Are OPEC’s Days Numbered? How Cartels Perish

Image source: marrakeshh © 123RF.com

Bijan Zangeneh, the Iranian petroleum minister, reportedly warned the visiting OPEC Secretary-General Mohammed Barkindo in Tehran that his country is not afraid to retaliate to threats from within the organization by fellow member-states should they try to pressure Iran.

“Iran is an OPEC member just for its interests, and if certain OPEC members want to threaten and endanger Iran, Iran will not refrain from responding to them.”

Mr Zangeneh was quoted by the oil ministry’s Shana news agency as further reiterating his caveat by stating that:

“I told Mr Barkindo that OPEC is being threatened due to unilateralism by certain members and this organization is likely to collapse.”

His words struck a chord with global news outlets, as ultimately Bijan Zangeneh fell short of name-calling the "certain members" in his statement and yet it is no secret to anybody that Iran's oil minister connoted Saudi Arabia – a long-time geopolitical and ideological rival of Iran. For that reason, global analysts have begun to speculate on whether the heightened altercations between the two countries, reinforced by the US foreign policy in the region, can lead to the eventual collapse of OPEC, and if so, what would be the future for the global oil market?

Initially, the Organization of Petroleum Exporting Countries was designed to give more market power to countries with abundant natural deposits of oil and gas, so that they can exert influence over the supply and demand forces and therefore directly impact the price setting in the market. That is because, in the antecedent years leading to OPEC’s inception, the prices of oil were thought to be significantly low, which benefited considerably Western economies, most notably the US, which at the time was satisfying almost its entire demand for the black gold by importing it from countries with abundant oil reserves.

However, that all changed with the creation of the cartel because as such, the organization gave the five founding-countries (Iran, Iraq, Kuwait, Saudi Arabia and Venezuela) the political and economic power to influence the international energy market as they pleased. Nonetheless, the fusion of several resource-based national economies into an influential structure with the market powers of a cartel only encouraged the local aristocracies and top-tier social structures to seize more power, both at the local and international level, to consolidate their standings.

The exceptional market opportunities to influence the price setting of global oil that had been opened up before the member-states of OPEC meant that they could combine their cartel powers to affect the price of oil, but the door was always open for either of them to cheat the rest and collect even more benefits. Ultimately, just like every other cartel, OPEC does not provide any compelling incentives to its members to continue to collaborate indefinitely.

Essentially, cheating the system which was meant to deceive the general market structure promises heaping dividends for the country that decides to abuse the commonly accepted norms for the conduct of OPEC, which is what Iran is currently accusing Saudi Arabia of doing. In an article on the Bloomberg website, it was stated that:

“Saudi Arabia will coordinate with other crude producers to ensure that adequate supplies are available and the market “does not go out of balance,” Energy Minister Khalid Al-Falih said after the US ended waivers for buyers of Iranian oil”

It appears that Saudi Arabia is taking the initiative and commits to continual production of oil at the same pace before the imposition of the same US sanctions on Iran, but from the perspective of Iran, Saudi Arabia is solidifying its partnership with the US all the while it disregards its commitments to OPEC. Hence, the developing discord between Iran and Saudi Arabia continues to illustrate the fragility of OPEC as a system that hangs together solely on mutual interests, which is inlined with Mr Zangeneh’s comments regarding Iran’s relationship with the cartel, and if those get distorted then the organization will become vulnerable to collapsing from insight out.

Currently, a question of paramount importance for the future integrity of the organization is, whether OPEC can continue to function without Iran? For the group to properly work in the future, they need to be in control of a critical amount of the precious resource, so that any commonly accepted course of action by the organization can have a substantial impact on the supply side economics of the market.

However, without Iran’s total output, OPEC’s ability to speculate with the price of the crude oil by reducing or expanding its total production would be significantly diminished, to the point where it would be hard to tell whether the member-states can exert any control as a collective whatsoever. A telling example of what is to come, should Iran leave OPEC, can be derived from Qatar’s decision to leave the group in January of this year.

