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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.

The death of OPEC has been announced in some quarters, with its long-term decline seemingly assured as global energy enters a new era.

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

Middle East OPEC crude oil oil prices oil exports
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TODAY IN ENERGY: The U.S. leads global petroleum and natural gas production with record growth in 2018

U.S. petroleum and natural gas production increased by 16% and by 12%, respectively, in 2018, and these totals combined established a new production record. The United States surpassed Russia in 2011 to become the world's largest producer of natural gas and surpassed Saudi Arabia in 2018 to become the world's largest producer of petroleum. Last year’s increase in the United States was one of the largest absolute petroleum and natural gas production increases from a single country in history.

For the United States and Russia, petroleum and natural gas production is almost evenly split; Saudi Arabia's production heavily favors petroleum. Petroleum production is composed of several types of liquid fuels, including crude oil and lease condensate, natural gas plant liquids (NGPLs), and bitumen. The United States produced 28.7 quadrillion British thermal units (quads) of petroleum in 2018, which was composed of 80% crude oil and condensate and 20% NGPLs.

estimated petroleum and natural gas production in selected countries

Source: U.S. Energy Information Administration, based on International Energy Statistics
Note: Petroleum includes crude oil, condensate, and natural gas plant liquids.

U.S. crude oil production increased by 17% in 2018, setting a new record of nearly 11.0 million barrels per day (b/d), equivalent to 22.8 quadrillion British thermal units (Btu) in energy terms. Production in the Permian region of western Texas and eastern New Mexico contributed to most of the growth in U.S. crude oil production. The United States also produced 4.3 million b/d of NGPLs in 2018, equivalent to 5.8 quadrillion Btu. U.S. NGPL production has more than doubled since 2008, when the market for NGPLs began to expand.

U.S. dry natural gas production increased by 12% in 2018 to 28.5 billion cubic feet per day (Bcf/d), or 31.5 quadrillion Btu, reaching a new record high for the second year in a row. Ongoing growth in liquefied natural gas export capacity and the expanded ability to reach new markets have supported increases in U.S. natural gas production.

Russia’s crude oil and natural gas production also reached record levels in 2018, encouraged by increasing global demand. Russia exports most of the crude oil that it produces to European countries and to China. Since 2016, nearly 60% of Russia’s crude oil exports have gone to European member countries in the Organization for Economic Cooperation and Development (OECD). Russia’s crude oil is also an important source of supply to China and neighboring countries.

Russia’s natural gas production increased by 7% in 2018, which exceeded the growth in exports. The Yamal liquefied natural gas (LNG) export facility, which loaded its first cargo in December 2017, can liquefy more than 16 million tons of natural gas annually and accounts for almost all of the recent growth in Russia’s LNG exports. Since 2000, more than 80% of Russia’s natural gas exports have been sent to Europe.

Saudi Arabia’s annual average crude oil production increased slightly in 2018, but it remained lower than in 2016, when Saudi Arabia’s crude oil output reached a record high. Saudi Arabia’s crude oil production reached an all-time monthly high in November 2018 before the December 2018 agreement by the Organization of the Petroleum Exporting Countries (OPEC) to extend production cuts.

In addition to exporting and refining crude oil, Saudi Arabia consumes crude oil directly for electricity generation, which makes Saudi Arabian crude oil consumption highest in the summer when electricity demand for space cooling is relatively high. Since 2016, Saudi Arabia’s direct crude oil burn for electric power generation has decreased for a number of reasons, including demand reductions from a partial withdraw of power subsidies, greater use of residual fuel oil, and increased availability of domestic natural gas.

Crude oil exports account for about 60% of Saudi Arabia’s total economic output. China, along with Japan, South Korea, Taiwan, and the United States remain critical markets for Saudi Arabia’s petroleum exports.

