OPEC’s Choice Is Pricing Power or Sales in New Oil Order

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OPEC Secretary-General Abdalla El-Badri
Abdalla El-Badri, General Secretary of the Organization of Petroleum Exporting Countries, said at a conference in London on Oct. 29 that current oil prices could take 50 percent of shale oil output “out of the market” as investment in higher-cost production dries up. Photographer: Chris Ratcliffe/Bloomberg

The decision OPEC faces at this month’s meeting isn’t just over whether to cut oil production. It’s a choice of whether the group is willing to fight to maintain the sway it has had over crude markets for decades.

The Organization of Petroleum Exporting Countries, buffeted by plunging prices, could reassert control by cutting output, said Societe Generale SA, ceding more market share to U.S. shale oil producers. The alternative -- waiting to see if lower prices choke off the North American shale boom -- would usher in a “new oil order” where pricing power is handed to drillers in Texas and North Dakota, according to Goldman Sachs Group Inc.

“We’ve not seen a turning point like this in decades,” Mike Wittner, Societe Generale’s head of oil market research in New York, said by phone yesterday. “Is OPEC going to abdicate its role in the market? If the Saudis do exactly what they’re signaling, and just let the market take care of the overproduction, then it could certainly become irrelevant.”

Oil plunged into a bear market last month, the result of a surge in shale drilling that has lifted U.S. production to a three-decade high as well as slowing growth in global demand. The drop has caused financial pain for some OPEC members, prompting Ecuador, Venezuela and Libya to call for action to halt the slide. Nigeria’s currency slumped to an all-time low last week and Venezuela’s benchmark bond fell yesterday to 56.63 cents on the dollar, the lowest level since March 2009.

Market Share

The group’s data show shale output has trimmed a percentage point from its market share and will take it to the lowest in more than 25 years during this decade. Reducing output is a tougher decision to make when there are more competitors ready to supply clients cut off by OPEC.

Brent crude for December settlement fell 67 cents to $81.67 a barrel on the London-based ICE Futures Europe exchange. It dropped 1.3 percent yesterday to close at the lowest level since October 2010. WTI advanced 54 cents to close at $77.94 on the New York Mercantile Exchange.

U.S. output surged 14 percent in the past year to 8.97 million barrels a day, the highest in U.S. Energy Information Administration data beginning in 1983.

Ministers from two of OPEC’s founding members, Saudi Arabia and Venezuela, will attend a natural gas forum in Acapulco, Mexico today and tomorrow, two weeks before all 12 members are scheduled to meet Nov. 27 in Vienna.

Saudi Intent

Saudi Arabia’s decision on Oct. 1 to cut prices for sales to Asian customers was a sign that the world’s largest oil exporter intends to preserve its sales volumes rather than pare output to defend prices, according to Commerzbank AG. The kingdom increased Asian prices this month, while deepening discounts for U.S. consumers. Iraq, OPEC’s second-largest producer, made similar changes yesterday.

OPEC Secretary-General Abdalla El-Badri said at a conference in London on Oct. 29 that current oil prices could take 50 percent of shale oil output “out of the market” as investment in higher-cost production dries up. The shale drilling boom showed signs of slowing last week. Oil rigs sank by 14 to 1,568, Baker Hughes Inc. said.

“OPEC has signaled a paradigm shift recently as countries moved from concentrating on price to concentrating on market share,” Eugen Weinberg, head of commodities research at Commerzbank in Frankfurt, said by e-mail on Nov. 4.

The group is retreating from its traditional role as a “swing producer” that influences prices by raising or lowering output to balance the market, Jeff Currie, head of commodities research at Goldman Sachs in New York, said in a report on Oct. 26. Such a shift would suspend the role OPEC has played since the 1980s, according to the International Energy Agency, a Paris-based adviser to 29 nations.

OPEC Estimates

OPEC’s own estimates show its share of the global oil market shrinking to 37 percent in 2017 from 40 percent last year. That would be the lowest in more than 25 years and well below the peak of 54 percent reached in 1973.

OPEC would need to cut production by 1 million to 1.5 million barrels a day to eliminate the supply glut and boost prices, Wittner estimates. A reduction of that size would take the group’s output to the lowest since 2011, according to data compiled by Bloomberg. OPEC produced 31 million barrels a day in October, 3.3 percent above its target of 30 million barrels.

Preserving market share by letting oil fall to a level that undermines U.S. shale production isn’t a practical option for many OPEC members, Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA, said by phone from London on Nov. 6. The strategy would require a Brent price of $70 a barrel for a prolonged period, a level too low for most members to cover government spending, Tchilinguirian said.

Balancing Budgets

At current prices only Kuwait, Qatar and the United Arab Emirates will earn enough to balance their budgets, while Iran, Iraq and Algeria need at least $100, the International Monetary Fund said in a November 2013 report.

There’s the added risk that producers in North America would respond to lower prices by developing cheaper ways to find and produce oil, meaning shale output would continue to grow even at lower prices, Ole Sloth Hansen, an analyst at Saxo Bank, said by e-mail from Copenhagen on Nov. 4. Production costs have fallen as much as $30 a barrel since 2012, Morgan Stanley analyst Adam Longson said in a report on Oct. 13.

OPEC’s 12 members are divided over how to respond to Brent crude’s plunge to its lowest in four years.

Cutting Target

The group should cut its collective output target to 29.5 million barrels a day, Samir Kamal, Libya’s governor to the group, said on Oct. 27. Ecuador Finance Minister Fausto Herrera told reporters Nov. 4 that his government is working with Venezuela and other members in a bid to “improve” prices. Kuwaiti Oil Minister Ali Al-Omair said in Abu Dhabi yesterday he doesn’t think there will be a supply cut and expects prices to stabilize when the market absorbs surplus production.

Saudi Oil Minister Ali Al-Naimi said in September that there was no reason for a special OPEC meeting to deal with the crude drop because prices “always fluctuate and this is normal.”

The last time OPEC ministers failed to reach consensus at a meeting, in June 2011, the existing output target was kept in place. The group may struggle to regain its influence if doesn’t reach a decision this time, said Weinberg at Commerzbank.

“This meeting in Vienna should give some answers on whether we’re witnessing ‘the end’ of the group,” he said. “Or its re-emergence as one entity with a strong voice.”

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