Just a couple months ago, some were declaring the old oil order dead after the Organization of the Petroleum Exporting Countries (OPEC) failed to agree on coordinated action at its April meeting in Doha.
That meeting was meant to bring about a production freeze to arrest the downward spiral of prices that began in July 2014. Instead, the Doha meeting was over before it began. Iran refused to slow production until it had regained its pre-sanctions position in the market, so Saudi Arabia canceled the freeze and continued to produce at peak levels.
This week, with oil trading at six-month highs, OPEC members once again had high hopes to show that the organization remains relevant as they gathered in Vienna. Yet, once again, the meeting ended without agreement, resulting in no change to the current policy of essentially unlimited production.
So does the verdict that OPEC is dead still stand, signaling the end of an era in which it supposedly ruthlessly controlled the price of oil? In fact, that era barely existed in the first place. The failed meetings confirm a longstanding truth: the world’s most famous cartel has never really been a cartel.
Rather than the arbiter of global energy, OPEC is and has always been a dysfunctional, divided and discouraged organization.
My recent research has taken me through the history of oil, particularly the relationship between oil revenues, economic development and the geopolitical balance of power in the 1960s and 1970s. Oil’s history has been dominated by a struggle for balance, a contest between competing interests, both economic and political, and between the fundamental market forces of supply and demand.
OPEC has never been shielded from or been able to fully thwart these forces.
Early days: divided and powerless
When it was created in 1960, OPEC was meant to offer members a greater say in how their oil was produced and priced, addressing the disproportionate power wielded by private Western corporations. Its larger goal, to bring order to the chaotic world of global energy, has always been elusive.
OPEC was formed from frustration. In the 1950s, the world was awash in oil as small nations in the Middle East and Latin America discovered enormous deposits, and Western oil companies sought to tap them to meet rising demand.
To gain access to those deposits, the major oil companies (known as the “Seven Sisters”) signed concessionary agreements with local governments, allowing them to pump, refine, transport and market a nation’s oil in return for a royalty, typically 50 percent of profits.
This arrangement gave the companies control over the oil – they set production levels and prices – while governments simply collected a check and had little influence on anything else.
In February 1959, amid an oil glut, the Seven Sisters decided that a price correction was necessary. And so they unilaterally began cutting the posted price, from $2.08 to $1.80 by August 1960. (Back then, oil prices didn’t always follow market forces and were typically set by producers.)
The cuts meant a significant loss of revenue for the oil-producing states. In protest, the oil ministers of Iraq, Iran, Venezuela, Saudi Arabia and Kuwait met in Baghdad that September and formed OPEC to achieve a more equitable arrangement with the Sisters.
In reality, the oil-producing states could do little to coerce the companies into offering better terms. The Seven Sisters dominated global markets and were capable of shutting out individual producers. Oil was abundant, and nationalization seemed out of the question because the companies could successfully exclude an offending country from the market, as they did with Iran in 1951.
In addition, the United States itself was the world’s top producer and immune from supply shocks thanks to import quotas.. If OPEC threatened to take production offline in order to put pressure on the companies, the U.S. could increase its own to make up the difference, as it did during a partial Arab oil boycott in 1967.
In the end, OPEC did not possess enough market share to make a meaningful impact.
A new balance of power
Besides being relatively impotent, OPEC couldn’t agree on a consistent policy among its members. Saudi Arabia wanted to keep production levels low and prices consistent, preserving the global economy and the political status quo. Iran and Iraq, with huge military and development budgets, wanted prices pushed as high as possible in order to maximize revenue.
According to scholar and oil consultant Ian Skeet, an attempt to extract more favorable terms from the Sisters in 1963 was sabotaged by the shah of Iran, who sought a separate agreement.
During the 1960s, OPEC met, debated and released grandiose statements on their rights, yet failed to form a united front.
