Saudi Arabia could cause the death of the OPEC

For some, the influence on the global price of oil that the Organisation of the Petroleum Exporting Countries (OPEC) has held in the global economy makes it little more than a cartel. For decades, the group has carried significant sway over global energy policy, with its primary role being seen as ensuring a stable price around the world.

However, the collapsing price of oil and an increase in the prominence of rival markets and technologies have led to concerns that OPEC’s influence is waning. Surprisingly, while this has caused great concern to many member states, the dominant OPEC nation – Saudi Arabia – is seemingly content to let things progress the way they have been.

Formally created in 1960 as a response to the influence the major oil companies – known as the ‘Seven Sisters’ – had on the global industry, OPEC has always been dominated by Saudi Arabia, though other prominent members carry significant sway over global oil supply. The current full list of 12 members is Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.

OPEC nations first flexed their collective muscles in 1973, when the Arab members – known as the Organisation of Arab Petroleum Exporting Countries – pushed up the price of oil as a response to the US government’s aid given to Israel during the Yom Kippur War. Libya embargoed oil shipments to the US, quickly followed by Saudi Arabia and other Arab OPEC states. The oil embargo lasted for around six months, forcing the price per barrel up from just $3 to $12. However, its impact on the global oil market has had far longer lasting effects.

In retaliation for the oil embargo, the US announced rationing of oil in the country, and imposed a national speed limit of just 55mph to conserve fuel, and a series of daylight saving initiatives. However, the biggest effect was the export ban US authorities placed on the domestic oil industry, which remains in place more than 40 years later.

Saudi dominance
The creation of OPEC represented a massive shift away from private ownership of the oil markets, instead giving power to the nations where the oil was located. By collectively deciding on production levels, OPEC countries have been able to keep the price of oil relatively stable for the last 50 years. Meeting twice a year in their Vienna headquarters, the OPEC nations operate on a one member, one vote system, giving each an equal say in policy. However, it is perhaps for this reason Saudi Arabia is growing tired of the constraints of the group, with the country controlling 16 percent of global oil, all of which is far easier to access than other nations’ fields.

As well as its ease of access, Saudi Arabia is one of the only OPEC members that enjoys a relatively stable political situation. Libya has been engulfed in trouble ever since Colonel Gaddafi was ousted in 2011, while Iraq continues to be deeply split between warring factions. While Venezuela has comparatively high levels of oil, its political leaders have run its economy into the ground and squandered any potential oil-related benefits.

Iran is perhaps the biggest rival to Saudi Arabia’s OPEC dominance. While it does not enjoy the levels of oil that Saudi Arabia sits on, its resources are relatively plentiful. However, it has been hampered for the last 35 years by the sanctions imposed on its economy by Western nations. With relations thawing considerably in the last year, Iran could be well placed to benefit from opening up its oil exports to the rest of the world.

Despite the huge demand for oil, Saudi leaders have been predicting its demise for well over a decade. In 2000, former Saudi oil minister Sheikh Yamani told The Daily Telegraph there would be far less demand for oil by 2030 as a result of new technologies taking over. “30 years from now there will be a huge amount of oil – and no buyers. Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil”, he said. “On the supply side it is easy to find oil and produce it, and on the demand side there are so many new technologies, especially when it comes to automobiles.”

Yamani also predicted a crash in the price of oil, although his timings were slightly off: “I have no illusion – I am positive there will be, some time in the future, a crash in the price of oil. I can tell you with a degree of confidence that, after five years, there will be a sharp drop in the price of oil.”

Cutting loose
In an article published at the start of the year on TheEnergyCollective.com industry website, analyst Elias Hinckley wrote that the sharp fall in the price of oil, and Saudi Arabia’s determination to maintain high production levels, reflected not only the end of OPEC’s influence, but was also a sign the country wanted to generate a more substantial share of the market for itself through its easier to access resources. “The theory assumes that this can be done in some kind of orderly bring-down of prices where the Saudis can find an ideal price below the production cost of this marginal oil production but still high enough to maintain significant profits for the Kingdom while this market correction plays out”, wrote Hinckley. “The assumption is that, following the correction, there will be a return to business as usual along with higher prices, but with Saudi Arabia commanding a relatively larger share of that market.”

Hinckley also suggested “an alternative rationale is that Saudi Arabia is fighting an economic war with oil; a strategy designed to economically, and in turn politically, cripple rival producers Iran and Russia because the governments of these countries that depend on oil exports cannot withstand sustained low prices and will be significantly weakened”.

Despite both strategies being quite likely, there is also a third, longer-term motivation behind Saudi Arabia’s increase of production, according to Hinckley. This goes back to former oil minister Yamani’s prediction in 2000 that the demand for oil will have evaporated by 2030: “Saudi Arabia has embarked on an absolute quest for dominant market share in the global oil market. The near-term cost of grabbing that market share is immense, with the Saudis sacrificing potentially hundreds of billions of dollars if low prices persist. In a world of endless consumption, this risk would be hard to justify merely in exchange for a temporary expansion of global market share – the current lost revenue would take years to recover with a marginally higher share of global supply. But in a world where a producer sees the end of its market on the horizon, then every barrel sold at a profit is more valuable than a barrel that will never be sold.”

