How OPEC Won the Battle and Lost the War

June 1, 2016

How OPEC Won the Battle and Lost the War

Liam Denning
June 1, 2016

How OPEC Won the Battle and Lost the War

How OPEC Won the Battle and Lost the War

When OPEC convenes again on June 2, its delegates will meet beneath the shadow of its last, failed get-together in Doha. That one, aimed ostensibly at agreeing to a supply freeze, was killed by Iranian absence and a volte-face by Saudi Arabia –- which also just jettisoned the oil minister that put it together.
Almost 60 years old, the Organization of the Petroleum Exporting Countries isn’t facing its first crisis by any means. But this current one could mark the beginning of the end.

Source: Bloomberg, BP
Note: Prices for 2015 and 2016 ytd assume annual inflation of 2 percent.

How OPEC Won the Battle and Lost the War

OPEC’s calling card is its 1.2 trillion barrels of proved reserves: seven out of every ten worldwide. It supplies four out of every ten barrels we consume each day. That is a lot of oil. Yet OPEC’s golden era ended a long time ago.

Source: Bloomberg, BP

How OPEC Won the Battle and Lost the War

OPEC first flexed its muscles effectively in 1973. It controlled more than half of total oil supply and several of its Arab members shook the world with an embargo amid the Yom Kippur War.
But look how quickly that market share fell -- within a decade it was down to less than one-third. What happened?
The market happened.

Source: Bloomberg, BP

How OPEC Won the Battle and Lost the War

Two oil shocks –- the Arab embargo and the Iranian Revolution -– sent real oil prices surging almost 10-fold in the 1970s. And when the price of something as essential as oil spikes, humanity does two things: finds more of it and finds ways to use less of it.

Source: Bloomberg, BP

How OPEC Won the Battle and Lost the War

Look at the U.K., for example. Brits have never again burned as much oil as they did in 1973, and the shock also kick-started the country’s North Sea boom. By 1983, the U.K. had swung from importing 2.2 million barrels of oil a day to exporting nearly 1 million a day.

Source: BP

How OPEC Won the Battle and Lost the War

Better fuel efficiency and rival oil production kept OPEC’s market power, and prices, low for much of the 1980s and 1990s. One thing that helped revive it was the arrival of a suddenly very thirsty customer: China, whose oil imports began to take off…

Source: BP, International Energy Agency

How OPEC Won the Battle and Lost the War

…and first broke above 1 million barrels a day in 1997. OPEC miscalculated that year and raised its output quotas just in time for the Asian economic crisis, sending real oil prices to a 25-year low. By 1999, though, OPEC had cobbled together an agreement with other producers like Russia to cut supply (sound familiar?). With Chinese demand still climbing, the bull market began.

Source: BP, International Energy Agency

How OPEC Won the Battle and Lost the War

By 2005, real oil prices were surging. So was OPEC’s self-confidence. Giving a speech in Moscow that year, an official predicted global demand would hit 113 million barrels a day by 2025, of which OPEC would supply 57 million each day -- getting it back to the 50 percent market share it enjoyed in the early 1970s.

Source: Bloomberg, BP
Note: Prices for 2015 and 2016 ytd assume annual inflation of 2 percent.

How OPEC Won the Battle and Lost the War

Today, the world uses about 96 million barrels a day and not even OPEC predicts getting anywhere near 113 million anytime soon. And the idea that OPEC could raise its daily output to almost 60 million barrels looks like pure fantasy: Of 10 longstanding members, seven saw their output peak before 2008.

Source: Bloomberg

How OPEC Won the Battle and Lost the War

So while triple-digit oil prices revived memories of OPEC’s 1970s heyday, they also had the same, predictable effect. Demand across the developed world began falling in 2006. And high prices once again unlocked a new source of supply –- only this time a more dangerous one for OPEC: shale.

Source: Energy Information Administration

How OPEC Won the Battle and Lost the War

OPEC’s members now fight each other, and the likes of the U.S., for market share.
This Herfindahl-Hirschman Index shows competition, based on each country’s share of output. A score of 2,500 or more indicates a highly-concentrated market; below 1,500 shows healthy competition.
Conditions were perfect for OPEC 40 years ago. But this is one `70s revival that isn’t happening.

Source: BP, PKVerleger LLC, Bloomberg Gadfly analysis
Note: 'Functioning' OPEC assumes the organization acts as one fully coordinated entity in terms of supply.