Opec’s role as global oil policeman under threat

Shale in America and sabre rattling from Iran and Iraq have put the heat on Opec.

Iranian oil minister Bijan Zanganeh. REUTERS/Heinz-Peter Bader
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It has been a long time since Iran has been able to throw its weight around as an oil producer. American-led sanctions have cost Tehran as much as US$80 billion in lost oil revenues since 2012 and its rival Saudi Arabia has long controlled world prices with its dominance of Opec.

But the last meeting of oil producing nations in November was notable for its Iranian sabre rattling, with the country’s oil minister pledging to disregard Opec quotas of three million barrels per day (bpd) – regardless of the effect on global prices.

Tehran’s renewed confidence has clearly been buoyed by the thaw in Iranian-United States relations that followed the election of president Hassan Rouhani last year.

Meanwhile, Iraq too has demonstrated its disdain for Opec quotas, also pledging to push production to four million barrels per day – one million more than the Opec agreed limit, which aims to keep prices at more than $100 a barrel. It has only failed to achieve its potential so far, analysts point out, because of a crippling lack of infrastructure and ongoing security concerns.

“Opec’s effectiveness as a cartel and its influence over oil prices is already waning. Compliance is poor and individual output quotas have been quietly dropped. Actual Opec production has averaged over 31 million bpd for the last two years, despite the quota,” argued Tom Pugh, an oil analyst at Capital Economics in London.

In the face of a marginalised Iran and a chaotic Iraq, Saudi Arabia has long held the purse strings on global oil prices, increasing and decreasing its own massive production to keep prices on an even keel.

Riyadh raised output to record levels above 10 million bpd more than once during 2012 and 2013 to keep prices from rising too high.

“The quarterly average floor and ceiling oil prices [in 2013] were largely set by significant changes in Saudi production volumes,” said Amrita Sen, an analyst at Energy Aspects.

But it is not only the new kids on the block that have thrown a spanner in the works. The American shale revolution has already caused oil production to rise by a third since 2005 and by 2015 the US is expected to become the world’s biggest oil producer. China and Russia are also expected to exploit the new push for shale.

“The result would be a further surge in non-Opec supply, which would continue to erode the cartel’s control of supplies and prices,” said Mr Pugh.

Meanwhile, while Libya remains plagued by political instability an end to the deadlock would challenge Opec’s ability to control prices even further, argues James Williams, an economist at WTRG. “It certainly could happen and if it does then it really exasperates the problem,” he said.

With its huge reserves, Saudi Arabia will continue to be able to keep prices from rising too high, but the re-emergence of Iran and Iraq as major players may prevent them from keeping them from dropping too low. Some analysts suggest that this will be a big worry for Riyadh, which has seen spending balloon since the Arab Spring.

Saudi Arabia’s only avoided budget deficits in 2010 and 2011 because of higher-than-forecast oil prices and output. In 2011, Saudi Arabia announced two fiscal packages totalling 480 billion riyals (Dh470.1bn), or near 25 per cent of GDP at 2011 prices, Ms Sen points out, putting a heavy burden on its oil sector.

“The growth of both US and Iraqi production, at least on paper, threatens the kingdom’s share of the market just as its own rising domestic consumption reduces its exports,” said Ms Sen. “Even if the question of how to accommodate Iraq was avoided at the Vienna meeting, it cannot be kept under wraps for much longer.”

Others point out that Saudi Arabia is not alone in needing oil revenues to pay for its monumental budget. Hassan Rouhani unveiled a budget worth $77bn at the end of 2013, while Iraq’s national budget clocks in at almost $120bn. To balance the books, both countries would need prices over $100 per barrel.

Mr Williams says break-even prices for Opec members last year were around $90 for the UAE, $95 for Saudi Arabia and more than $120 per barrel for Iraq and Iran. The Saudis, meanwhile, have enough spare capacity to up their own production by 25 per cent and still remain revenue neutral.

“Less than a third of global oil production comes from countries that can break-even at any number significantly below US$100 per barrel, so Opec as a group will take action to support prices,” said Mr Williams.

“At the same time, the Saudis know that any enforcement they carry out will have less of an impact on them than it does on other Opec countries.”

Ms Sen agrees Saudi Arabia has the fiscal firepower to withstand a fall in oil prices to $80, or potentially even $70, for a short period of time, for 12 to 24 months. She adds that like any other country, Saudi Arabia does not need to balance its budget every year.

At a meeting of Arab oil exporters in Doha, Qatar, at the end of the year, oil ministers from Saudi Arabia and Kuwait played down fears that either an increase in supply from Iraq, Iran or Libya or the US shale revolution threatened the ability of Opec to perform its role as global oil policeman.

“I am optimistic the market will stay balanced and stable next year,” the Saudi oil minister Ali Al Naimi said in a speech, reported by Bloomberg.

“Opec can meet demand for years to come, so don’t make shale oil a scarecrow for Opec and other producers,” his Kuwaiti counterpart, Mustafa Al Shemali, added in comments to reporters.

Analysts are less optimistic, arguing that it will not be enough for the major players in Opec to sit quiet and pretend that Iran, Libya and Iraq and US shale will simply go away. WTRG’s Mr Williams says quotas will need to be introduced for countries individually, something that it could be a significant challenge for states such as Iraq, which has not had a production quota since 1998.

At the same time, he believes that Iraqi and Iranian arguments that they should be allowed to increase production after decades of war and sanctions will have a sympathetic ear in the Arabian Gulf.

“It’s almost written in the Opec guidelines for members to care about each other, so I don’t think there is going to be a shoot out at the OK Coral,” he said.

“You’ll see headlines that have this as a fight and while it is certainly a disagreement it is not the demise of Opec.”