August, 21 2019
Your Weekly Update: 12 - 16 August 2019

Market Watch 

Headline crude prices for the week beginning 12 August 2019 – Brent: US$58/b; WTI: US$54/b

  • Saudi Arabia’s overtures to further stabilise prices was met with a largely positive response by the market, allowing crude prices to claw back some ground after being hammered by demand concerns
  • Saudi officials reportedly called other members in the OPEC and OPEC+ producer clubs to discuss options on how to stem the recent rout in prices, with an anonymous official quoted as saying that it ‘would not tolerate continued price weakness’
  • Reports suggest that Saudi Arabia plans to keep its oil exports at below 7 mmb/d in September according to sales allocations, which was seen as a stabilising factor in crude price trends
  • This came after crude prices fell as the US-China trade war entered a new front, causing weakness in the Chinese Yuan, although President Trump has floated the idea of delaying the new round of tariffs beyond the current implementation timeline of September 1
  • Crude had also fallen in response to a slide in American crude oil stockpiles and a receding level of tensions in the Persian Gulf
  • In a new report, the International Energy Agency said that the outlook for global oil demand is ‘fragile’ on signs of an economic slowdown; there is also concern that China will target US crude if the US moves ahead with its tariff plan
  • The US active rig count lost another 8 rigs – 6 oil and 2 gas – the sixth consecutive weekly loss that brought the total number of active rigs to 934
  • Demand fears will continue to haunt the market, which will not be offset so easily of Saudi-led efforts to limit production; as a result, crude prices will trade rangebound with a negative slant in the US$56-58/b range for Brent and US$52-54/b for WTI


Headlines of the week

Upstream

  • Nearly all Anadarko shareholders have approved the Occidental Petroleum deal, completing the controversial takeover bid despite investor Carl Icahn’s attempts to derail the purchase
  • Crude oil inventories in Western Canada have fallen by 2.75 million barrels m-o-m to its lowest level since November 2017, as the production limits in Alberta appear to be doing their job in limiting a supply glut while output curbs are slowly being loosened on the arrival of more rail and pipeline capacity
  • Mid-sized Colorado players PDC Energy and SRC Energy – both active in the Denver-Julesburg Basin – are reportedly in discussion to merge their operations
  • Pemex has been granted approval by the National Hydrocarbon Commission to invest US$10 billion over 25 years to develop onshore and offshore exploration opportunities in Mexico
  • Qatar Investment Authority has acquired a ‘significant stake’ in major Permian player Oryx Midstream Services from Stonepeak Infrastructure Partners for some US$550 million, as foreign investment in the basin increases
  • PDVSA and CNPC’s Venezuelan joint venture Sinovensa has announced plans to expand blending capacity – lightening up extra-heavy Orinoco crude to medium-grade Merey – from a current 110,000 b/d to 165,000 b/d
  • BHP has approved an additional US$283 million in funding for the Ruby oil and gas project in Trinidad and Tobago, with first production expected in 2021
  • CNPC, ONGC Videsh and Petronas have reportedly walked away from their onshore acreage in Sudan, blaming unpaid oil dues on production from onshore Blocks 2A and 4 that have already reached more than US$500 million

Midstream/Downstream

  • Expected completion of Nigeria’s huge planned 650 kb/d Dangote refinery has been delayed to the end of 2020, with issues importing steel and equipment cited
  • Saudi Aramco’s US refining arm Motiva announced plans to shut several key units at its 607 kb/d Port Arthur facility in Texas for a 2-month planned maintenance, affecting its 325 kb/d CDU and the naphtha processing plant
  • ADNOC has purchased a 10% stake in global terminal operator VTTI, expanding its terminalling capacity in Asia, Africa and Europe
  • A little-known Chinese contractor Wison Engineering Services has reportedly agreed to refurbish Venezuela’s main refineries in a barter deal for oil produced, in a bid for Venezuela to evade the current US sanctions on its crude exports
  • Swiss downstream player Varo Energy will increase its stake in the 229 kb/d Bayernoil complex in Germany to 55% after purchasing BP’s 10% stake
  • India has raised the projected cost estimate of its giant planned refinery in Maharashtra – a joint venture between Indian state oil firms with Saudi Aramco and ADNOC – to US$60 billion, after farmer protests forced a relocation

Natural Gas/LNG

  • The government of Australia’s New South Wales has given its backing to South Korea’s Epik and its plan to build a new LNG import terminal in Newcastle
  • Kosmos Energy is proposing to build two new LNG facilities to tap into deepwater gas resources offshore Mauritania and Senegal under development
  • In the middle of the Pacific, the French territory of New Caledonia has started work on its Centrale Pays Project, a floating LNG terminal with an accompanying 200-megawatt power plant, with Nouvelle-Caledonia Energie seeking a 15-year LNG sales contract for roughly 200,000 tons per year
August, 16 2019
The State of the Industry: Q2 2019

The momentum for crude prices abated in the second quarter of 2019, providing less cushion for the financial results of the world’s oil companies. But while still profitable, the less-than-ideal crude prices led to mixed results across the boards – exposing gaps and pressure points for individual firms masked by stronger prices in Q119.

