After 60 years, what future for OPEC

Sep 16, 2020

In the face of new global energy changes, going through these traumatic times, and after 60 years, what future for OPEC, can we expect of this organisation.

OPEC was established on September 14, 1960 and celebrated its 60th anniversary with a declining share in both energy decision-making and global marketing. With the coronavirus outbreak despite a substantial drop in production, prices are struggling to recover to 2019 levels.  With a crisis like no other, since the 1928/1929 crisis, at a time when the interdependence of economies was low, no expert, able only to develop scenarios, can predict whether consumer and investment activities will be able to rebound, depending on the control of the epidemic. However, a high growth rate in 2021 compared to a negative growth rate in 2020 would mean it recovers, and in any case, the level of 2018/2019 will not be reached until 2022. However, the growth of the world economy and the future energy consumption model for 2020/2025/2030 are the fundamental determinants of the price of oil/gas, as the market has experienced ups and downs have not yet reacted favourably to the various OPEC decisions.

OPEC was created on September 14, 1960, at a Baghdad conference mainly on the initiative of the Shah of Iran, the Saudi Abdullah Tariki and the Venezuelan Juan Pablo Pérez, with initially only five member countries: Saudi Arabia, Iran, Iraq, Kuwait and Venezuela. Other producers joined such as in Africa, Algeria joining in 1969 was the first country to nationalise its hydrocarbon production;  Angola:  member since 2007. One of the largest areas of exploration, mainly conducted as production by the major oil companies of the OECD;  Congo:  the last member country to join the organisation (in the summer of 2018); Gabon:  a member who left the organisation in 1995 and rejoined it back in July 2016; Equatorial Guinea, a country that joined OPEC in May 2017; Libya:  member since 1962. Immense potential for untapped exploration due to the conflict in that country;  Nigeria: OPEC’s least nationalised oil industry. In South America:  Venezuela a country with the world’s largest oil reserves thanks to its oil sands resources but currently experiencing a severe political and economic crisis; Ecuador,  which was a member of OPEC between 1973 and 1992 and then again in 2007 In the Middle East:  Saudi Arabia as a founding member. The traditional leader of OPEC and the second-largest producer in the world with the largest conventional reserves; the United Arab Emirates, a member since 1967, a significant producer; Iran, founding member, OPEC’s second-largest producer and fourth-largest exporter of crude oil in the world before sanctions; Iraq: a founding member with the world’s largest open-air reserves; Kuwait: a founding member, a unique deposit whose peak production is declining. Qatar, a country that announced that it would leave the organisation in January 2019, officially to focus on its gas production. 

Since 1982, OPEC has had a system for regulating production and selling prices using a total amount of production (slightly more than 30 million barrels of crude per day). This volume of production, defined according to member countries’ reserves, is adjusted according to the needs of the consumer countries. The system of production quotas by member country was agreed in 2011 and negotiations have been expanded since the end of 2016 with other non-OPEC producers, Russia, produces as much as Iran, Nigeria, Venezuela, Algeria and Ecuador combined. However, the functioning of this regulatory system is affected by fluctuations in the price of the dollar, the transaction currency of oil: the purchasing power of producing countries decreases when the dollar falls and vice versa. 

OPEC manages a quantification instrument: the OPEC basket (ORB) which sets a benchmark price based on the costs of fifteen crude oils type (one per member country). The different qualities type reflect the major crude exports of member countries (e.g., the “Arab Light“ of Saudi Arabia). This basket is competing with the WIT and the Brent, whose prices are usually only a few cents different. Production and price management is extended by periodic assessment of available reserves. For all these countries, oil and gas revenues contribute significantly to their development through taxation. Still, these being very fluctuating over time and depending on the number of inhabitants of a country. For example, according to the EIA (2019), oil revenues in 2018 amounted to $14,683 per capita in Kuwait (nearly 4.2 million inhabitants), compared to only $212/hab for Nigeria (-200 million inhabitants). When the dollar falls against other currencies, OPEC states see their revenues decline for purchases in different currencies, which reduces their purchasing power as they continue to sell their oil in dollars. Local constraints (political instability, wars) or international crisis (embargo, sanctions) also affect the availability of the oil resource and thus its price. Always according to the IEA, in 2018, OPEC states as a whole benefited from a total of about $711 billion in oil revenues compared to $538 billion in 2017, due to higher average crude oil prices and higher exports, where Saudi Arabia benefited of $237 billion in 2018, ahead of Iraq with $91 billion.

OPEC decisions have, for some time, had some influence on the world’s oil price. Beyond the economic context, OPEC’s action on oil price developments is closely linked to the geopolitical environment. The organisation’s influence, however, has diminished since the 1990s, as has its share in world oil production. 55% in 1970, 42.6% in 2017 and about 38/40% in 2019 and indeed an even lesser rate is expected in 2020. One example is the oil crisis of 1973 during the Yom Kippur War: OPEC’s embargo on Western countries that support Israel caused a fourfold increase in the price in five months from October 17, 1973, to March 18, 1974. However, this historical version of the first oil shock is highly questionable.