Nevertheless, significant changes were occurring at the time. Demand for oil shot up, while production in the U.S. stagnated. The ability of the Seven Sisters to control the market was undermined by international competitors drilling new fields in North Africa, where Libya’s Muammar Qaddafi threatened to shut off supply if he didn’t get higher prices.
The companies were under more and more pressure to deliver satisfactory terms to the OPEC members. The price of oil, which had held steady at $1.80 a barrel for years, began ticking upwards. American import quotas ended, leaving the U.S. more vulnerable to supply shocks as its production capacity steadily declined.
These conditions, while not the result of actions by OPEC, gave the organization an opportunity to influence the market and upset the balance of power.
The oil price revolution
This shift accelerated in the 1970s as war broke out between Israel and its Arab neighbors, creating an opportunity for OPEC to wrest control from the Western oil companies.
To punish the U.S. for supporting the Jewish state, Arab oil producers (not OPEC, as popularly believed) cut production and declared an embargo. Together with the war, this destabilized energy markets as demand outpaced supply.
Amid the fighting, OPEC met with the Seven Sisters in Geneva and demanded an increase in the posted oil price. After rejecting a small change, OPEC announced it would double the price to $5 and later doubled it again to $11.65.
This triggered a massive shift in economic power, what Stanford University professor Steven Schneider called “the greatest non-violent transfer of wealth in human history.” With the uptick in oil revenues, OPEC states spent lavishly on economic development, social programs and investments in Western industry and steadily nationalized their domestic industries, pushing out the Seven Sisters.
How did the balance of power seem to shift so suddenly? Among other reasons, the major oil companies could not agree among themselves on a new price and were actually tempted by the high profits that would result. In other words, OPEC had seized control of the oil market largely due to circumstances beyond its control.
The oil crisis
Despite its victory, OPEC had come no closer to resolving its internal divisions. This became evident when another energy crisis hit.
In January 1979, the shah of Iran fled amid revolution, and global oil markets panicked. Prices soared, from $12.70 to over $30 by 1980. Iran’s 6 million barrels per day (bpd) disappeared, and other OPEC states eagerly seized the opportunity to sell oil at costly premiums, sending the price even higher.
In the ensuing years, Saudi Arabia tried to impose a quota system, with overall production capped at 20 million bpd. Most members ignored their quotas or over-produced to gain greater revenue.
Meanwhile, the West worked to improve energy efficiency and invested heavily in non-OPEC oil sources, including Alaska, Canada and the North Sea. By 1985, OPEC’s market share had fallen below 30 percent. OPEC dropped its production quota to 19 million bpd, then 17 million, to account for diminishing demand, but only the Saudis obeyed the rules, losing market share as other producers pumped above the quota level.
By 1986, the Saudis had had enough. Without warning, the Saudi oil minister announced that Saudi production would increase. Overnight, Saudi production shot up more than 2 million bpd, flooding the market and sending prices plunging below $10 a barrel. Sick of watching other OPEC members cheat them out of profits, the Saudis chose to enforce new discipline through an artificial market shock.
Just as the kingdom did in 2014, this move indicated Saudi willingness to use its massive reserves to “correct” the market and push out high-cost producers, even at the cost of its OPEC allies.
Feeling the pain
OPEC’s fortunes have oscillated since the 1986 shock. Cooperation remained elusive.
A 2011 meeting, dubbed “the worst ever” by recently-removed Saudi oil minister Ali al-Naimi, produced disagreements over production levels. Acrimony reigned as OPEC states ignored calls for economic diversification in favor of oil-fueled economic growth.
High prices during the early 2000s accounted for a huge boom in oil revenues for OPEC members. For Venezuela and Nigeria, oil accounts for over 90 percent of all exports. Most OPEC states believed that high demand would last forever, that high prices could fund government programs and that the good times would never end.
Yet the good times appear to be over. OPEC has failed to control the downward spiral in prices, reportedly begun by Saudi Arabia in November 2014 to flood the market with cheap crude to put new and old competitors – U.S. shale producers and Iran – out of business. Saudi Arabia pursued its political interests and existing market share, leaving other OPEC members to fend for themselves.