The jarring split between the small Gulf state and OPEC was arguably influenced by Saudi Arabia’ decision to sever its diplomatic relations with Qatar. According to official data, the Gulf monarchy has more than doubled its output in the two months leading to its departure from OPEC and this period was marked by a 20 dollars drop in the price of WTI Oil.

In November and December, Qatar has been producing 1460 barrels a day, which measures a tremendous increase of 851 barrels a day more, compared to the previous month, which ranks the country 15th in the world’s rankings of biggest producers. Naturally, these results would have impacted the entire performance of OPEC positively for the period, and expectedly higher output leads to lower prices.

However, the aggregate world production for the same period fell from 84.56 million barrels per day in November to 84.07 million barrels per day. In comparison, Saudi Arabia’s total production was 11093 BBL/D/1K in November and 10643 BBL/D/1K in December, which still averaged higher than its output in the prior seven months. Iraq, which has the second biggest share of oil production in OPEC after Saudi Arabia, was producing respectively 4455 and 4465 barrels a day for the same period.

Arguably, OPEC’s total output in the two preceding months of Qatar’s withdrawal from the organization remained relatively high compared to the previous months and yet, the price was consistently falling.

These statistics manifest two interesting conclusions – firstly, OPEC’s aggregate output is no longer the crucial tool it once was for the oil market, and secondly, former member-states are not necessarily destined to fail without the mutual support of the organization.

OPEC’s apparent diminished influenced can be attributed to many possible causes, from internal spats such as the disagreements between Iran and Saudi Arabia and Qatar and the Saudis to external, such as new market realities in global output. In regards to the latter, the US and Russia’s respective outputs are currently overshadowing the performance of even the top-performance within OPEC’s.

The US’s production was topping 11900 BBL/D/1K in November, surpassing Saudi Arabia and Iraq.

Similarly, Russia’s overall performance can be exemplified by the same trend of increasing production, and in that it parallels the same directional movement of the US.

Ultimately the biggest threat to OPEC’s stability at the present rate is not its curbed ability to exercise market power on the price setting of oil, and instead, it is the lack of assurances that the cartel is ready to give to its members for sustained mutual reliance on each other. The growing discord between Iran and Saudi Arabia epitomizes the internal frailties of OPEC’s structure, as national interests surpass the common good.

By definition, the compelling power of the cartel lies in its ability to entail financial benefits to its members, but if countries no longer perceive OPEC as being adept at providing such an edge, then they would no longer have the incentive to stay members in it. Qatar’s recent withdrawal from the organizations has signalled to countries like Iran, that there are economic prospects for future business even without the support of the cartel and countries like China and Russia are more than eager to work together with countries like Iran on bilateral terms.

Conversely, the rampant increase in production in the US and Russia means that the aggregate market share of OPEC would also be proportionately decreasing, and as a result, the underlying casualty of this ongoing process is OPEC’s image of a prevalent force that everyone should take under consideration.

In either case, OPEC is less likely to suddenly “explode” and seize to exist and seemingly the dominance of the organization is more likely to gradually fizzle out as the supply and demand forces in the market find a new equilibrium, as they get divided among the US, Russia and the rest of the world. If this possibility becomes a reality, then there are several considerations about the future of the market that can be made now.

Firstly, in a world without OPEC, joint coordination would become increasingly difficult, as separate national states would all have to decide on how much output of oil to produce independently. Consequently, global trends in the supply-side economics of the oil market would become less distinctive.

Secondly, it can be anticipated that in world post-OPEC, the market share of the former giant is going to be divided by the remaining biggest producers.

Oil prices getting too high. OPEC, please relax and take it easy. World cannot take a price hike - fragile!

— Donald J. Trump (@realDonaldTrump) February 25, 2019

The market is likely to become more volatile with less clear-cut defined trends in the underlying price, as it would become more challenging to funnel any general policy of production. On the other hand, it is reasonable to expect the long-term trend in the price to drive it lower than the present rate, as the growth in global supply would be virtually unobscured.