On the other hand, from 1983, the price of a barrel collapsed, and from then on, would no longer be controlled by OPEC for several years. The London futures markets (ICE) and New York (NYMEX) playing an increasing role in determining prices, took over the pricing process away from OPEC. Recall that on September 28, 2016, OPEC met in Algiers with a historic decision to limit crude oil production to a level of 32.5 to 33 million barrels per day. On November 30, 2016, in Vienna, its output from 1.2 million barrels per day to 32.5 million with an effective agreement as of January 01, 2017, and Russia’s commitment to reduce its production by 300,000 barrels per day. In May 2018, the Vienna meeting, the members signed the integration of another country: Equatorial Guinea, which then officially became the 14the member of OPEC (the sixth African country). It was in a particular context that on April 09 2020, the group of oil-exporting countries, comprised of the 13 of the OPEC and ten-member partner countries, negotiated a new agreement on a joint reduction in production: a 22% reduction in output from the ten non-quota-exempt OPEC countries (i.e. OPEP without Iran, Venezuela and Libya) and their 10 OPEC partners, the final agreement covered 10 million barrels per day less on the market during May and June, with reductions up to 8 Million Barrel per Day (MBD) between July and December 2020, and then to 6 MBD up to January 2021. The effort will be supported mainly by Saudi Arabia and Russia, the second and third largest producers in the world behind the U.S., which would each cut nearly 2.5 Mbj from a reference production smoothed to 11 MBD. The remaining 5 million barrels to be cut would be distributed among the other 18 countries in the agreement, depending on their production level over a typical reference month, which is October 2018. According to experts, discussions focused on this reference period, with each measuring its actual production capacity, having to decide whether or not to take into account condensates (hydrocarbons associated with natural gas deposits) in the reference period can also play on final quotas. The organisation hopes that the United States, the world’s largest producer, and other countries such as Canada, Norway and Brazil, will reduce their production to a total of 5 MBD. This is only a wish since the United States has indicated that it will not participate in this reduction,(the majority being private companies, U.S. laws prohibiting executive directives in the management of the private sphere) as the U.S. Department of Energy has declared that the country’s production is already declining, because the majority of marginal deposits, which are the most numerous, although costs have fallen by more than 50% in recent years, shale oil is no longer profitable below $40 per barrel

During the 1990s, OPEC’s influence with the importance of Saudi Arabia on oil price resulted in prices declining for three reasons: a) internal divergences and the violation of production quotas by some of its members, b) the failure to extend its zone of influence to new producers (Russia, Mexico, Norway, United Kingdom, Colombia) and c) the impact of the London and New York markets that significantly drive prices. 

So sixty years after its founding, OPEC faces also three significant challenges that have persisted since the 1990s.  

• First,  the resolution of new internal conflicts: the rift between pro and anti-American members exacerbates these conflicts. Saudi Arabia, a traditional U.S. ally, is facing Iran and Venezuela, two of the most overtly anti-American countries in the world, challenging its influence on the organisation. Beyond ideological differences, there are therefore two trends between countries for which OPEC must above all be the facilitator of a commodity market and those wishing to make it a more political weapon.  
• Secondly,  the rise of Russia, wherewith more than 11.3 million barrels per day, produces as much as Iran, Nigeria, Venezuela, Algeria and Ecuador combined, having pledged since late 2016, alongside OPEC to cap its production to raise oil prices. 
• Third,  the growing production of unconventional hydrocarbons in the United States, which makes it the world’s largest producer in 2019 with more than 12 million barrels per day, has reduced OPEC’s influence. However, its hydrocarbon reserves are announced as the world’s first. Still, it will all depend on the price vector and costs that may have large reserves but are not economically profitable. New deposits discovered, particularly in Canada or off the coast of Brazil, could disrupt the global distribution of these reserves and thus significantly reduce OPEC’s share. But the critical medium and long-term decline in its influence is the new model of global energy consumption that is emerging.  

Years 2020 through 2040 could be impacted by the Coronavirus, as already shown by the reorientation of public investment in Europe. As per B.P.’s recent statement of September 11, 2020, companies should redirect their investments towards other alternative energies with the combination between 2025/2035 of renewable energy and hydrogen, the cost of which will be widely competitive compared to conventional fossils. 

By 2030, lower dependence on oil is expected by industrialised countries. In contrast, conversely, OPEC countries remain highly dependent on oil, mainly due to the absence of a sustainable economic model that can replace the oil industry. Oil revenues account on average more than half of their Pia developed a “Vison 2030” to diversify its economy. The combination of these factors weakens the geopolitical influence of the OPEC institution and acts on the price level.

The price of oil in 2020/2021 is as always fundamentally dependent on the growth of the world economy. 