In a preview of general performance in the industry, Total – traditionally the first of the supermajors to release its earnings – announced results that fell short of expectations. Net profits for the French firm fell to US$2.89 billion from US$3.55 billion, below analyst predictions. This was despite a 9% increase in oil and gas production – in particularly increases in LNG sales – and a softer 2.5% drop in revenue. Total also announced that it would be selling off US$5 billion in assets through 2020 to keep a lid on debt after agreeing to purchase Anadarko Petroleum’s African assets for US$8.8 billion through Occidental.

As with Total, weaker crude prices were the common factor in Q219 results in the industry, though the exact extent differed. Russia’s Gazprom posted higher revenue and higher net profits, while Norway’s Equinor reported falls in both revenue and net profits – leading it to slash investment plans for the year. American producer ConocoPhillips’ quarterly profits and revenue were flat year-on-year, while Italy’s Eni – which has seen major success in Africa – reported flat revenue but lower profits.

 After several quarters of disappointing analysts, ExxonMobil managed to beat expectations in Q219 – recording better-than-expected net profits of US$3.1 billion. In comparison, Shell – which has outperformed ExxonMobil over the past few reporting periods – disappointed the market with net profits halving to US$3 billion from US$6 billion in Q218. The weak performance was attributed (once again) to lower crude prices, as well as lower refining margins. BP, however, managed to beat expectations with net profits of US$2.8 billion, on par with its performance in Q218. But the supermajor king of the quarter was Chevron, with net profits of US$4.3 billion from gains in Permian production, as well as the termination fee from Anadarko after the latter walked away from a buyout deal in favour of Occidental.

And then, there was a surprise. In a rare move, Saudi Aramco – long reputed to be the world’s largest and most profitable energy firm – published its earnings report for 1H19, which is its first ever. The results confirmed what the industry had long accepted as fact: net profit was US$46.9 billion. If split evenly, Aramco’s net profits would be more than the five supermajors combined in Q219. Interestingly, Aramco also divulged that it had paid out US$46.4 billion in dividends, or 99% of its net profit. US$20 billion of that dividend was paid to its principle shareholder – the government of Saudi Arabia – up from US$6 billion in 1H18, which makes for interesting reading to potential investors as Aramco makes a second push for an IPO. With Saudi Aramco CFO Khalid al-Dabbagh announcing that the company was ‘ready for the IPO’ during its first ever earnings call, this reporting paves the way to the behemoth opening up its shares to the public. But all the deep reservoirs in the world did not shield Aramco from market forces. As it led the way in adhering to the OPEC+ club’s current supply restrictions, weaker crude prices saw net profit fall by 11.5% from US$53 billion a year earlier.

So, it’s been a mixed bunch of results this quarter – which perhaps showcases the differences in operational strategies of the world’s oil and gas companies. There is no danger of financials heading into the red any time soon, but without a rising tide of crude prices, Q219 simply shows that though the challenges facing the industry are the same, their approaches to the solutions still differ.

Supermajor Financials: Q2 2019

  • ExxonMobil – Revenue (US$69.1 billion, down 6% y-o-y), Net profit (US$3.1 billion, down 22.5% y-o-y)
  • Shell - Revenue (US$90.5 billion, down 6.5% y-o-y), Net profit (US$3 billion, down 50% y-o-y)
  • Chevron – Revenue (US$36.3 billion, down 10.4% y-o-y), Net profit (US$4.3 billion, up 26% y-o-y)
  • BP - Revenue (US$73.7 billion, down 4.11% y-o-y), Net profit (US$2.8 billion, flat y-o-y)
  • Total - Revenue (US$51.2 billion, down 2.5% y-o-y), Net profit (US$2.89 billion, down 18.6% y-o-y)
August, 14 2019