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Opec’s swan song
Latest oil pact is last hurrah, not return to past market power
4 HOURS AGO by: Martin Sandbu
To judge by the soaring price of crude on Monday morning, the cartel of oil-producing countries is back with a vengeance, and then some. Rumours of Opec’s death, occasioned by the collapse in oil prices two years ago, seem to have been exaggerated. But not greatly.
The latest rise reinforces a longer trend. As the charts show, oil prices were already on a sustained rise from below $30-a-barrel levels a year ago, buoyed by the refound vigour with which Opec countries committed to rein in production levels to drive global prices up. The latest encouragement for bullish oil traders was the deal at the weekend on limiting output between Saudi Arabia and non-Opec Russia, which also rolled in several other non-Opec producing countries. So, in addition to the return to Opec form, which has traditionally involved Saudi Arabia balancing world production to keep prices from falling in exchange for commitments to cap production at agreed levels by other Opec members, the cartel has managed to rally non-members behind it. The FT’s commodities team tells the story of the combined effort, which increases oil producers’ joint market power over consumers — a politically impressive feat in light of the deep differences between Saudis and Russians (and many others) in other policy areas, most prominently Middle Eastern power struggles.
To top it off, Saudi Arabia’s oil minister signalled a willingness to cut, if necessary, even beyond the agreed limits to prop up prices — an announcement billed by some as a “whatever it takes” moment to warn markets off testing the cartel’s resolve.
But for all the drama, and the undeniable market response, don’t expect a return to the days of old, when Opec could cause geopolitical turmoil and deal economic body blows to the industrialised west. Even if the latest production pacts stick — and that’s a big if — the cartel has reached the limit of what it can achieve when oil prices hover around $60 a barrel.
The reason is that even if Saudi Arabia’s oil industry remains a “swing producer” in the physical sense of having the spare capacity and cost structure quickly to ramp production up and down, the influence on the global market price of such managed swings is quickly waning when the price hits about today’s level. The reason is the shale revolution in the US. As BP’s chief economist Spencer Dale has convincingly argued, technological progress has created a nimble shale oil industry that can quickly expand when prices rise because its fixed costs are lower than conventional oil production. That makes the shale oil industry, in particular in the US, the effective global swing producer once prices are high enough for a significant portion of the industry to produce viably. Should Saudi Arabia or Opec more generally cut production to force prices beyond that level, shale will fill the gap.
There are two further important facts about shale that blunt Opec’s power. The first is that the break-even price for many shale producers is coming down surprisingly fast. That means the level at which shale can replace any Opec cutback keeps going lower. The second is that, partly due to its manufacturing-style cost structure, shale is a dispersed private activity. Especially in market economies, it would be very difficult to decide production levels strategically even if one wanted to. So if US shale oil takes over Saudi Arabia as the global market’s swing producer, it will behave in a very different, and largely unstrategic, manner.
All this means is that Opec — even with its new non-Opec friends — has largely used up its ammunition by driving prices to where they are now. Should prices fall again, they may succeed in stopping or reversing the decline, but even that ability will be limited to lower and lower prices ranges. This marks the end of an era, not the return to an old one. |
