Dying OPEC: The Woes of the Oil Oligopoly

BY: RAHUL ROKKAM, SENIOR CONTRIBUTOR

An unregulated essential commodity market is a lose-lose scenario. If OPEC cannot collude on a price and quantity, they simultaneously lose market power and significantly reduce profits. The problem is, they’ve already done that. In 1973 OPEC controlled 60% of crude oil production but as of 2015 that number has fallen to 30%. OPEC has effectively taken the role of a price-taker rather than a price-maker. The inability to collude allows easier access for new entrants to the oil market, further adding to the failed oligopoly’s woes. The price increase of crude to triple-digit levels post-2008, let run wild by an uncooperative OPEC, has drawn big players to the market. Triple-digit crude has attracted the development of capital expensive offshore oil fields in the North Sea, Gulf of Mexico, and Brazil as well as as capital expensive onshore fields such as the Canadian tar sands and US shale oil. The cost of the capital-rich oil fields is now almost completely accounted for, and the new entrants are here to stay.

OPEC is also unable to control the opposite side of the price spectrum—oil has fallen 70% since its peak 2014 levels, to just over $40. But the race for market share in the Middle East is only self-defeating, as the IMF announced they lost $390 billion in oil revenues in 2015 due to low oil prices. As a result, Saudi Arabia posted a record-breaking $98 billion budget deficit in 2015, leading Riyadh to cut energy subsidies, raise taxes, and borrow internationally to ease fiscal pressures. Saudi deputy crown prince Mohammed Bin Salman even confirmed that Riyadh is seeking to list around 5% of its state-owned oil company Saudi Aramco, giving it a whopping valuation of more than $2 trillion. But is too little too late for oil-dependent OPEC?

Is American shale dampening hope for the OPEC oligopoly?

Even far after peak oil prices a few years after the Great Recession, American shale producers have proved surprisingly resilient. In fact, they were one of the major factors in OPEC’s decision to end negotiation of production quotas. OPEC sought to ramp up supply, drive down oil prices, and force the nascent American shale producers into the red, slashing investment. As American supply decreased, supply would tighten, and lift up oil prices. But that didn’t happen. One of the main benchmarks for crude, West Texas Intermediate (WTI), is around $48 – far from the optimum price for significant OPEC profitability. This price is obviously not profitable for American shale either, however, there is a reason for their resilience – greater productivity. 

The amount of shale oil produced per dollar invested is projected to rise 65% in 2015, according to Daniel Yergin of IHS, an independent research firm. The Economist explains that this astronomical rise is due to “better seismic data, improvements to the fracking liquids pumped into wells and more intensive deployment of rigs.” As a result, the IHS predicts that 80% of the additional oil capacity produced in 2015 will be profitable if WTI is at $50 to $69 a barrel.

The increased productivity over the next few years will make American shale profitable enough to expand production, even if the WTI benchmark is not above $70. Because of these developments in shale drilling technology, the Energy Information Administration has increased its forecast of American shale output in 2020 by 3.1m barrels per day (bpd), to 10.6m bpd – half a million bpd over Saudi Arabia’s current level of oil output. To compound this issue, as American production continues to rise far above domestic demand, pressure will likely increase on the government to ease restrictions on exports of crude. Finally, American importation is decreasing, falling below China’s in 2015. Orange may be the new black, but according to American shale, “$40 is the new $70.”

OPEC’s dead, but oil isn’t (in the short-term).

A leftward shift in demand by the industrialized world because of cost-effective renewables and climate change isn’t enough to kill oil immediately. “This is a cyclical business and it always will be,” says Teng Ben. Paul Spedding, a former head of oil research at HSBC. The emerging world plays a pivotal role in the oil market, and the fact is that – they’re emerging. As tens of millions of individuals from the emerging world enter the consumer market each year, their search for cheap and available energy sources will definitely overpower, in the short term, gains in renewable energy. So what explains the recent drop in oil prices? Well, the obvious decimation of consumer spending post-2008 had something to do with it. But other factors, such as the aforementioned geopolitical feud, are significantly contributing to the worldwide dilemma. Furthermore, the failure of oil and gas companies to find profitable extraction areas in the Arctic, as well as a lack of infrastructure in emerging markets to effectively drill oil, especially in Tanzania and Mozambique, isn’t helping either.

But in the long run there are obvious macroeconomic trends across the board signaling the weakening of the revered commodity. For one, the industry is executing widespread cost-discipline. Shell, for example, cut roughly $30 billion in operating costs and capital development in 2015. This is just one example of what the Economist calls an “industry-wide mantra.” Next, investment projects are becoming more realistic because the industry is realizing that volatility is here to stay. And finally, renewables are grabbing more and more energy market share each year, a trend consistent over the past fifteen years. Oil might not have a burning bright future at this rate.

 

Photo By Not given [Public domain], via Wikimedia Commons

 

  • Nandagopal Polamada

    Brilliantly comprehended and summarized! Very well done Rahul.