Upheaval in the Middle East confounds forecasts of energy markets, such as Oil & Gas Journal’s annual Forecast & Review (p. 18). The political nature of that upheaval is well-documented and important. Less reported but no less important is its economic dimension.
Middle Eastern changes present the Organization of Petroleum Exporting Countries, dominated by Persian Gulf producers, with a paradox. OPEC can claim continuing success in one dimension but not in the other.
Successful agreement
The exporter’s group succeeded in assembling the late-2016 agreement to limit oil production, with help from Russia and other nonmembers. The deal now enters its third year after a December correction trimming supply from October levels by 1.2 million b/d. Past OPEC efforts to manage supply elicited only empty promises from potential collaborators and didn’t last nearly this long. The agreement has succeeded politically.
And it has succeeded despite extraordinary Middle Eastern tension. Hit anew by US sanctions, Iran is pressing its expansionism through proxies in Iraq, Syria, Yemen, and Lebanon while again threatening to close the Strait of Hormuz. Saudi Arabia, ever wary of Iran, is losing international stature because of its quagmire in Yemen and the murder of a journalist in its consulate in Istanbul. Qatar, blockaded by Saudi Arabia, the United Arab Emirates, Bahrain, and Egypt, has quit OPEC to concentrate on natural gas. Russia, allied with Iran and Turkey and flirting with Saudi Arabia, wants to strengthen its influence in the region as the US disengages—most recently via the sudden military withdrawal from Syria.
Still, the production accord endures. Yet, still, oil prices ended 2018 in descent. Succeeding politically, the agreement now struggles economically.
OPEC’s leading Middle Eastern producers find themselves losing oil-market influence while needing to restructure their economies. The Arab Spring uprisings of 2011 and oil-price crash of 2014-16 demonstrated limits to their abilities to buy regional friendship, domestic tranquility, and superpower protection with oil money. To varying degrees, Saudi Arabia, the United Arab Emirates, and Kuwait now scramble to reform away from the rentier economics their budgets have outgrown.
Pressure to change comes not only from fiscal strain but also from competition in the oil market. In a relatively few years, US oil production has come to rival output by Saudi Arabia and Russia, supplemented by rising output elsewhere, such as in Canada and Brazil. Much of the US supply, moreover, comes from shale and other tight-oil plays and can respond quickly to changes in the oil price. Rapid-response supply is new to the oil market and a new problem for OPEC’s supply managers. And it’s growing rapidly. The US Energy Information Administration expects US production of crude oil to be up 1.5 million b/d this year and to rise by 1.2 million b/d next year. Most of the growth is tight oil.
In this newly competitive oil market, the Middle Eastern producers retain a theoretical advantage: physical lifting costs still comparatively low. But their fiscal dependency on oil revenue suppresses physical cost as a factor of practical decision-making about production. Analysts discuss “fiscal break-even” oil prices for the rentier countries to, in effect, fuse the costs of producing oil with those of running countries where populations have grown accustomed to free or cut-rate services, not to mention the occasional cash handout. Those prices will remain high in relation to the physical costs of producing Middle Eastern oil—and much oil from shale—until fiscal burdens move substantially away from national oil companies to citizens resistant to taxation. That touchy process has barely begun.
New variables
For the oil market, with budgets of North American producers already adjusting to oil-price weakness, these are new but lasting variables. Where the imperative to change leads Middle Eastern oil producers is, as 2019 begins, uncertain.
Recent history makes clear, however, that OPEC can’t afford another oil-price crash. Equally clear is that an oil market in surplus won’t go long without coordinated supply restraint.
