Oil price fall: OPEC on trial

Geopolitics is losing its power to influence the oil market. The fundamental forces driving prices lower from rising supply outside OPEC from shale to sluggish demand growth as result of conservation and substitution have been clearly visible for at least two years.

On the demand side, consumption of refined products in the United States is still more than 2 million barrels per day lower than it was in 2005, and the drop is more like 3 or 4 million barrels if population and output growth are taken into account.

The International Energy Agency (IEA) in its latest report has cut demand forecasts again by 200,000 barrels a day projecting global oil demand for 2014 at 92.4 million b/d, on lower than expected economic growth. Despite this, production is rising. Higher output from both OPEC and non-OPEC producers lifted global supply by almost 910,000 b/d in September to 93.8 million b/d. OPEC’s crude output surged to a 13-month high in September of 30.66 million b/d, led by Libya’s continued recovery and higher Iraqi flows. The IEA said a weaker global demand outlook will cut the call on OPEC crude and stock change by 200,000 b/d next year, to 29.3 million b/d.

For the last three years, the incipient imbalance between supply and demand was masked by a series of one-off supply interruptions which removed enough crude from the market to offset rising shale output.

US sanctions on Iran coupled with civil wars and unrest in Libya, South Sudan, Syria and Iraq all helped conceal the extent to which the market was fundamentally oversupplied. Production losses as a result of these interruptions have broadly matched the rise in US shale output. But the fact that the decline was triggered by resurgent oil exports from Libya, which rose from 200,000 barrels per day in June to 900,000 at the end of September, according to the EIA, should come as no surprise.

OPEC no longer a monopoly

Amidst abundant supply and faltering demand, crude exporters from OPEC have little room to maneuver and may put up with lower oil prices for now. Against a weakening global economic backdrop, however, OPEC’s options may be limited. Members have less of an incentive to stick to their quotas.

Rift between OPEC members deepened as producers in the cartel moved in different directions amidst falling oil prices. Rather than cut production, Saudi Arabia increased its oil output by 50,000 barrels per day (bpd) in September to 9.73 million. Venezuela is breaking ranks with its OPEC colleagues to call for an emergency meeting of the group to respond to falling prices. The country cannot pay its bills if oil is below $100 per barrel prompting news of debt default by the country.

Saudi Arabia is now asking for stronger commitments from some of its buyers in Europe, a move that would lock in those customers, including any new ones it would gain with recent price reductions.

Iraq’s State Oil Marketing Company cut the price of Basrah Light crude in November for Asian and European buyers by 65 cents. That marks a discount of $3.15 a barrel below the Oman/Dubai benchmark for Asian customers and $5.40 below the Brent benchmark for European customers.

The moves and countermoves are the latest in a time of particular discord in OPEC. The organization was founded to leverage members’ collective output to help influence global prices.

OPEC members are due to convene on November 27 in Vienna to formulate policies for 2015—and possibly demonstrate to the world how they plan to remain a potent force in today’s oil market. Due to hydraulic fracturing along with directional drilling, oil is no longer monopolized by OPEC.

Options before OPEC

If OPEC could cut production enough to push prices back above $100, it would just encourage more shale drilling and the continued stagnation of demand, making the problem worse. OPEC, would be sacrificing market share to support prices at an artificially high level, and within a few months, or at most a year, even deeper cuts would become necessary.

Higher prices would only encourage more drilling from US shale groups and other high-cost producers. All the while, they would only continue to lose market share. Shrinking exports from 10m barrels a day in 1980 to less than 3m five years later failed to support prices as non-OPEC supply grew and demand slowed.