The end of OPEC ? – and its not Trump, shale, or Tesla

A quick question: what was the global oil demand in 2012?

An interesting article tries to dispel the idea that the Oil Price Spike in 1973 was not a direct reaction to US foreign policy (support for Israel in the 6-days and Yom Kippur wars) but a direct result of US domestic policy, specifically the decoupling from the gold standard. The argument is that the OPEC nations saw their revenues in “real” terms dropping due to the devaluation of the dollar with the gold-standard exit. To recover their losses, OPEC cut back production and raised prices – if this is so it was a bit of a blunt instrument as it clearly overshot. The argument continues that this was not the cause of stagflation as these petro-dollars were recycled back into the economies of the west. The price-manipulation angle is backed by reports of a significant paper trail from OPEC in the years preceding 1973, stating that OPEC would act to recover their position

“member states would automatically adjust crude oil posted prices calculated in dollars if a change in dollar parity emerged from the present monetary crisis.” OPEC Aug ’71

I don’t have any opinion on the merit of this article. However, the idea that OPEC is this huge force in world oil has been a mainstay of media opinion for decades. There have been various chapters in the story; focus on market share, internecine strife between members, focus on price, war on shale, worry about renewables and obsolescence etc.

In the last 18 months we have seen how OPEC (or more accurately, OPEC + Russia, (“ROPEC” anyone?)) can cut production to rebalance a world that was (a) holding significant(?) storage and (b) had forgotten about geopolitics. My question today is – is ROPEC relevant on the other side, when the world demands more oil, not less?

As recently as January 2016 – the term “drown in oversupply” was used:

On January 19th [2016] the International Energy Agency (IEA), a prominent energy forecaster, issued a stark warning: “The oil market could drown in oversupply.”

So today we have a strong belief that ROPEC is managing the oil price by making drastic cuts and that due to US shale we are drowning in (actual and potential) oversupply. ROPEC is clearly in charge. So why am I nervous? Well, two reasons:

  • ROPEC has very little spare capacity
  • Even the Saudis are saying more investment is needed

1) Managing oil price is a two way game

Yes, ROPEC has managed the supply side, making cuts in production to raise oil prices. Some countries are doing really well, Angola has >140% compliance with its reduction targets. Wait, what ??

The catch is that it isn’t actually a voluntary reduction, more of an inability to produce at its quota level. This is repeated in many countries. But these are all small fry compared to Russia and Saudi Arabia. If we look here in detail, we see that oil production has been cut back as per the agreements, but from a position that was (a) boosted just before the cuts were calculated and (b) is close to historical highs.

What is the probability that these mature oil producing regions can easily just open the taps up in the case that world supply is hit by “unexpected” outages? Obviously the Trump administration’s decision yesterday on the JCPOA has the potential to hit supply – as does the gruesome demise of Venezuela.

Clearly Saudi Arabia has made significant cuts to support oil prices.

But when you see this in the context of its historical production (below), you can see that the post-agreement production level was a historical high.

Probably the biggest unknown in all Oil Price speculation is the “spare” capacity that Saudi Arabia has. In the past this has been several million barrels.

Today it is very unclear, but I am postulating that there is not a lot. Indeed the 2010-2014 period of “unsustainable” oil prices (above $100) did not see a massive reaction by OPEC to “flood” the market despite the clear concern that the high prices were fuelling the Renewables revolution and making oil obsolete. So the question is, why not?

Russia is the same story:

With the current “restraint” being nothing more than a record production level (post-Soviet era) – if you ignore the pre-allocation boost.

The bigger picture is much the same. Ignore Venezuela, Norway, Indonesia, UK, Libya, Angola and Mexico – none of these are likely to step production back up to peak levels anytime soon if at all (Angola, Norway, Mexico, Libya etc) or anytime ever (UK, Indonesia). We have seen the situation in Saudi and Russia. The USA is a wildcard as it is at a historical high and has some running room. The amount of additional production – and the cost of that production is the subject of many other articles and posts. My view is that there is more to come, but it is going to be very expensive and won’t do more than kick the problem down the road a few years.

Lastly, and much in the news, Iran is a stand out. But here again, the historical is not much of a guide, given that production is at post-revolutionary highs. Even without new sanctions, I’d not hold my breath on a rapid ramp up. The effect of previous sanctions can be clearly seen prior to 2016. Even without sanctions, the “next step” in production from Iran is going to a lot harder than the step from 2mmbbls/day to 4 mmbbls/day.

So my conclusion is that if/when the world says “actually, that bit about drowning in oil and not needing it…, well now it is $150/bbl we’d be really pleased if you could just open the taps a bit and add a million or two barrels/day to the world supply?” – there will be no one able to react. When the “markets” and the mainstream media wake up to this the headlines will be doom and fear, and the price will soar. As discussed previously – a pretty awful scenario for everyone.

2) Cry for help?

So if I am wrong and Saudi (and ROPEC) has massive excess capacity, and are concerned about their oil never being produced as it becomes “stranded” by renewables (as I erroneously wrote about here) why are they worried about under-investment in the industry?

Saudi Oil Minister Khalid Al-Falih said Investment in the oil industry is a challenge. OPEC and its allies need to seek market confidence in the long term to attract capital, according to the Saudi minister. Bloomberg

We also had the recent announcements concerning Bahrain getting excited about shale oil – yes big numbers of oil in place (as with any source rock), but cheap and easy it ain’t.

Nervous… me?

So that is why I am nervous – ROPEC may well have the capacity to engineer supply constraint in a world of (minor) over supply, but I think it lost the capacity to plug a gap in demand about 10 years ago. US shale has hidden this fact, but it can’t do so forever (see here). ROPEC can no longer be counted on as having significant excess capacity to react to even a modest outage. Again, this is very bad news if correct. What the world needs is stable oil prices that allow (1) confidence in new oil investments to preserve the status quo as long as possible (even if that doesn’t quite jive with the Paris accord), and (2) allows the energy transition to continue to whilst it can be subsidised by cheap(ish) oil.

The best cure for high oil prices…

…is high oil prices. Which is true enough. But what this doesn’t mention is that instead of this being a glowing green utopian future where oil is rapidly substituted by renewables, it is much more likely to be a massive economic shock that will cause a global depression.

I did mention that I am a catastrophist didn’t I ?

So back to my original question.

In 2012, oil was being consumed at 89.7mmbbls/day. This year it is expected to pass the 100mmbbls/day threshold (earlier than any forecast I have seen). Demand is somewhat elastic with price, so as prices climb I’d expect to see the annual growth-rate slow, independently of demographics. But will still grow.

Meanwhile the unloved supply-side monster is getting restless.

Not strictly core to this article, but I do love this infographic from the inimtable : The Oil Market is Bigger Than All Metal Markets Combined (oh and if you read recently that coffee is the second largest traded commodity – it isn’t, its about the same as Graphite.) And if you redo this with $80 oil the number is well over $2 trillion!