Why Opec is increasingly irrelevant

Nawaf Obaid
 

Saudis have sent message that market not Opec should decide oil prices

The oil minister of Saudi Arabia, Ali Naimi , before the 162nd Organisation of Petroleum Exporting Countries (OPEC) meeting in Vienna, Austria, 12 December 2012. EPA/HERBERT PFARRHOFER
©EPA

Ali al-Naimi, Saudi Arabia's oil minister, expects the oil market ‘to stabilise itself eventually’

When the Saudis, the leaders of Opec, decided at the cartel’s recent meeting in Vienna to maintain their oil production levels, it sent a strong message to the world: the market, not Opec, should decide oil prices. As a result, oil prices dropped, falling below $60 per barrel this week.

This is a big change for the world’s largest oil exporter, which has in the past attempted to manage the global oil markets by altering production levels. The Kingdom essentially decided to pursue a policy that not only preserves its market share in the long term but also heralds the coming end of Opec as a united organisation that still has a collective say in export decisions.

While the decision was unpopular with most oil exporting countries and major international energy companies, there are several reasons why Saudi Arabia is taking this approach.

First, the Saudi leadership has long recognised the strategic importance of spare production capacity, so it has spent at least $10bn over the past decade to maintain a 2m-barrels-per-day spare capacity that can be called upon at short notice.

No other country has had the political will and foresight to do this, and it provides the Saudis with the means to go it alone against the will of the majority of oil producers, led by Russia, Iran and Venezuela.

This decision will have major political and economic effects on some of the Kingdom’s fiercest adversaries. In short, significantly lower prices over the medium to long term will directly neutralise what Saudi Arabia perceives as the destructive geopolitical actions of these countries in the Middle East.

From an internal Saudi perspective, lower oil prices are entirely manageable. Saudi oil is relatively cheap to extract so crude production can remain highly profitable at lower prices. In fact, with new drilling technologies, Saudi production costs have decreased even further while field reservoir management, a technique to prolong the life cycle of a producing field by better managing its proven reserves, has become more efficient.

Second, the Saudis have about $900bn in foreign assets, so their public finances are immune to a sudden big fall in revenues from petroleum sales. Finally, it seems clear the Saudis want to bring back the realism of raw power to the global energy markets, which means the long-term national security interests of the Kingdom — the top Opec producer and exporter — come first.

The Saudis also clearly view lower prices as helping them keep market share in the face of the shale oil production boom in the US. This revolutionary innovation will add several million new barrels of oil per day to the global market.

However, shale oil is expensive to extract, so lower prices will mean several important US producers will find their business models unsustainable over the mid to long term. Of course, the Saudi objective is to mitigate the increase in shale oil, not eradicate it, in order to assure a soft landing for global markets when oil prices rebound.

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The Kingdom holds about 25 per cent of the world’s oil reserves, 85 per cent of global spare production capacity, and is the world’s largest crude exporter by far. Hence, it has always taken a long-term moderate approach to implementing energy policy, in stark contrast to the other Opec countries (save its Gulf allies).

Through various revenue model projections based on different oil price averages and export levels, the Saudis can sustain oil prices falling to $60 per barrel on average for at least the next five years, with temporary dips as low as $40 per barrel. It would be a mistake to doubt the political resolve of the Kingdom to see this new policy through in this new oil era.

Inevitably, the Saudi decision shows that Opec is becoming increasingly irrelevant as a force in the global oil market. Further, the Opec and non-Opec members that have no room to increase their exports and lack the political will and financial means to cut production — Iran, Iraq, Venezuela, Russia, Mexico and Nigeria — will become mere passive spectators in this new era.

The Kingdom, in keeping up with the changing realities in the energy markets, has realised that the market will rule. Oil producers that have not understood this tectonic shift and begun to adapt to this new reality will suffer, and be left behind to face their day of reckoning.

Nawaf Obaid is a visiting fellow and associate instructor at the Belfer Center at Harvard’s Kennedy School of Government

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