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OPEC's Divisions Keep Oil Low and Volatile

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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The failure of the Organization of Petroleum Exporting Countries to reach any meaningful agreement at their meeting in Vienna on Friday confirmed that the historic storm besetting the oil market has markedly reduced this once-powerful group's effectiveness and influence.

Far from adding an element of stability, an internally divided OPEC will contribute to further volatility in oil markets, with prices remaining low for longer than many anticipated.

QuickTake Oil Prices

The oil market is being battered by a perfect storm, as three distinct forces come together. The supply side has been destabilized by the rapid encroachment of shale energy technology. The demand side is undermined by declining global growth in general, and the sharper relative fall in emerging economies in particular. Third, the role of “swing producer” on the downside once played by Saudi Arabia and some of its OPEC partners -- by reducing output when prices are low -- has de facto been taken over by the U.S. This has shifted the mechanics of the market from discrete decisions on tightening supply to waiting for natural market supply and demand forces to set the pace.

The resulting collapse in oil prices sharply reduces export earnings of all producers. But their resilience, including the ability to manage their economies with lower income, varies significantly.

Some, such as Saudi Arabia and the United Arab Emirates, have sufficient financial reserves, other accumulated wealth, debt capacity and policy flexibility to manage the longer-term transition to an oil regime in which many of the non-traditional suppliers will be knocked out by lower prices. Others, including Venezuela, are being destabilized in ways that extend well beyond economic and financial factors and produce a growing possibility of political and social turmoil. Put these two sets of actors together in a negotiating room and the scope for disagreements is considerable, if not guaranteed.

Hoping to camouflage the degree of internal division, OPEC's official statement on Friday noted that, “in examining the current status of the oil market, the Conference respected the input and ideas of all Member Countries to find ways and means to deal with the challenges they are facing in the global oil market today.”

But when it came to action, the statement offered rather feeble guidance: “Member Countries should continue to closely monitor developments in the coming months.”

In the absence of any new agreement, OPEC has officially kept in place existing production quotas until the ministers meet again in June. In practice, individual member states will not feel constrained by any OPEC agreements on output levels. As a result, they all are likely to produce as much as they can, but each will be doing so for its own reasons.

For better-off OPEC members, producing more today is intended to secure a better competitive position in the future, exchanging sacrifice now for the well-being of future generations. For the struggling countries, the goal is to generate as much income as possible, and as soon as possible, to avoid major internal dislocations in the next few months.

Barring a major geopolitically driven shock, this set of dynamics will mean that oil prices will stay low and volatile for a while. Over time, this price configuration will drive out the higher-cost energy producers and encourage higher demand, which would restore OPEC's influence. In the short-term, however, the group will have little influence in stabilizing this unhinged oil market.

Oil Falls Below $40 as OPEC Extends Glut

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net