It is often said that when the tide goes out, you can see who was swimming naked. Something similar is happening in the oil market. The collapse of prices in recent weeks has highlighted the shame of the Organization of the Petroleum Exporting Countries (OPEC). Although the cartel tried to reverse the decline in crude oil, by extending its deep production cuts (several million barrels of crude oil), this time the situation seems different. Its decision does not drown the world (as happened in the 1980s) nor does it succeed in reviving oil, as happened on other, more recent occasions. The result of this measure is to reduce OPEC market share at near historic lows. The cartel suffers the blow of sacrifice (decrease in market share) without practically reaping the benefits. Why? The oil market could change hands, going from strict OPEC control to a market “controlled” by several hands, which would look more like a competitive market than a cartelized market.
Brent crude oil, the benchmark in Europe, is trading in the $72 area. About 18% below the highs of early July (more than 24% if we take the benchmark at the end of 2023). Many will say that $72 is not an alarming price and they are right. The barrel of Brent fell into the $20 area during the covid crisis. The difference is that today, Covid is a thing of the past and the factors shaping the market should take crude oil to much higher levels. This is not happening because the oil supply is stronger and more secure than ever. Diversification is security. Oil is also produced today in large quantities in many countries outside the Middle East.
There are several near-term factors (apart from weak demand from China) that should push up the price of crude oil: tornadoes in the US and Mexico that are limiting production, interruptions in major oil fields in Libya, OPEC cuts, falling inventories, tensions in the Middle East, the war in Ukraine… With these ingredients, it would not be strange for a barrel of crude oil to trade near or above $100, especially in a still expansive global economic cycle. However, crude oil is faltering.
“These supply and demand dynamics, together with the abundance of available capacity (millions of barrels that could be produced overnight), have indeed helped to ease market concerns about a possible geopolitical disruption of supply. Middle East and between Russia and Ukraine. Even the loss of some 600,000 barrels per day of Libyan production did not prevent prices from falling.“, they point out in a report from BCA Research.
While this part (OPEC) of the supply is suffering, another very different story has been brewing for some time and is now bearing its most visible fruits. Crude oil production in America (United States, Canada, Brazil, Guyana and even Argentina) is emerging. OPEC cuts are being “eaten” by America. While the cartel countries remain essential to the smooth functioning of the crude oil market, the International Energy Agency (IEA) said this month that the market would be well supplied even if OPEC does not reverse its cuts, because production in the Americas is growing faster than global demand for crude oil.
However, the latest data reveal that the weight (market share) of total OPEC production in the market could be about to fall into the 28-30% zonelevels close to the lows seen in the 1980s. The difference is that in the 1980s, OPEC cut and lost market share in exchange for “choking” the world with extremely high oil prices. Today, market share is down to the same level and oil is relatively cheap (especially considering the sharp rise in inflation in recent years).
OPEC loses control of oil
As one analyst pointed out last week: “OPEC is losing control of the market.” The OECD countries, led by the Americans, Today they have a quota similar to that of OPEC.. The cartel still has a clear advantage, since its new version, OPEC+ (involving Russia), brings its market share above 35%. But Russia is not a reliable partner, as it has demonstrated on several occasions, which leaves OPEC in an unprecedented situation.
From Capital Economics, they explain that oil prices have fallen despite OPEC+’s decision to maintain production cuts. And given the way OPEC+ is losing market share, we believe Saudi Arabia, the de facto leader of the group, has reason to increase its oil production more aggressively: “This production increase would already be a desperate measure that would put even more downward pressure on crude oil prices. Another market twist. A new cycle with all its ups and downs: increase production to lower prices, wait for low prices to “temporarily destroy” competition, and then reap the rewards of higher prices and greater market share.”
The problem is that in the process, OPEC loses hundreds of millions. Oil has to stay low for a while before the companies that extract crude oil in America start to run into problems and their least profitable wells are forced.
With all of Bank of America Merrill Lynch at BCA Research have begun to downgrade their crude oil price forecasts: “Our commodities team is already warning of the buildup in global oil inventories, although they continue to assume that OPEC+ will postpone its planned increase in production quotas. Global oil price volatility, coupled with record excess capacity in OPEC+, is, in our view, clouding the outlook for oil prices and could become OPEC’s Achilles heel in maintaining discipline and quota compliance if cuts are prolonged further,” these experts say.
OPEC is a pressure cooker
“After all, discipline within a cartel is harder to maintain if the promise of meeting future demand growth turns into a war for market share: and our commodities research team forecasts non-OPEC+ supply growth of about 3 million barrels per day over the next five years, enough to satisfy 80% of the growth in global demand during this period,” these experts estimate.
BCA Research provides the key reasoning behind why OPEC is not going to cut production further (which would make sense given the drop in crude): “Ultimately, OPEC+ would have to cut production further to push oil prices higher. Having already cut production by 11.5%, further supply cuts would increase the risk of coalition conflict and compliance fatigue (there are countries that want to produce more sooner rather than later to avoid losing their quota market).”
“This reduces the likelihood that the group will give up further market share to support prices.”. It is important to note that OPEC policy has always been reactive rather than proactive. Therefore, it is unlikely that it will be possible to cut crude oil production until oil prices fall to a much lower level,” they admit from BCA Research.
Moreover, one of OPEC’s major customers is having serious difficulties maintaining its growth levels, which is further intensifying the battle between the cartel countries to sell its oil. China is buying less crude and accepting offers. If Russia sells cheaper, Beijing will buy Russian crude and leave Saudi crude out. There is no doubt about it. These clashes over an ever-shrinking pie could end up blowing up everything in OPEC’s agreements.
In the meantime (we will have to wait for OPEC to officially open the taps or for one or more members to rebel) “it is possible that prices will rebound in the short term, especially in the event of a factor-induced supply shock. In a cyclical period, the path of least resistance for prices is downward. Therefore, investors should reduce their exposure to oil. We will wait for confirmation, but oil prices are on the verge of a sustained decline.” by BCA Research.
Although OPEC has tried to remedy this loss of control, by expanding the family and creating OPEC+, the truth is that this move is more a symptom of weakness than strength. If it has been difficult to coordinate a series of countries (many of which are neighbors and have intense relations) to control crude oil production, managing the current situation requires even more audacity. OPEC+ market share is also at its lowest since its creationas the International Energy Agency explains in its monthly bulletin for April. Now it could have been reduced even further.
