This week energy ministers from the Organisation of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, and its allies, of which the most important is Russia, are meeting to discuss the future of the oil market. But a recent paper by researchers at the European Central Bank calls into question how much influence this group, known as OPEC+, can have on the matter that most concerns it: the oil price.
Certainly the ministers will be glad to see the back of 2020. In March, as the covid-19 pandemic spread, the Saudis and Russians fought a bruising price war to gain market share by flooding the world with oil supplies. Then travel shut-downs sent prices into free fall—on one day in April the price of American futures contracts plunged into negative territory. Russia and Saudi Arabia set aside their differences to respond to the demand shock by cutting production. OPEC+ now has to decide how to respond to an uncertain economic recovery. And the paper finds that OPEC’s most recent period of co-operation with Russia, Mexico and others has been surprisingly ineffective.
When OPEC was formed in 1960, its five members (Iran, Iraq, Kuwait, Saudi Arabia and Venezuela) controlled four-fifths of the world’s oil exports. By 2019, although its membership had expanded to include 14 countries, its share of global production had fallen by half, to 39%. That decline resulted in part from the rapid rise of America’s oil production brought about by shale oil: its share of the global oil market rose from 8% to 19% between 2011 and 2019. At first OPEC responded to this threat by opening the floodgates, lifting production caps in 2014. Oil prices tumbled from $110 per barrel to a low of less than $30 in 2016. Cheap prices were intended to kill off the American shale industry by making it unprofitable. The plan didn’t work. Rather, OPEC countries’ finances took a hit while the more efficient and flexible American competitors endured. The expanded OPEC+ group tried a different tactic in 2016.
The group sought to turn back the clock on oil prices by reducing global output, at first by 1.8m barrels a day, but eventually by more than 5m. To judge the coalition’s success, the researchers built two models to predict what might have happened to the oil price without the cuts. The first assumes no “strategic interaction” between OPEC+ members and other oil-producers (meaning that one group doesn’t change its output in response to that of the other). The output of OPEC+ is assumed to stay at around 46m barrels a day and that of non-members is the same as its actual level. The second allows for non-OPEC+ countries’ output to vary according to how much OPEC+ produces.
At first blush, the coalition’s efforts appear successful (see chart). The price of oil rose fairly steadily from the start of 2017, apart from an episode of widespread non-compliance at the end of 2018, when some members ignored the production limits. But the researchers find that only about 6% of the oil price on average, or around $4 per barrel, was attributable to OPEC’s restrictions between 2016 and 2020. Not only did some members consistently produce more than they promised to, but producers outside the agreement, such as America, seized the opportunity to increase their own market shares. The researchers find that far more drastic cuts would have been required to push global stocks down to the levels OPEC+ had envisaged.
After the upheaval of March and April, the pandemic has convinced OPEC+ to try again. Its members agreed to record cuts of 9.7m barrels per day (around 10% of global supply), a target that was eased by 2m barrels per day during the summer’s economic recovery. This week OPEC+ will debate a second such production increase. With new lockdowns further hurting demand, the coalition is expected to defer it. OPEC countries such as Nigeria and Iraq, struggling under the burdens of covid-19 and reduced oil revenue, are unhappy. But without a sustained increase in demand, the coalition has little choice but to put up with painful limits.