It is possible that Saudi Arabia may emerge from this current crisis unscathed, free to embark upon its recently announced Vision 2030 plan for an “oil-less” economy, however dubious that plan might appear. It’s possible that OPEC may succeed in concerted action in the future. But its recent failures suggest that political interest will be more likely to divide OPEC and prevent mutual self-interest from uniting its members.
By Gregory Brew
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Headline crude prices for the week beginning 20 May 2019 – Brent: US$73/b; WTI: US$63/b
Headlines of the week
Midstream & Downstream
At first, it seemed like a done deal. Chevron made a US$33 billion offer to take over US-based upstream independent Anadarko Petroleum. It was a 39% premium to Anadarko’s last traded price at the time and would have been the largest industry deal since Shell’s US$61 billion takeover of the BG Group in 2015. The deal would have given Chevron significant and synergistic acreage in the Permian Basin along with new potential in US midstream, as well as Anadarko’s high potential projects in Africa. Then Occidental Petroleum swooped in at the eleventh hour, making the delicious new bid and pulling the carpet out from under Chevron.
We can thank Warren Buffet for this. Occidental Petroleum, or Oxy, had previously made several quiet approaches to purchase Anadarko. These were rebuffed in favour of Chevron’s. Then Oxy’s CEO Vicki Hollub took the company jet to meet with Buffet. Playing to his reported desire to buy into shale, Hollub returned with a US$10 billion cash infusion from Buffet’s Berkshire Hathaway – which was contingent on Oxy’s successful purchase of Anadarko. Hollub also secured a US$8.8 billion commitment from France’s Total to sell off Anadarko’s African assets. With these aces, she then re-approached Anadarko with a new deal – for US$38 billion.
This could have sparked off a price war. After all, the Chevron-Anadarko deal made a lot of sense – securing premium spots in the prolific Permian, creating a 120 sq.km corridor in the sweet spot of the shale basin, the Delaware. But the risk-adverse appetite of Chevron’s CEO Michael Wirth returned, and Chevron declined to increase its offer. By bowing out of the bid, Wirth said ‘Cost and capital discipline always matters…. winning in any environment doesn’t mean winning at any cost… for the sake for doing a deal.” Chevron walks away with a termination fee of US$1 billion and the scuppered dreams of matching ExxonMobil in size.
And so Oxy was victorious, capping off a two-year pursuit by Hollub for Anadarko – which only went public after the Chevron bid. This new ‘global energy leader’ has a combined 1.3 mmb/d boe production, but instead of leveraging Anadarko’s more international spread of operations, Oxy is looking for a future that is significantly more domestic.
The Oxy-Anadarko marriage will make Occidental the undisputed top producer in the Permian Basin, the hottest of all current oil and gas hotspots. Oxy was once a more international player, under former CEO Armand Hammer, who took Occidental to Libya, Peru, Venezuela, Bolivia, the Congo and other developing markets. A downturn in the 1990s led to a refocusing of operations on the US, with Oxy being one of the first companies to research extracting shale oil. And so, as the deal was done, Anadarko’s promising projects in Africa – Area 1 and the Mozambique LNG project, as well as interest in Ghana, Algeria and South Africa – go to Total, which has plenty of synergies to exploit. The retreat back to the US makes sense; Anadarko’s 600,000 acres in the Permian are reportedly the most ‘potentially profitable’ and it also has a major presence in Gulf of Mexico deepwater. Occidental has already identified 10,000 drilling locations in Anadarko areas that are near existing Oxy operations.
While Chevron licks its wounds, it can comfort itself with the fact that it is still the largest current supermajor presence in the Permian, with output there surging 70% in 2018 y-o-y. There could be other targets for acquisitions – Pioneer Natural Resources, Concho Resources or Diamondback Energy – but Chevron’s hunger for takeover seems to have diminished. And with it, the promises of an M&A bonanza in the Permian over 2019.
