Got this e-mail from STRATFOR about the complexities of oil producers
trying to move prices higher...
Global Intelligence Update
Red Alert
June 8, 1998
>From the Persian Gulf to Latin America: A New Epoch in Energy Policy
With the Indian subcontinent calming down, and Russia moving back from the
brink by cutting interest rates to a mere 60 percent, the main global
focus this week was on oil prices. Oil ministers from Saudi Arabia,
Venezuela and Mexico met in Amsterdam this week and agreed to cut oil
production for the second time in recent months. Oil prices, which have been historically low for nearly a generation, have dropped to near the lowest they have been in this century, when measured in real terms.
The decline in oil prices, while generally benefitting consumer industrial societies, has reached disastrous levels for oil producers. For example, the Russian financial crisis was in large part rooted in the decline of oil prices, as unexpectedly low income from oil and gas exports undermined hard currency reserves and jeopardized internal financing of development, creating a massive crisis of confidence. Indonesia has also been particularly damaged by low energy prices. But the list of victims includes more distinguished world citizens. Saudi Arabia, for example, still considered by the general public to be a bottomless pit of wealth, is in fact in serious financial trouble, as are other Persian Gulf oil
producers. For example, Kuwait's oil minister, Sheikh Saud Nasser al-Sabah, said recently that his country could face "economic catastrophe" if the price of oil didn't rise. The fall of oil prices to the low teens has left the economies of oil producers stretched to the limit.
It was in this context that Saudi Arabia, Mexico and Venezuela met in
Amsterdam this week to initiate a second round of oil production cuts. The first round of cuts, initiated after the Riyadh meeting, seemed to stop the fall in oil prices, but failed to raise prices sufficiently. It is unclear, of course, whether the fall was stopped by the cuts or whether the market had reached equilibrium by itself. Thus, it is unclear whether a second round of production cuts can achieve the desired effects. Initial reaction was fairly subdued, with prices rising modestly and the markets apparently waiting to see whether other producers would be joining in the Amsterdam round of cuts.
There are several reasons why the markets don't expect production cuts to work. First, unlike the situation in the 1970s, oil production is no longer concentrated in the hands of the relatively few players that make up OPEC. This means that there is no institutional mechanism in place for imposing and monitoring production. Mexico, for example, has become a crucial player in the oil production game, but is not a member of OPEC. This diffusion of production capacity not only makes decision making difficult, it also makes monitoring impossible. It is one thing to announce production cuts. It is quite another to know whether those cuts have actually been implemented. The temptation to announce cuts and then
to covertly try to take advantage of competitor's cuts by increasing
production is sometimes overwhelming. In a vast market like that for
petroleum, the ability to verify agreements is severely limited. It
follows that, where verification is impossible, trust is limited. Thus, regardless of what producers promise, the market is dubious. This tends to undermine the ability of producers to raise prices through psychological mechanisms. Production itself must contract, which will take a while at the very least, even if cuts actually happen.
Whatever happens to oil prices, however, something extraordinary has
happened in the oil equation. For the second time this year, crucial
decisions on oil production policy have been taken by three nations meeting
privately. Only one of these nations is from the Persian Gulf, which is
conventionally regarded as the center of gravity of oil production. No one
was present from Central Asia, regarded as the emerging center of gravity.
Two of the nations present were from Latin America. This is of tremendous
long term significance for the international system. Saudi Arabia, the
acknowledged power of petroleum exporters, was forced to turn to Venezuela
and Mexico to have any hope of raising oil prices.
There is something odd in this. Venezuela exports a little over 5 percent
of the world's oil, while Mexico exports less than 4 percent. Saudi Arabia
exports 20 percent, while the Persian Gulf taken together controls over
one-third of the world export markets. Other non-OPEC countries, like
Norway and Russia, each export more than 7 percent of the world's
petroleum. Thus, the numbers alone don't explain why Saudi Arabia has
become so dependent on Latin American producers for market control.
There are several reasons for the Saudis' reliance on Latin America.
