When OPEC meets this week the energy industry will collectively hold its breath. Tumbling crude prices have rattled producers and investors around the world. With near-term demand flagging, anxious looks in the direction of Saudi Arabian officials, alongside fervent analysis of any hints from the Kingdom, are in strong supply. US producers are searching for the King’s number.
But this time, the call on Saudi Arabia to cut production is not so straight forward. Saudi Aramco cutting differentials for US refiners earlier this month is a clear sign it is competing for US market share, in large part with Canada, Mexico and Venezuela. Intra-OPEC competition is nothing new, but this latest reaction of the Saudis highlights the difficulty the group will have in agreeing production figures, even among the Founder Members. Producing at the top of the cost curve and in domestic crisis, Venezuela is crying out for a higher price. Reliance on oil revenues in Iran, Algeria, Nigeria and Ecuador is likely to inspire these countries to push for production cuts; while the heavyweights in the Gulf will sense an opportunity to defend or expand market share. In the first group, $115/barrel is required to balance budgets and support social programs but Qatar, the UAE and Kuwait can cope with $75/barrel.
As usual, Saudi Arabia holds the key to the OPEC chest. Buoyed by robust prices in recent years brings speculation that it has over-extended itself, domestic commitments have grown, not helped by concern around an expanding population of under 25s maturing in the middle of social and political upheaval in the region. Can the Saudis withstand lower oil prices? Yes, but not without absorbing revenue cuts in the dozens of billions of dollars per year. The more important question might ask whether the Saudis can cope with production cuts.
The policy to cut production in order to drive up prices between 1980 and 1986 was disastrous for the Saudis. Crude exports fell by more than 70%, OPEC supply was replaced by development and production in other geographies. Lessons learnt from this episode would suggest that while a $75 price is sub-optimal, the priority for the Kingdom must be to remain the crucial oil exporter. Would a coordinated production cut be possible across OPEC members? History suggests this will be challenging to agree and more difficult still to enforce. Whether this is ultimately plays into the hands of non-OPEC producers will be of further concern.
Oil is a cyclical business and the industry has begun to prepare for a period of lower prices and capital discipline. Some important indications of the length and depth of this period will come out of Vienna on November 27. In the meantime, the anxious looks in the direction of Dhahran will continue.
Matt Loffman, Douglas-Westwood Houston
+1 713 714 4795 or Matt.Loffman@douglaswestwood.com