The Occidental-Anadarko deal:
Source: U.S. Energy Information Administration, Short-Term Energy Outlook
In April 2019, Venezuela's crude oil production averaged 830,000 barrels per day (b/d), down from 1.2 million b/d at the beginning of the year, according to EIA’s May 2019 Short-Term Energy Outlook. This average is the lowest level since January 2003, when a nationwide strike and civil unrest largely brought the operations of Venezuela's state oil company, Petróleos de Venezuela, S.A. (PdVSA), to a halt. Widespread power outages, mismanagement of the country's oil industry, and U.S. sanctions directed at Venezuela's energy sector and PdVSA have all contributed to the recent declines.
Source: U.S. Energy Information Administration, based on Baker Hughes
Venezuela’s oil production has decreased significantly over the last three years. Production declines accelerated in 2018, decreasing by an average of 33,000 b/d each month in 2018, and the rate of decline increased to an average of over 135,000 b/d per month in the first quarter of 2019. The number of active oil rigs—an indicator of future oil production—also fell from nearly 70 rigs in the first quarter of 2016 to 24 rigs in the first quarter of 2019. The declines in Venezuelan crude oil production will have limited effects on the United States, as U.S. imports of Venezuelan crude oil have decreased over the last several years. EIA estimates that U.S. crude oil imports from Venezuela in 2018 averaged 505,000 b/d and were the lowest since 1989.
EIA expects Venezuela's crude oil production to continue decreasing in 2019, and declines may accelerate as sanctions-related deadlines pass. These deadlines include provisions that third-party entities using the U.S. financial system stop transactions with PdVSA by April 28 and that U.S. companies, including oil service companies, involved in the oil sector must cease operations in Venezuela by July 27. Venezuela's chronic shortage of workers across the industry and the departure of U.S. oilfield service companies, among other factors, will contribute to a further decrease in production.
Additionally, U.S. sanctions, as outlined in the January 25, 2019 Executive Order 13857, immediately banned U.S. exports of petroleum products—including unfinished oils that are blended with Venezuela's heavy crude oil for processing—to Venezuela. The Executive Order also required payments for PdVSA-owned petroleum and petroleum products to be placed into an escrow account inaccessible by the company. Preliminary weekly estimates indicate a significant decline in U.S. crude oil imports from Venezuela in February and March, as without direct access to cash payments, PdVSA had little reason to export crude oil to the United States.
India, China, and some European countries continued to receive Venezuela's crude oil, according to data published by ClipperData Inc. Venezuela is likely keeping some crude oil cargoes intended for exports in floating storageuntil it finds buyers for the cargoes.
Source: U.S. Energy Information Administration, Short-Term Energy Outlook, and Clipper Data Inc.
A series of ongoing nationwide power outages in Venezuela that began on March 7 cut electricity to the country's oil-producing areas, likely damaging the reservoirs and associated infrastructure. In the Orinoco Oil Belt area, Venezuela produces extra-heavy crude oil that requires dilution with condensate or other light oils before the oil is sent by pipeline to domestic refineries or export terminals. Venezuela’s upgraders, complex processing units that upgrade the extra-heavy crude oil to help facilitate transport, were shut down in March during the power outages.
If Venezuelan crude or upgraded oil cannot flow as a result of a lack of power to the pumping infrastructure, heavier molecules sink and form a tar-like layer in the pipelines that can hinder the flow from resuming even after the power outages are resolved. However, according to tanker tracking data, Venezuela's main export terminal at Puerto José was apparently able to load crude oil onto vessels between power outages, possibly indicating that the loaded crude oil was taken from onshore storage. For this reason, EIA estimates that Venezuela's production fell at a faster rate than its exports.
EIA forecasts that Venezuela's crude oil production will continue to fall through at least the end of 2020, reflecting further declines in crude oil production capacity. Although EIA does not publish forecasts for individual OPEC countries, it does publish total OPEC crude oil and other liquids production. Further disruptions to Venezuela's production beyond what EIA currently assumes would change this forecast.