Opec has no duty to fight this energy market

Saudi Arabia is not responsible for the collapse of oil prices. If we are looking for an aggressor, look no further than US shale, writes Steven Kopits.

US-based Aramco shook up the oil trade with discoveries in Saudi Arabia in the 1950s; now US-based shale drillers are doing it again. AP Photo
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Seven years ago, when I first turned my attention full time to oil, one of the strangest concepts I encountered was the “call on Opec”. The call on Opec means different things in different contexts, but fundamentally, it is as non-economic and culturally imperialist a term as one could imagine.

The call on Opec works like this: non-Opec countries are assumed to produce as much as they can, guided essentially by price signals. Whatever demand is left over can be served by Opec. Opec is thus assumed to “balance the market” and the number of barrels necessary to do so is the “call on Opec”.

Now, imagine this grafted onto, say, automobile production. Suppose an American policymaker argued that GM and Ford should produce as many cars as they like and then Toyota could supply any demand left over. From an economic viewpoint, this would be incomprehensible. And moreover, the political uproar would be deafening. The reaction would be complete outrage – and rightly so.

And yet, when the call on Opec has a similar effect, no one complains.

Now, the call on Opec does exist for certain practical reasons. First, the cartel is assumed to act in concert. In theory, unified Opec decisions can affect oil production and prices in ways that hundreds of profit-maximising firms cannot. Therefore treating Opec as a kind of entity makes some sense.

Further, Opec production decisions are assumed to be geared to meeting national fiscal needs rather than maximising profits. If Exxon ran, say, the Algerian oilfields, then production would be much higher than today, but the resource would be depleted much faster as well. Profit-maximisers will behave differently than revenue-satisfiers.

Finally, Saudi Arabia is the only country with material spare capacity that can be called, and the only Opec country with the financial reserves to buffer any lost revenues due to curtailed production. Nor have the Saudis renounced this role.

Analysts, therefore, treat Opec as a separate analytical category, and divining Opec intentions has become a skill unto itself.

Until the plunge in oil prices, however, analysts believed that the kingdom was prepared to cut production to maintain market stability. Of course, this proved untrue. Regardless, Saudi Arabia has drawn extensive criticism for failing to “do its duty”.

Why analysts should believe that the kingdom has a duty in contravention of its own interests is a paradox, but one that is resolved by “the call on Opec”, which creates the illusion of obligation where none should exist.

And that in turn leads to unwarranted criticism, for Saudi Arabia is not responsible for the collapse of oil prices. Today, Saudi oil production is only modestly higher than its level three years ago and lower than in either 2012 or 2013.

Indeed, Saudi production is lower than the same period last year. The kingdom has actually cut production, even if not by much.

That is true of Opec as well. Opec output would be all but unchanged since 2011 if not for the recovery of Libyan output since the middle of last year. Indeed, Opec output is lower than its level during 2012 and much of 2013.

If we are looking for an aggressor, look no further than US shale. US production is more than 4 million barrels per day more than its 2011 level. The US shale producers are the ones upsetting the apple cart. They are doing the attacking, and Saudi Arabia is merely holding well-established production levels.

This does not mean the kingdom is without options. Saudi Arabia can still cut around the margins, when prices are unnaturally low or high and the market dislocation is temporary.

For example, oil prices today are so depressed that the Saudis may have room for an intermediate production cut without hurting their long-term interests.

Nevertheless, we simply do not know how much shales can produce, at what pace and what price. The Saudis, therefore, are allowing price discovery, painful as that may be to US oil producers and Opec budgets – and until the actual effect of low prices can be seen, that is the right thing to do. At the margins, the call on Opec can still have some meaning.

But the cost is too high. The call on Opec creates the illusion of duty by the Saudis where none exists — nor should it. It allows investors and oil companies the mistaken sense of security that Saudis will subordinate their interests even when the maths flatly contradict the proposition.

In short, whatever benefits the call on Opec may have had in the past, today, it is more of a liability than an asset. It is time to scrap the whole notion.

Steven Kopits is the president of Princeton Energy Advisors

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