The emergence of American shale oil has since 2010 gradually changed the situation. American production stabilized at around 5 million barrels per day has grown steadily until reaching a growth threshold of one million barrels per day from one year to the next. This new contribution to world production ended up creating an imbalance on the market at the end of 2014, with an excess of supply compared to demand. How would OPEC and the other producers react?
Saudi Arabias response: the first fall
In those happy years, for producers, the price per barrel was above $ 100. The production costs for shale oil producers appeared high, given the high proportion of chemical additives used in injection. Based on these basic facts, Saudi Arabia then set itself the objective of bringing these new operators out of the market. It also used a specific expression: “to bring non-competitive producers out of the market”. How? ‘Or’ What ? It was simply a question of increasing Saudi production, in order to bring prices down, and to force, with prices back to 40-50 dollars, the new American operators to leave the market.
The diagram was simple, and borrowed from common sense, except that it did not integrate two elements, the first being the reactivity of the American industry, and the second the marketing practices. Indeed, providers in the petroleum industry had “optimized” the price of their services taking into account the low capital costs of this new drilling technology, and the price per barrel at more than 100 dollars. They could reserve the lion’s share between the two without anyone coming to challenge them.
Faced with this new situation, American shale oil producers initially effectively reduced their production, from the second half of 2015, by reducing the number of wells exploited. But at the same time, providers were put under pressure to reduce operating costs, and there was room. A year later, that is to say in mid-2016, shale oil producers had rationalized the exploitation of their wells, and had much lower chemical formulation costs. They could now be competitive at $ 50 a barrel.
The possibility of this American response had not been considered. Since 2016, the production of the United States has continued to grow until offering this country the place of first world producer of oil, since the summer of 2018 and to this day.
For the first time, the leading country of the cartel, and therefore the cartel, was no longer in a position to be the arbiter of price fixing. How can this situation be changed?
The creation of OPEC + or the second fall
Since the presence of these new American producers was now unavoidable, there was only one way to bring prices up, to decrease the world supply.
OPEC members were not the only ones who wanted prices to go up. The Russian economy was strongly impacted by the fall of the hydrocarbon countries, a decrease in its revenues accompanied by a fall in its currency, reaching … 50%! When we have common interests, why not work together?
Moscow then very cleverly made Venezuela play the role of canvassing agent, the Venezuelan oil minister undertook a judicious visit of capitals, Algiers, then Moscow, and finally … Riyadh.
The process was underway and would culminate in the first coordinated reduction agreement, at the end of 2016, in the context of a format which was to be called OPEC +. Russia participated in this reduction of supply, and OPEC joined on this occasion with 10 other participants. OPEC thus recognized the limit of the powers of the initial cartel. This stage was his second fall.
OPEC + failure or the third fall
Last week, this new OPEC + format failed to agree on a new stage of production reduction. The founding members wanted to offer a rapid response to the drop in Chinese consumption, linked to the severe slowdown of its economy by the outbreak of the covid-19 virus.
Russia has refused a further reduction in production, arguing that its 2020 national budget was built on a barrel at $ 42 a barrel. In addition, Moscow considers that such a strategy leads once again to allow the United States to increase its share of the world market. This last point is real, but who has market share? Person. An oil producer sells volumes and collects foreign exchange. The market share is only a consequence, and with around 15% of the world market the United States is certainly the market leader, but by no means in a dominant position!
Analysis of the Russian position
Given the risks on the price level, this argument is difficult to accept. That of the Russian budget based on a barrel at 42 dollars is, meanwhile, very surprising. This 2020 budget was naturally prepared during the year 2019. It is easy to verify that the average price per barrel during the whole of 2019 stood at practically 65 dollars. Why choose a base almost 30% lower in a provisional budget? Why underestimate its revenues, which lead to a proportionate reduction in spending, when we want to boost growth, as promised by President Putin?
The real answer to this Russian refusal must be sought elsewhere. This elsewhere lies in the causes of this new situation, namely the 20% drop announced by China in its refining volumes. This represents a decrease of almost 3 million barrels per day of its imports. Where does its imports come from? From Russia for only 10%! China has not put all its eggs in one basket. Russia is its main supplier of gas, but not of oil. 70% of Chinese imports come from the Middle East. Therefore, can we not consider, seen from Moscow, that it is the OPEC countries, and mainly the Middle East, which must manage this situation, and not Russia? But this analysis, and this choice, cannot be without consequence for the Russian economy.
The consequences of the Russian choice
Even before the Russian refusal decision was acquired, the drop in barrel prices last week drove the ruble down sharply. At the close of last Friday this drop reached 15%, at the rate of 77.5 rubles for one euro. Inflation in Russia will therefore start to rise again. This is far from good news.
Now Saudi Arabia has just announced that it will significantly increase its production from April 1. If such a situation materializes, the price of crude oil risks once again falling sharply, reaching a level below 40 dollars. Russia could therefore be doubly penalized, both by a fall in its revenues and by a strong rebound in inflation.
It should also be mentioned that his refusal to rebalance the oil market is likely to leave a legacy in his diplomatic relations with the countries of the Middle East. However, Moscow had done a lot and bet to make “a breakthrough in the Middle East” as had materialized the visit of the King of Saudi Arabia to the Russian capital in October 2017.
From OPEC to OPEC +, Saudi Arabias strategy is neither simple to develop nor easy to implement. The Russian convergence that has just turned face to face with Russia will also leave its mark. Now, what format for the organization, and around which consensus? Founding Iran is practically banned from exporting by the United States, and the latter have become the world’s leading producer for almost 2 years!
The creation in 1960 in Baghdad of OPEC, a major regulator of the world oil market, with Iran and Saudi Arabia among others, seems far away.
(*) Gerard Vespierre, graduate of ISC Paris, Master of Management, DEA in finance, Paris Dauphine. Site author www.le-monde-decrypte.com