OPEC Fights Back

(Bloomberg) -- Since its creation more than a half-century ago, OPEC has been jolting the world. The 14-member club of oil exporters is the textbook case of a successful cartel, wielding immense control over the world’s most critical commodity. As waves of new technologies and petroleum discoveries have upended the global energy trade, OPEC’s obituary has been written many times. Yet the Organization of the Petroleum Exporting Countries has just as often defied its critics. Now it’s facing another challenge for long-term survival as the U.S., once its biggest customer, unleashes record supplies of shale oil and the planet turns to renewable energy. So OPEC is again deploying its most trusted tool: cutting output to push up prices. But whether such a tactic can still succeed is unclear.

The Situation

Battered by an oil glut in late 2016, Saudi Arabia and fellow OPEC members launched their first intervention in eight years with a pact to cut production. They even joined forces with Russia, for years a fierce competitor. By mid-2018 the gamble seemed to have paid off: The surplus was eliminated, and oil soon touched a four-year high of more than $85 a barrel. But the victory in some ways proved self-defeating. OPEC's support for prices re-invigorated “fracking” by American shale drillers, propelling the U.S. to overtake Saudi Arabia and Russia as the world's No. 1 crude producer. The rally also elicited the ire of President Donald Trump, who continues to put pressure on his allies in Riyadh to stop prices surging again. As a result, oil slipped in  late 2018 and remained down from its peak in 2019, even as political crises and U.S. sanctions slashed output from OPEC members Venezuela and Iran. That leaves the cartel walking a tight-rope, seeking prices that are high enough to finance their economies without provoking a backlash.

The Background

OPEC formed in 1960 when Saudi Arabia, Iran, Iraq, Kuwait and Venezuela sought to wrest power from the giant U.S. and European oil companies that determined the price of crude. It shot to prominence in 1973, when its Arab members imposed an oil embargo on Western countries in retaliation for their support of Israel. Though OPEC gave up on using oil for political goals, it still operated as the “swing producer,” raising or cutting output when supplies — and thus prices — were too high or too low. Currently OPEC accounts for about 40 percent of world output, controls the bulk of global reserves and operates the most profitable fields on the planet. Yet as “petro-states,” OPEC’s members depend on high oil prices to fund government spending. In some, notably Venezuela and Nigeria, the burden is intensified by corruption and mismanagement. Saudi Arabia has a further incentive to hold prices high as it’s pursuing a partial privatization of its state oil company, Aramco. OPEC’s latest challenge emerged as U.S. production, once in terminal decline, began to soar in 2011 thanks to fracking — blasting apart underground rocks with high-pressure liquids to tap the oil and gas within. The group’s first response was to keep pumping, waiting for this new source to fizzle out. But as prices tumbled from $115 in mid-2014 to $27 in early 2016, OPEC reversed course.

The Argument

How long can OPEC keep it up? The cartel has expanded its powers through the alliance with Russia and another 10 non-member countries, a pact it aims to make permanent. The world’s appetite for oil isn’t going away: Most forecasters expect that consumption will keep expanding for at least another two decades and any decline will be slow. OPEC has a built-in competitive advantage, since its Middle Eastern members can produce crude at about a third of the cost of U.S. shale. Yet the cartel’s share of the market is much smaller now than during its 1970s heyday. Its current intervention has struggled to maintain higher prices. Plus the threat of shale is bigger than ever, threatening to break OPEC’s hold over the market permanently. Then there’s the growing popularity of electric cars and renewable energy, technologies that could mean demand for oil peaks sooner than expected.

The Reference Shelf

• This Bloomberg graphic shows which countries are reaching their targets for oil production cuts.
• Mohamed El-Erian, a Bloomberg Opinion columnist, explains why OPEC is confronting a game-theory dilemma. 
• A QuickTake on the Armaco IPO and another on what drives oil prices. 
• OPEC enshrined its main objectives in a statute in 1961.
• Daniel Yergin’s history of the petroleum industry, “The Prize,” won the Pulitzer Prize in 1992 and was turned into a popular television series. He published a follow-up book, “The Quest,” in 2011. 
• “Out of the Desert: My Journey from Nomadic Bedouin to the Heart of Global Oil,” a book by Ali al-Naimi, the former oil minister of Saudi Arabia.

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