 per barrel in 2025. And that is the group’s most optimistic scenario. It also considers the possibility that oil drops below $50 per barrel in the 2020s. $100 oil does not figure into the group’s considerations.

OPEC disputed that it put together such a pessimistic outlook, but if the WSJ report is correct, the implications would be profound.

The WSJ believes that OPEC, under this scenario, would consider returning to production limits in order to prop up prices. If prices stayed low, the group probably would not be able to produce flat out and wait out US shale for a decade. Internal pressure would be too great.

For the June meeting, however, the Saudi strategy should carry the day. November’s meeting could be a lot more interesting though. If prices don’t recover, and US shale is not making big cut backs, the grumbling within OPEC could grow louder.

By Nick Cunningham of Oilprice.com

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