First, the Persian Gulf states are a fractious lot under the best of
circumstances. Following this week's cuts, Kuwait and Iran both made it
clear that they would wait before agreeing to cut their own production,
even though both had previously called for additional cuts. Morever, even
if all the Persian Gulf producers could be lined up on one side of the
issue, their market share would not be enough to control world markets
without outside support. Thus, the Saudis realize that their ability to
deliver the Persian Gulf producers would depend on their ability to
generate outside support. Lining up non-Persian Gulf support became
critical for holding the Persian Gulf producers together. In the end, the
fact was that even with Saudi Arabia speaking for all of them, including
Iran, the Persian Gulf states simply don't have the economic power to
impose their will any longer.
Russia and Norway are the largest non-Arab, non-OPEC exporters. But Russia
is not in a position to cut production. Indeed, if the last few weeks are
any indication, the Saudis will be lucky if the Russians don't want to
increase production. Norway, on the other hand, is an industrialized
nation and an integral part of Europe, at least unofficially. As much as
Norway benefits from higher oil prices, its industrial sector, and those
of its European trading partners, is hurt by them. Norway is hardly going
to lead the pack in raising prices.
This is the core problem. Oil producers are falling into two groups.
Some, like Russia and Indonesia, could not possibly afford to cut
production, regardless of the long-term benefits. Others, like Norway and
Canada, are on the whole beneficiaries of low oil prices in spite of the
fact that they are also exporting oil. The number of nations that have an
interest in higher oil prices and can afford to cut production is rather
limited. They do not include traditional powers, such as Kuwait, or
industrial producers like Norway.
They do include Venezuela and Mexico. Venezuela is particularly important
because it exports almost all of its production. Thus, production cuts in
Venezuela have disproportionate effects on export availability. More
important, Venezuela has vast reserves and is therefore critically
important to the long term stability of the market. Both Mexico and
Venezuela are interested in higher prices and are in positions to curtail
production in order to achieve those prices. This has created a
dramatically new constellation of oil powers, defined less by their
production and export rankings than by their relative freedom to maneuver.
As much as both Mexico and Venezuela have been hurt by lower energy prices,
they are in substantially better condition than other oil exporters. This
is in part the result of the fact that countries like Kuwait and Indonesia
have dramatically overreached themselves in their development plans, which
has left them incapable of cutting back on consumption without seriously
damaging their economies. Mexico and Venezuela have combined solid growth
in recent years with much more modest development policies, leaving them
with room to maneuver. Therefore, Saudi Arabia, more financially exposed
than Mexico or Venezuela, finds itself dependent on their willingness to
cooperate in controlling production.
We are not persuaded that this consortium will be able to lead the oil
producing world back to $20 a barrel oil. But that is not the important
point. The increased power of the Latin American producers is part of the
general process that has led us to regard Latin America as the growth
leader of the next generation. But the increased power of the Latin
American producers also points to the decreased power of the Persian Gulf
producers. Not only has their economic position deteriorated internally,
but their external dependence has shifted as well. The Saudis cannot any
longer speak to the Iranians or the Omanis to determine the course of the
oil market. They now must speak to the Venezuelans and Mexicans, who may
or may not accommodate them.
The shift in the center of gravity of energy decision making to the Western
Hemisphere obviously shifts the political landscape as well. Mexico and
Venezuela are both well in the American sphere of influence. As good as
that is for the United States, it means that a new set of issues are
emerging for the U.S.. The stability of both Venezuela and Mexico are of
critical importance to the United States, not only because they are nearby,
but also because they have become central pieces in the global energy
equation. This increases the importance of maintaining stability in both
countries.
Thus, the Colombian mess, always a regional issue, becomes crucial for the
United States because of the proximity of Venezuela. If the Persian Gulf
is important because its ability to affect the availability and price of
oil, then with Mexico and Venezuela in similar key positions, containing
the Colombian chaos becomes an issue on the order of the Persian Gulf. It
is not surprising, therefore, that the United States is increasing the
tempo of its involvement in Colombia at this time. Similarly, instability
in Mexico is more than a border issue for the United States. Suddenly, two
of the world's largest commodity markets, oil and drugs, are coming
together into a single policy dilemma for the United States. With two out
of the three major decision makers in the oil field now speaking Spanish,
we have entered a new epoch in energy policy. The implications are
enormous and, as yet, poorly thought out.
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