LONDON: Since the turn of the century, global oil production has become more geographically concentrated, making market management easier in comparison to the acrimonious disputes of the 1980s and 1990s. It has, however, highlighted the vital significance of strategic consistency among industry leaders in the three main producing countries: Saudi Arabia, Russia (previously the Soviet Union), and the United States.
According to BP, these three countries accounted for 52% of global output in 1980, after becoming as the top three producers in the preceding decade (“Statistical review of world energy”, 2020).
As a result of the collapse of post-Soviet production, the long-term reduction in US supply, and Saudi Arabia’s on-again, off-again role as a swing producer, their combined share had fallen to 31% by 2000.
Since then, each of the top three producers has enjoyed a comeback, with their combined market share rising to more than 42% by 2019 (https://tmsnrt.rs/3hFfjMr).
Between 2000 and 2019, worldwide output climbed by +20.5 million barrels per day, with the top three producing +17.0 million bpd, or 83 percent of total production.
Armed conflict, civil upheaval, corruption, mismanagement, growing expenses, and the failure to identify new super-giant resources have all impacted production elsewhere.
As a result, global output is more concentrated geographically than it has been since the early 1980s.
OPEC+ BREAKDOWN OPEC+ BREAKDOWN OPEC+ BREAK
Despite a dispute between Saudi Arabia and the United Arab Emirates over production levels that forced OPEC+ production talks to break down this month, the key participants remain the same.
In 2019, UAE output amounted for only 4% of global totals, significantly less than the United States (18%), Russia (12%), and Saudi Arabia (12%), and had only a minor impact on overall global production.
The failure of the discussions implies that Saudi Arabia, in particular, hesitated to agree to an ad hoc rise in UAE output primarily on principle, rather than because of any practical implications for oil supplies.
Saudi leaders appear concerned about setting a precedent or giving a signal of waning determination to other significant suppliers, including Russia and the United States, as well as hedge funds that have aided in driving up prices.
FRAGMENTATION
The Herfindahl-Hirschman index (HHI) is a metric used by economists to assess market concentration. It ranges from 0 (corresponding to a slew of small producers with no market impact) to 1 (similar to a single large producer with a significant market impact) (a single monopoly supplier).
The oil industry’s geographic concentration increased to 0.08 in 2019, up from 0.05 in 2002, according to the HHI.
In comparison to other industries such as phosphates or semiconductors, the oil business has a very low concentration.
The high level of dispersion explains why producers have had a strong motivation to coordinate their output in order to attain greater prices and revenues, but it also explains why this has been difficult in practice.
However, after increasing in the 1980s and 1990s, geographic dispersion was largely reversed in the 2000s and 2010.
The current HHI is the equivalent of an idealised market in which 13 producing countries have equal output shares, down from 19 at the turn of the century.
COORDINATION
In practice, only the top three producers matter because they account for over half of total output and practically all marginal growth, allowing them to control prices.
This explains OPEC’s and its de facto leader Saudi Arabia’s efforts in recent years to reach out to Russia and US oil producers.
Since the 1980s, Saudi Arabia has served as the market’s swing producer and price leader, but since the late 1990s, it has moved to condition market management on Russian collaboration.
Saudi Arabia and Russia have both recently pushed to ensure that US producers do not undermine the market-management system by increasing their own output.
Reaching out to the US oil industry has been difficult due to the fragmentation of domestic production among dozens of companies that are prohibited from entering market management agreements according to antitrust regulations.
As a result, the US oil industry will be unable to participate in the expanded OPEC+ group’s output control efforts with Saudi Arabia, Russia, and their allies.
As a result, the US industry remains a complex and unreliable component of the theoretical market-management triangle.
When exponential growth in US output contributed to Saudi Arabia’s choice to wage volume wars in 2014 and 2020, the problem became clear.
TRUCE OF THE MARKET
However, the impact of two volume wars in the last six years has chastened US oil producers and pushed shareholders and managers to demand higher profits.
As a result, production in the United States has shifted to a smaller number of larger players, lowering the incentives for unrestrained output expansion.
More crucially, rather than raising production, U.S. business leaders are now concentrating on reducing debt and increasing payments to owners.
As a result, Saudi Arabia and Russia have less of a problem with American business.
In the medium term, formal coordination between Saudi Arabia and Russia, as well as a reduction in the threat posed by US oil producers, will suffice. Other, lesser producing countries’ assistance is diplomatically beneficial but not strictly required. In the near run, rising prices are expected to persuade both Russia and the United States’ oil industries to break ranks and begin expanding output more quickly, putting existing market management under significant strain. Higher pricing, if maintained, would eventually lead to quicker production growth outside of the big three, undermining market control and demanding its expansion to other producers in the long run. The UAE’s aim to boost short-term production and long-term capacity, which has resurfaced as prices have recovered from last year’s terrible drop, is an early illustration of this problem, which explains why Saudi Arabia has been so adamant in its opposition. – Oil prices rise despite the fact that consumption is below trend (Reuters, June 25) – Rising oil prices indicate a need for increased production (Reuters, June 16) – Oil prices hit multi-year highs as a result of US shale restriction (Reuters, June 4) (David Evans edited the piece.)/n