For China, which is heavily demanding hydrocarbons and dependent on external markets at half-mast, industrial production is recovering very modestly. Such a decline is unprecedented in China since the country turned to the market economy in the late 1970s. According to the Asia-Pacific report released on April 8, 2020, the world’s second-largest economy could see its GDP growth limited to 2.3% over the whole of 2020, or, as per a darker scenario, be almost nil, at 0.1%. It is not to be compared to its 2019 estimated 6.1% for a population exceeding 1.3 billion requiring a minimum growth rate of 7 to 8%. As far as India is concerned, the demand for hydrocarbons will also be low because its economy is geared towards globalisation. The impact on its growth rate is evident and is still in a declining trend in 2019. After falling to 4.5% from 7.5% in 2018, it is accompanied by an increasing rate in unemployment. In addition to all potential health and social crises, its economy paralysis could lead to the breakdown of the supply chain of many global companies. India, with more than 4 million low-cost employees (Indian I.T. engineers are paid up to 5 times less than their Western counterparts) is the leading player in ICT outsourcing. Almost all of the major international groups delegate part of the management and maintenance of their digital tools to Indian companies.  For the Euro area, dependent on more than 70% on hydrocarbons, the PMI (survey of business purchasing managers) saw the most significant drop on record, after reaching 51.6 in February 2020. This index is a figure that if it is below 50, it indicates a contraction, but if above, represents an expansion of activity. For instance, the President of the European Central Bank stated “In the economies of the Euro area, for each week of Lockdown, GDP‘s are shrinking by 2 to 3%. The longer it goes on, the bigger the shrinking of the economy.” Growth in the euro area and the E.U. generally will fall below zero by 2020. This necessitated a $1 trillion bailout from the ECB, plus $500 billion for all ancillary institutions. For the two leading European economies, according to officials, in France, the notices give less 9%. In Germany, the leading economic institutes have forecast that Germany, which plunged by 9.8% in the second quarter of 2020, double the co. Recorded in the first quarter of 2009 following the financial crisis. For the United States of America, the job market is deteriorating at an unprecedented rate, despite the government’s injection of more than $2 trillion. With data contradictions showing the extent of uncertainty, Morgan Stanley sees GDP fall by 30%, Goldman Sachs by 24% and JP Morgan Chase by 12%. The bailout package, which is more than 9% of U.S. GDP, is a mix of non-refundable aid and hospital loans, a massive increase in unemployment insurance for individuals. But this raises the whole problem of the health care system in the United States. According to the Kaiser Family Foundation, which specialises in health issues, the average cost of family insurance in 2018 was $19,600 (about 18,000 euros), 71% funded by the employer. To keep it, a sacked employee will have to support it in full. To avoid a significant increase in the number of uninsured (about 28 million in the United States), a dozen states, mostly Democrats, have relaxed the rules for subsidised insurance underwriting.  For the global economy as a whole, and according to several international institutes, including the Institute of International Finance (IIF), Global Financial Sector Association, a note dated April 7, 2020, highlights the global economy is expected to contract by 1.5% in 2020 in the context of the COVID-19 pandemic, lowering its forecast from 2.6% to 0.4%. According to the report, I quote “our global growth forecast is now -1.5%, with a contraction of 3.3% in mature markets and growth of just 1.1%” in emerging markets, adding that there would be “enormous uncertainty” about the economic impact of COVID-19.” Over the full year, the IIF expects growth rates in the United States and the euro area to contract by 2.8% and 4.7% respectively. For its part, the IMF anticipates a “partial recovery” in 2021 provided the pandemic subsides in the second half of this year. That containment measures can be lifted to allow for the reopening of shops, restaurants, a resumption of tourism and consumption. According to the IMF, low-income or emerging countries in Africa, Latin America and Asia “are at high risk” where we have seen capital outflows from emerging economies more than triple that for the equivalent period of the 2008 financial crisis.

What are the prospects for the price of oil? 

Global oil consumption in 2019 was around 99.7 million BDD globally, according to IEA data, and OPEC countries accounted for only 40 per cent of global crude oil production.   China on a global consumption for the same period imported 11 million barrels or about 11/12% of world consumption. According to energy experts, a drop or rise of a dollar in the price of oil would mean an impact between 500 and 600 million dollars. If you take a median average of 550, the shortfall from this decision is $5.5 billion per day per year. It will therefore be a matter of establishing a currency balance of the net gain of this decision, assuming that, if the price falls to $30 or less, before this reduction, allowing the market price to be between $40/45 per barrel. If the barrel were less than $30/35, this decision would have had a very mixed impact. In September 2020, it seems that the market is reacting timidly after this reduction, knowing that the price increase will depend mainly on the return or not to ‘growth’ in the world economy. The primary determinant of demand, because the reduction of 10 million barrels per day is based on the assumption that global demand market declines by only 10/11% while the coronavirus epidemic has caused a drastic fall in global demand, up to 33% or about 30 million BPDs.  

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