For a group said to have arrived at death's door many times in 55 years, the Organization of Petroleum Exporting Countries displays remarkable survivability. Speculation lately has returned about OPEC's end. Who knows? It might be right this time.
OPEC survives by adapting. Past death pronouncements emerged when oil-market changes undermined the group's effectiveness. Each time, the group accommodated its role to new realities and moved on, its adjustments and processes neither smooth nor precise. OPEC is a political group. It manages the often-conflicting interests of a geographically, economically, and ethnically diverse membership. Relations between members, as Saudi Arabia and Iran demonstrate now can be hostile.
Adapting and managing
The group nevertheless has endured, adapting to markets and managing through internal strife. It started life mainly to seek consultation on the price of oil owned by expatriate companies. As membership grew, it gained strength through nationalizations and demonstrations of market clout during the politically motivated oil embargo by Arab exporters in 1973-74 and the supply shock caused by revolution in Iranian of 1978-79. Between then and the market collapse of 1986, the group tried to become a cartel, limiting production to lift the crude price. After that effort failed, the group settled, neither steadily nor unanimously, into the role of marginal supplier, adjusting production in rough accordance with contemporaneous estimates of demand.
OPEC's methods, like its role, have been evolutionary. At times the group targeted a specific price. At other times it tried to keep the marker price within a target band-the boundaries of which inevitably proved flexible. At still other times the group just based production targets on market expectations, using price more as a demand indicator than as a target. OPEC's performance has been mixed, its failures related usually to flawed ambition for supply management and to misreading of the market.
What seems like the death of OPEC to some observers in fact might be merely uncertainty about a new role adjustment. Led, as always, by Saudi Arabia, the group in November 2014 publicly vacated its position as the oil market's supply manager. When it refused to seek production cuts by members to defend the price of crude oil, the market was shocked. Yet the decision defies argument.
OPEC's leaders correctly perceive that the oil market is diminishingly amendable to coordinated supply management. OPEC no longer dominates idle production capacity. Indeed, the very concept of production capacity has changed. Unconventional resources, especially shales but including oil sands, represent supply that can be developed and brought onto production relatively quickly when price elevation signals the need. This isn't spare capacity in the conventional sense. Economically, though, it functions nearly the same way.
In this new environment, if OPEC trims production to defend the crude price, nonmember producers quickly can respond with new supply able to lower the price anew and leave OPEC's supply managers with nothing to show for the effort except lost market share. The prompt availability of incremental supply outside OPEC changes the market fundamentally. While it doesn't fully explain current conditions-geopolitical tensions influence production decisions, too-it does mean that the supply-balancing mechanism on which the oil market long has depended is, until further notice, out of service.
Historic changes
OPEC's appreciation of new futility of supply management is evident in more than its refusal to lower production goals a year ago last November. Individual members, including Saudi Arabia and the United Arab Emirates, are beginning to nudge their economies away from lavish subsidization of consumption and in other ways to modernize. Saudi Arabia is even discussing the measured sale of equity in Saudi Aramco.
OPEC members thus recognize and are adapting in historic ways to basic changes of the oil market. They might, in fact, decide OPEC no longer serves their interests and prove doomsayers right. No matter what happens to OPEC, however, the rest of the oil-producing world must adapt to the shrunken role of coordinated supply.
http://www.ogj.com/index/current-issue.html">More Oil & Gas Journal Current Issue Articles http://www.ogj.com/index/past-issues.html">More Oil & Gas Journal Archives Issue Articles http://www.pennenergy.com/index/petroleum.html">View Oil and Gas Articles on PennEnergy.com