Renewable uprising
Although oil has been the dominant fuel for the global economy for many decades, it is widely assumed its days are numbered – certainly in the medium term. Whereas much has been written about the failures of certain renewable technologies – including their unreliable nature and high cost of installation – the industry has, in recent years, begun to grow at a rate that suggests it is finally ready to be taken seriously.

Solar power has enjoyed a rapid upsurge in use, with the cost of the technology falling sharply and the number of solar plants being installed across the world increasing. China has even taken a prominent role in the industry, heavily investing in solar firms.

Car manufacturers are increasingly looking at ways to run on electricity rather than petrol. It is thought the next decade will see these types of cars become far more prominent on the roads as charging infrastructures are improved. Even big technology companies such as Apple and Google are thought to be on the verge of entering the electric car industry.

Alongside the new efficiencies in renewable technologies, there have been firmer commitments from the world’s two leading economies (the US and China) to make serious cuts to their carbon emissions. Last year, US companies invested around $52bn in clean energy technologies, up $4bn on the previous year’s figure. By contrast, China snapped up $89bn worth of clean energy investments, considerably more than 2013’s $68bn.

Things to come
The likely result of Saudi Arabia’s actions will be severe economic pain for Iran, Russia, Venezuela and other oil-producing nations that have weak economies. It could also lead to further political turmoil in those countries. With Russia intent on seizing back parts of Eastern Europe and ensuring its dominant role as Europe’s oil and gas supplier, a collapse in the price of oil could not come at a worse time. Sanctions on its economy and oil industry as a result of its actions in Ukraine mean it can ill afford to lose more money from a drop in the price of oil.

Russia’s state-owned energy company
Rosneft has seen its profits tumble as a result of OPEC maintaining high production. Rosneft President Igor Sechin told a room full of delegates at the International Petroleum Week event in London in early February: “A group of countries in the Middle East is pursuing its policy and considers the interests of other members of OPEC as secondary.”

Sechin has also warned the American shale revolution might not be the long-term solution to the US’s energy needs that some may think. “We know that revolutions are short-lived and the US production increase is not well supported by reserves”, he told the conference.

For the US shale industry, the falling oil price will mean a lot of its costly projects will no longer be seen as financially viable. This may crush a large number of smaller US oil-producing companies, but the larger ones should be able to weather the storm. However, President Obama’s refusal to pass the Keystone XL pipeline extension project in February could hamper the industry’s growth yet further.

Saudi Arabia is also concerned about the warmer relations between the US and Iran. With ongoing negotiations over a potential deal allowing Iran to develop nuclear power and a softening of sanctions on its key industries, Iran could be on the verge of becoming a wealthy and influential neighbour to Saudi Arabia.

Ending exploration
With the price of oil languishing below $50 per barrel, it is proving increasingly difficult for producers to justify investing in new wells. North Sea oil exploration has been dramatically scaled back by UK operators in recent months, while a number of US shale producers are starting to worry they might not be able to afford new digs.

In a note to investors in February, analysts Capital Economics said 2015 would likely see a continuation of oversupply of oil. Commodities economist Tom Pugh wrote: “It is clear that there are no signs of OPEC’s output being cut in response to lower prices.”

Surprisingly, it is not just Saudi Arabia that has been leading the way in pushing up oil production. According to Pugh, a large amount of the increase in oil production from OPEC came from Iraq during December, with the country providing the second largest amount of oil to the global supply last year. The country is reportedly producing 3.6 million barrels per day, which represents a new record, despite the political troubles across large parts of the country and neighbouring Syria.

Pugh added: “Much of this increase has come from the Kurdish region after the two governments finally agreed a revenue sharing deal. The increase in Iraqi production was only partly offset by further falls in Libyan output due to strike action. The upshot is that supply should continue to remain ample over the next year. But we expect lower growth in non-OPEC production and higher demand to put some upward pressure on oil prices in 2016.”

Hinckley concludes: “Saudi Arabia no longer needs OPEC.” Because of global efforts to cut carbon dioxide emissions and the increasing effectiveness of renewable energy technologies, oil’s future is looking increasingly uncertain. As a result, Saudi Arabia has realised it needs to get all its oil out of its wells as quickly as possible if it is going to make any money from it at all. Hinckley says: “The Kingdom has effectively opened the valve on the carbon asset bubble and jumped to be the first to start the race to the end of the age of hydrocarbons by playing its one great advantage – a cost of production so low that it can sell its crude faster, and hoping not to find itself at the end of the age of oil holding vast worthless unburnable reserves.”

The effects of such a strategy are likely to be profound both politically and economically. The days when OPEC held sway over the global energy market may not be over just yet, but, with the leading producer looking to preserve its own interests over the wider industry, it seems the organisation is less concerned with regulating global prices and more about getting any money for oil while it can.