Cartel Of Cards: The Future Of OPEC
Summary
- OPEC holds a weak hand.
- A Prince worries.
- Discord shatters the cartel.
- OPEC went all-in.
I wonder whether the twelve oil ministers who met in Vienna at the end of November foresaw what their inaction would cause. Oil has gone from a pre-meeting price of $73.69 per barrel on active month NYMEX crude oil to $57.81 in the space of eleven trading sessions. That is a drop of another 21.55%. I am quite sure that some the ministers who represent the weaker OPEC members like Venezuela, Nigeria and Iran would love a do-over. Alas, they have to wait for June, which is the next time the cartel convenes.
OPEC holds a weak hand...
OPEC decided not to cut production at the November meeting. The powers that be in the cartel decided that the best course of action is to flush the high-cost oil producers out of the market in order to retain market share and tighten long-term control on the price of the commodity.
At prices north of $80 per barrel, production from the United States has skyrocketed. The United States, one of the world's largest consumers of energy commodities, became self-sufficient and is even exporting condensaten - a form of light crude that is feedstock for oil refining and other petrochemicals.
Furthering OPEC concern is the migration of Asian traders to Houston, the hub of the US oil business. Mitsui & Company, Japan's second-largest trading company, has doubled employees relocated to Houston to 50 over the past two years, while Cosmo Oil Company, another Japanese concern, opened an office in the city in April. South Korean company SK Innovation Company has also established a presence in Houston. These companies are presently buying condensate, but are positioning themselves to purchase more oil and oil products if Congress ends export restrictions.
These events have weakened OPEC's hand in the international poker game for crude oil control. Crude oil is not only a commodity, but also an important political tool. Just look what OPEC inaction has done. Oil is falling, and it seems like there is no bottom at present. It is good news for oil consumers around the world, but it's very bad news for the producers - some, like the Russians, are suffering a domestic economic meltdown. OPEC's action at the recent meeting - or better put, inaction - has shown what a weak hand the cartel really has and how their fear of losing control has truly hurt their own membership. Venezuela is on the verge of default, and other members of the cartel are badly hurting. The Saudis are the main power brokers in OPEC. Saudi influence prevented a production cut. However, one very prominent Saudi voice is worried about the country's reliance on crude oil.
A Prince worries...
In many ways, he is the Warren Buffett of Saudi Arabia. Prince Al-Waleed bin Talal bin Abdulaziz al Saud is a Saudi business magnate, an investor and a member of the Saudi royal family. He is the nephew of Saudi King Abdullah, and the grandson of the first Saudi King, Ibn Saud. The prince is one of the richest men in the world, and has considerable business ties to the United States, as well as other countries around the world.
In early November and before the OPEC meeting, Prince Al-Waleed said in an interview, "Saudi Arabia is 90 percent dependent on oil revenues and this is not a good choice. It is wrong and, in fact, is dangerous." The comments of the Prince are particularly interesting, considering the path taken by OPEC. If one reads between the Prince's words, his message could be a warning about the biggest threat to the Saudi royal family - radical Islamic influences that wish to unseat the royals. Saudi Arabia is home to many holy sites for the religion. It has a generous system that provides services and payments to its citizenry. The country also has long ties to the West, particularly to the United States, the stated enemy of many radicals in the Middle East. A reduction in revenue from oil could cause the support system to break down. That would leave the door open for an attack on the current Saudi rulers, perhaps from within the country.
The comments of Prince Al-Waleed are telling - perhaps more telling than the recent actions of OPEC.
Discord may shatter the cartel
OPEC first convened in 1960. The mission of the cartel has been to ensure stability of oil markets to secure an efficient, economic and regular supply of petroleum to consumers and a steady income and fair return on capital for those investing in the petroleum industry. OPEC currently has twelve member countries. The poorer OPEC members that rely heavily on crude oil revenues include Algeria, Angola, Iran, Nigeria and Venezuela. At the recent meeting, many of these poorer nations argued for a production cut to bolster prices. The poorer members have always looked to richer producing countries, like Saudi Arabia, to stand up for the cartel and take the brunt of production cuts. It is clear that the Saudis were not willing to do this. OPEC currently has a production ceiling of around 30 million barrels per day.
Everything was all good and well when oil prices remained above the $90 per barrel level. Now that prices have fallen the hardest in six years, all is not well within the cartel. However, let us not forget that prior to 2004, crude oil never was above the $41.15 per barrel level, and today, we are still above that level. I suspect that with lower oil prices, those countries experiencing economic hardship will cheat - they will sell more crude oil than their quotas to bolster revenues. The poorer OPEC members do not have the time, nor do they have the patience to wait until higher-cost producers fall by the wayside and prices head back up. For them, lower prices mean that they just have to sell more to maintain revenue levels. Therefore, because of the hard line taken by the Saudis, it is likely that production from the cartel will actually increase above the 30 million barrel per day quota.
OPEC went all-in
Discord within OPEC could sow the seeds of its own destruction. Discord within the Saudi royal family could deepen the problem. Given the oil market's reaction to OPEC inaction, the cartel is now playing a high-stakes game of poker in the oil market. This could continue to push prices lower unless, of course, OPEC decides at some point to hold an emergency meeting and announce a surprise and coordinated supply cut. In poker, sometimes you need to bluff to win. If OPEC does eventually cut and the price does not go higher, it will expose a very weak and losing hand for the cartel.