RELEVANCE OF OPEC?

In its 167^th Meeting on 5^th June, 2015, OPEC decided to maintain the existing quota @30 million bbls a day. Immediately after the decision, oil prices went up almost 2 % (Brent-$62.03 to 63.19/bbl) despite oil glut. The market reaction was contrary to the same decision taken earlier in the 166^th meeting on 27^th November, 2014, when Brent crude oil prices had fallen by 7 % from $77.39/bbl to $71.89/bbl. The decline of 7% in Nov., 2014 was notwithstanding the fall of nearly $40/bbl during June to Nov.2014, prior to the meeting. The decline continued for next 2 months to bring down the price of Brent crude oil to $45/bbl in January, 2015

Decline in Crude oil prices after the 166^th OPEC meeting was in line with the strategy of OPEC.  What about the increase in prices after 167^th OPEC meeting? Did OPEC maintain existing quota to support the prices? Certainly Not!

If so, this brings us to the issue of Relevance of OPEC for Oil markets.

According to OPEC, its main purpose is to unify the policies of its member countries regarding petroleum to create:

(a)    Stability in Oil Markets as swing producer.

(b)   Security of supply to consumers.

(c)    Fair return to member countries.

Unfortunately, OPEC’s decision in the 166^th meeting in Nov.2014 did not meet the objectives stated at (a) and (c). The decision was aimed to get supremacy in Oil Markets by creating oil glut; lowering the prices to the extent that shale oil producers are forced to stop production. Subsequent, increase in discounts by Saudi Arabia in Dec’14/Jan’15 further strengthened the underlying objective of the decision of the meeting.  The decision of the 167^th Meeting on 5^th June, 2015 was no different. However, this time the market reaction surprised many, possibly the OPEC members also.

 According to IEA, the production by OPEC and non OPEC producer will continue to create surplus of more than 1.5 million bbls per day unless non OPEC producers reduce production.

Discussions with some Shale oil producers have revealed that some of them may be back in the market/increase production, if US Oil (WTI) stabilizes above $60/bbl. Price on 5^th June was $58.88/bbl.

What happens, if?

- Oil Supply/demand gap continues at existing level?

-Shale oil producers start returning to the market

·         There is already glut in the oil market and additional crude oil storage is limited.

·          Due to high refining margins, most refineries are operating at maximum capacity and the glut has moved from crude oil to products. It is unlikely to last long.

·          It is hard to say, if US shale producers will be back or increase production in short term.

·         Though the operating Rigs in USA have gone down by almost 60%, there is insignificant reduction in oil production so far. Further idling of oil rigs is unlikely after June’15.

·         Some Oil companies in US are seriously considering storing oil in cavern till 2016 or beyond.

·         The proposal to remove 40 year old ban on oil exports by USA is already with the senate. Experts familiar with the issue and procedures believe that the ban is likely to be lifted but may take 6 months or even more. Once the ban on export is lifted, it will help in increasing the price of WTI and hence a boon to shale oil producers.

Ø  Price of WTI/Brent crude oil is not sustainable at current level unless glut is taken care of or additional storage is found.

Ø  The operation of refineries at maximum capacity cannot continue as surplus product availability will bring down the refining margins, besides storage limitation.

Ø   Most Non-Opec producers are unlikely to cut production.

Ø  Shale Oil producers are unlikely to cut further production unless Oil prices go under $50/bbl.

In Conclusion:

OPEC will have to wait longer to bring down the shale producers to their knees. The question arises—OPEC supremacy at what cost? Will OPEC emerge stronger, if the shale oil producers are forced out of the market for few years? They will be back, in any case, within few years, once demand picks up in Europe and China as OPEC is already producing at full capacity.

This leads us to believe that OPEC will continue to be relevant to Oil markets as significant producer but not as swing producer, ensuring stability of the markets.