What Next For OPEC+?

Suhail Mohamed al-Mazrouei, UAE Oil Minister and current OPEC Conference President. (It should read: Photo… [+] credit.) AFP/GIUSEPPE CACACE/Getty Images)
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After last week’s failed OPEC+ meeting, oil prices are climbing, which is irrational considering that the cause for the failure was the UAE’s desire for an increase in its quota. How can the possibility of increased supply result in lower prices? Traders appear to believe that if there is no agreement, the anticipated 2 mb/d increase in supply for August to December will not happen. The price bulls are engaging in wishful thinking. Because it’s vital to remember that OPEC+, or even OPEC2, lacks substantial enforcement capabilities. The Texas Railroad Commission employed weapons to enforce its quotas, and the Seven Sisters used interlocking contractual agreements to avoid overproduction, but OPEC is more like a gentleman’s club without the cigars and alcohol (well, mostly). To keep members in line, they use persuasion and the nuclear option of a price war/collapse.
In the past, a dissenting member has exceeded its quotas, most notably in the cases of Iraq in 1989/90 and Venezuela in the mid-1990s. With the end of the Iran-Iraq War, Saddam Hussein resurrected his intentions to increase capacity to 6 mb/d and requested a quota equivalent to Iran’s. When the group balked, he just increased production to meet his preferred quota, and they eventually agreed to his terms. It didn’t hurt that the market was close to equilibrium, so his extra production had little effect on prices.
Venezuela naively imagined it could win any price war when it stated in the 1990s that it would no longer adhere to its quotas—while officially declaring that its output was complying to its given amount, which no one believed. According to one official, the Orinoco belt’s production costs were so low, at $4/barrel, that they could withstand pressure from Saudi Arabia and others. Not only was Venezuela significantly above its quotas, but their example pushed other members to increase output as well, prompting the Saudis to demand a quota increase to compensate. This, combined with the Asian recession of 1998, caused the price of oil to plummet to $12/barrel, putting a lot of oil corporations out of business (albeit through acquisitions, not bankruptcies).

During the 1990s, production exceeded quotas.
EIG data was used by the author.
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This illustrates one of OPEC+’s concerns about the UAE’s demand: the group’s relatively strict quota adherence during the previous sixteen months might be jeopardized if the UAE succeeds in obtaining a bigger quota or simply raises production without the group’s consent. Outside of Saudi Arabia, OPEC+ has about 4 mb/d of spare capacity, but 1.4 mb/d of that is Iranian and unlikely to come online anytime soon. Nearly all of the rest is concentrated in Iraq, Kuwait, Russia, and the United Arab Emirates, so the market would hardly notice if each of the smaller members opened their taps.
Whether or not Iraq and Russia respond to the UAE’s demands by requesting more allocations or simply cheating will determine whether prices drop. Because if either or both of these things happen, the Saudis are likely to lessen their voluntary supply cuts, signaling to markets that prices will fall rather than rise. The prospect of $100 a barrel would vanish, but it’s unclear if this would deter US shale companies from continuing to add rigs.
Paul Eckbo wrote The Future of World Oil in 1976, noting that commodity producers’ attempts to stabilize, control, and/or raise prices have rarely lasted more than a few years. OPEC has been significantly more effective than its predecessors in this regard. Long-term pricing, on the other hand, have frequently relied on two factors: supply disruptions, such as the Iran/Iraq War or the Arab Spring, and resource nationalism, which urged oil-rich countries to curtail use of their resources. The lifting of sanctions on Iran, as well as the UAE’s (and possibly many others’) decision to profit from high prices, would lessen both of those variables, resulting in lower prices for longer. For the industry, the current level will only be a good memory./nRead More