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Market Meltdown: How OPEC Is Projected to Change


As fallout over Jamal Khashoggi’s murder continues, the U.S. – Saudi relationship may be facing its toughest test since the 1973 Oil Embargo. The world’s largest crude exporter, and defacto leader of the Organization of Petroleum Exporting Countries (OPEC), is once again threatening to use its vast energy resources as political retribution, alluding to possible price spikes reaching $200 per barrel (bbl) if foreign governments attempt to punish the Saudi regime for Khashoggi’s murder. A Riyadh engineered oil price-spike seems less likely now given the recent downturn in oil prices, but the Kingdom’s influence over energy markets should not be underestimated.


The overlap of mutual interest looks compelling. Both the United States and Saudi Arabia seek to contain Iranian power and fatally damage its regime. Both the US and the Kingdom are protective of their respective oil market share. Both see the best long-term benefit in stable, moderate oil prices. And between August and October of this year, oil prices seemed to be climbing at a dangerous pace – reaching their highest point since 2014.


To achieve the common aim of market stability, both understood that more oil needed to be pumped into the global economy, necessarily exerting downward pressure on oil prices. For the Trump administration, more oil production means cheaper gas at the pump in the run-up and aftermath to the 2020 November elections. For OPEC and its new group of non-member allies – which now includes Russia – moderate prices translate to locked-in demand, preventing consumers from investing in electric vehicles and alternative fuel sources.


Foreign producers watched all this very intently. Correctly perceiving a threat to market share, OPEC moved to stifle -- if not strangle outright -- the fledgling U.S. shale industry’s merging impact on the global market. The Saudi-led strategy had a basic simplicity: Flood the world with low-cost crude and push oil prices down, thereby undermining the budding shale industry and prevent the US from recovering its mid-20 th century oil market pre-eminence.


But this “drive ‘em to the wall” strategy failed. By this past August, the US reached a daily output of 10.9 million barrels of oil per day (b/d), with unconventional shale responsible for 7.6 million b/d of that supply. The US Energy Information Agency (EIA) estimates that, earlier this year, the United States surpassed both the Russian Federation and the Kingdom of Saudi Arabia to become the world’s largest producer of crude oil.


As usual, OPEC members quarrel with one another about production levels and price targets. The so-called ‘price-hawks’ (notably Iraq, Iran, and Venezuela) want the 1.8 million b/d production cut to which the cartel agreed back in November 2017. Others, fiscally less desperate, take a market-protection stance, arguing for production increases to prevent a collapse in demand, which would slap down prices again. One thing that all members can agree on, however, is that America’s unconventional producers are encroaching on OPEC market share in Europe and in Asia.


Russia and Saudi Arabia – representing two of the world’s three most prolific energy producers – now face a decision: should they double-down on a cut-price assault on North American shale, or, can they learn to live or even work with this new fixture of the global energy landscape?


And while Russia and Saudi Arabia share few geostrategic goals, the advantages of a collaborative supply-growth approach over the past 6 months were too many to ignore.


Saudi Arabia: The Kingdom’s greatest geopolitical rival is Iran. With U.S. energy sanctions now back in effect, the regime is facing declining demand for its exports, which have fallen from a high of 2.7 million b/d in April to around 1.7 million b/d this month . By increasing output, the Saudis put a downward pressure on prices and helped to make up for the supply shortfall, thereby depriving the struggling Islamic Republic of much-needed energy revenues (and negotiating power).


Increased production also served to protect Saudi Arabia’s market share from competitors. While market rivals in North America and OPEC-Plus pump at full tilt, the Kingdom possess the largest spare capacity of any oil producing nation (purportedly capable of activating an additional 2 million b/d), meaning that every additional barrel of oil brought online displaces a barrel of competition.


Finally, lower oil prices support the enduring Saudi goal of guaranteeing long-term oil demand. As prices and volatility increase, consumers move to electric and hybrid vehicles, and increase investment in renewable energy sources. A well-stocked global supply of oil defends against fuel switching, thereby prolonging the Kingdom’s economic future. Too far below $70/bbl and we may see the Saudis reverse course – cutting production to maintain the goldilocks price range. But for now increasing production has served them well.


The U.S. Position


The current U.S. administration aspires for high domestic energy revenues and lower global oil prices. This is a winning combination for both U.S. energy security and those running for re-election. Increased pressure on the oil-dependent Iranian economy is a significant added bonus.


From the Oval Office, this means encouraging private operators – to the extent they can -- to produce as much as possible, while demanding the same of influential petro-states. Responding to rising oil prices, Trump leveled frequent accusations and threats against ‘OPEC-Plus. The most recent diktat came last September, when he tweeted :
We protect the countries of the Middle East – they would not be safe for very long without us, and yet they continue to push for higher and higher oil prices!...The OPEC monopoly must get prices down now!”


Despite pumping a record 11 million b/d of crude (65% of which is onshore shale), the United States cannot unilaterally dictate global oil prices, particularly as mid-stream infrastructure constraints look to crimp shale growth. To achieve its goals, then, the administration must coerce or convince OPEC-Plus to play ball. Threats of dissolving U.S. defense ties and invoking NOPEC legislation suggest that this White House has, at least publicly, adopted a “Stick” approach thus far. But can there be a “Carrot?”


A Russia-Saudi-U.S. Axis of Convenience?


Whether deliberate or inadvertent, a triangular interest-based understanding about production levels have emerged between the Saudis, Russians and the United States. Together, these three energy giants constitute 1/3 of global oil supplies, meaning that any joint effort to affect energy market outcomes will be consequential.


First, Saudi Arabia and Russia have demonstrated a willingness and perhaps even a preference for bilateral consultation about oil output, as opposed to at least the pretense of conferring with other OPEC-Plus producers. Market-moving power flows from these two petrostates, which between them control a quarter of total world oil production: Saudi (10.7 million b/d) and Russia (11.3 million b/d). Working together, neither needs backing from lesser producers, OPEC or non-OPEC.


Second, while hydrocarbon extraction from shale has brought enormous benefits for American energy security, fracking cannot insulate the U.S. from the vagaries of global energy markets. Trump’s appeal to OPEC to increase production and lower prices shows the persistent power of global oil producers. Shale does not confer energy autarky. In fact, its meteoric development also embeds us firmly in the world oil market, if only in ways that differ from earlier, import-dependent decades.


It may still seem far-fetched, but we may be witnessing the emergence of a new de facto cartel, one steered by the US shale energy advantage. Stay tuned to see how Russia, Saudi Arabia, and U.S. producers respond to stabilize an oil market headed back to the doldrums.