Growing discontent within OPEC has some members calling for a stabilization of prices and an easing of the present supply glut. Indeed, the current situation within OPEC basically resembles Saudi Arabia – and maybe a combination of the Gulf Arab states – versus everyone else. But given that Saudi Arabia accounts for roughly one-third of OPEC production and given the divisions among members, it is doubtful that the cartel can compel the Kingdom to back down from its current policy.
For a start, no one member even comes close to matching the sheer scale of Saudi production of ~10 mmbbl per day. The rest of OPEC’s members individually account for only fractions of that amount, and would alone bear a disproportionate amount of the costs and miss out on a disproportionate amount of the benefits if they unilaterally attempted to raise prices by cutting production.
Collusion would simply be problematic. After all, coordinating a unified response within a cartel has always been tricky given the incentive to free ride. Cheaters might benefit from higher prices while simply letting other members cut production and lose out on sales. This coordination challenge is exacerbated by the vastly different operational profiles and fiscal needs of OPEC’s individual members. It would also be imprudent to neglect the extreme geopolitical rivalries and sectarian rifts that characterize relations between some OPEC members, i.e. the predominately Sunni Gulf Arab states on one side and Shiite Iran on the other. The bottomline is that some members need the glut to end while others gain much from the status quo, so there is no universal interest within OPEC to undermine Saudi Arabia’s strategy, at least for now.
While it is intuitively obvious that Saudi Arabia has some incentive to appease its fellow members, it has a host of competing interests – be they economic, geopolitical, or sectarian – that rank higher than OPEC solidarity. Indeed, Saudi Arabia’s own oil minister, Mr. Ali al-Naimi, made abundantly clear that OPEC could not rely on Saudi Arabia to support the price of oil. This would remain the Kingdom’s stance “even if oil ‘goes down to $20,’” he said.
That is why the consensus is bearish on OPEC’s December 4 meeting yielding any substantial change in policy. It does not help matters that Iran – accounting for ~2.8 mmbbl per day of production in October, 2015 – is eager to ramp up production as sanctions ease. Nor does it help that Iraq – the number two OPEC producer with production amounting to ~4 mmbbl per day – remains a desperately cash-strapped, crumbling state mired in a brutal counterinsurgency against the Islamic State. Given these circumstances, Iraq can ill afford to cut production. Thus, while not outright irrelevant, OPEC is at least down for the count.
Matters are no more optimistic outside OPEC. Russia – the world’s third largest oil producer – has repeatedly stated that it is both unable and unwilling to cut production, its unwillingness stemming from a belief that any such engineered cut would be artificial and unsustainable.
So that leaves North American shale. Innovation and cost controls are major drivers for profitability in volatile price environments, but the worry is that these measures cannot outpace declines in production. With capital expenditures down and D/CF ratios up, some players will likely not survive this downturn intact, particularly as debt matures. Although time is a factor, there is no obvious short-term fix.
Certainly, Saudi Arabia’s reputation for comparatively low-cost oil production is exaggerated once fiscal needs are factored. But many would agree that the Kingdom, while feeling the pinch, has exceptionally deep pocket. So despite its high social and defense spending, Saudi Arabia can stay the course for at least another year and possibly longer. And while there are signs that some Saudi officials are growing uneasy with current prices, it would take some time for unease to translate into actual concrete policy changes. Again, the takeaway is that there is no short-term fix.
Recovery will come, even though timing remains hazy. But it should not be expected overnight. Patience is thus the order of the day, although given how tightly the squeeze is being felt, continued patience is an an exceptionally tall order.