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 Schneidercalled '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 circumstancesbeyond 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. ForVenezuela 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.
Gregory Brew - PhD Student in History, Energy and Foreign Relations, Georgetown University
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Headline crude prices for the week beginning 18 March 2019 – Brent: US$67/b; WTI: US$58/b
Headlines of the week
Midstream & Downstream
Risk and reward – improving recovery rates versus exploration
A giant oil supply gap looms. If, as we expect, oil demand peaks at 110 million b/d in 2036, the inexorable decline of fields in production or under development today creates a yawning gap of 50 million b/d by the end of that decade.
How to fill it? It’s the preoccupation of the E&P sector. Harry Paton, Senior Analyst, Global Oil Supply, identifies the contribution from each of the traditional four sources.
1. Reserve growth
An additional 12 million b/d, or 24%, will come from fields already in production or under development. These additional reserves are typically the lowest risk and among the lowest cost, readily tied-in to export infrastructure already in place. Around 90% of these future volumes break even below US$60 per barrel.
2. pre-drill tight oil inventory and conventional pre-FID projects
They will bring another 12 million b/d to the party. That’s up on last year by 1.5 million b/d, reflecting the industry’s success in beefing up the hopper. Nearly all the increase is from the Permian Basin. Tight oil plays in North America now account for over two-thirds of the pre-FID cost curve, though extraction costs increase over time. Conventional oil plays are a smaller part of the pre-FID wedge at 4 million b/d. Brazil deep water is amongst the lowest cost resource anywhere, with breakevens eclipsing the best tight oil plays. Certain mature areas like the North Sea have succeeded in getting lower down the cost curve although volumes are small. Guyana, an emerging low-cost producer, shows how new conventional basins can change the curve.
3. Contingent resource
These existing discoveries could deliver 11 million b/d, or 22%, of future supply. This cohort forms the next generation of pre-FID developments, but each must overcome challenges to achieve commerciality.
Last, but not least, yet-to-find. We calculate new discoveries bring in 16 million b/d, the biggest share and almost one-third of future supply. The number is based on empirical analysis of past discovery rates, future assumptions for exploration spend and prospectivity.
Can yet-to-find deliver this much oil at reasonable cost? It looks more realistic today than in the recent past. Liquids reserves discovered that are potentially commercial was around 5 billion barrels in 2017 and again in 2018, close to the late 2030s ‘ask’. Moreover, exploration is creating value again, and we have argued consistently that more companies should be doing it.
But at the same time, it’s the high-risk option, and usually last in the merit order – exploration is the final top-up to meet demand. There’s a danger that new discoveries – higher cost ones at least – are squeezed out if demand’s not there or new, lower-cost supplies emerge. Tight oil’s rapid growth has disrupted the commercialisation of conventional discoveries this decade and is re-shaping future resource capture strategies.
To sustain portfolios, many companies have shifted away from exclusively relying on exploration to emphasising lower risk opportunities. These mostly revolve around commercialising existing reserves on the books, whether improving recovery rates from fields currently in production (reserves growth) or undeveloped discoveries (contingent resource).
Emerging technology may pose a greater threat to exploration in the future. Evolving technology has always played a central role in boosting expected reserves from known fields. What’s different in 2019 is that the industry is on the cusp of what might be a technological revolution. Advanced seismic imaging, data analytics, machine learning and artificial intelligence, the cloud and supercomputing will shine a light into sub-surface’s dark corners.
Combining these and other new applications to enhance recovery beyond tried-and-tested means could unlock more reserves from existing discoveries – and more quickly than we assume. Equinor is now aspiring to 60% from its operated fields in Norway. Volume-wise, most upside may be in the giant, older, onshore accumulations with low recovery factors (think ExxonMobil and Chevron’s latest Permian upgrades). In contrast, 21st century deepwater projects tend to start with high recovery factors.
If global recovery rates could be increased by a percentage or two from the average of around 30%, reserves growth might contribute another 5 to 6 million b/d in the 2030s. It’s just a scenario, and perhaps makes sweeping assumptions. But it’s one that should keep conventional explorers disciplined and focused only on the best new prospects.
Global oil supply through 2040
Things just keep getting more dire for Venezuela’s PDVSA – once a crown jewel among state energy firms, and now buried under debt and a government in crisis. With new American sanctions weighing down on its operations, PDVSA is buckling. For now, with the support of Russia, China and India, Venezuelan crude keeps flowing. But a ghost from the past has now come back to haunt it.
In 2007, Venezuela embarked on a resource nationalisation programme under then-President Hugo Chavez. It was the largest example of an oil nationalisation drive since Iraq in 1972 or when the government of Saudi Arabia bought out its American partners in ARAMCO back in 1980. The edict then was to have all foreign firms restructure their holdings in Venezuela to favour PDVSA with a majority. Total, Chevron, Statoil (now Equinor) and BP agreed; ExxonMobil and ConocoPhillips refused. Compensation was paid to ExxonMobil and ConocoPhillips, which was considered paltry. So the two American firms took PDVSA to international arbitration, seeking what they considered ‘just value’ for their erstwhile assets. In 2012, ExxonMobil was awarded some US$260 million in two arbitration awards. The dispute with ConocoPhillips took far longer.
In April 2018, the International Chamber of Commerce ruled in favour of ConocoPhillips, granting US$2.1 billion in recovery payments. Hemming and hawing on PDVSA’s part forced ConocoPhillips’ hand, and it began to seize control of terminals and cargo ships in the Caribbean operated by PDVSA or its American subsidiary Citgo. A tense standoff – where PDVSA’s carriers were ordered to return to national waters immediately – was resolved when PDVSA reached a payment agreement in August. As part of the deal, ConocoPhillips agreed to suspend any future disputes over the matter with PDVSA.
The key word being ‘future’. ConocoPhillips has an existing contractual arbitration – also at the ICC – relating to the separate Corocoro project. That decision is also expected to go towards the American firm. But more troubling is that a third dispute has just been settled by the International Centre for Settlement of Investment Disputes tribunal in favour of ConocoPhillips. This action was brought against the government of Venezuela for initiating the nationalisation process, and the ‘unlawful expropriation’ would require a US$8.7 billion payment. Though the action was brought against the government, its coffers are almost entirely stocked by sales of PDVSA crude, essentially placing further burden on an already beleaguered company. A similar action brought about by ExxonMobil resulted in a US$1.4 billion payout; however, that was overturned at the World Bank in 2017.
But it might not end there. The danger (at least on PDVSA’s part) is that these decisions will open up floodgates for any creditors seeking damages against Venezuela. And there are quite a few, including several smaller oil firms and players such as gold miner Crystallex, who is owed US$1.2 billion after the gold industry was nationalised in 2011. If the situation snowballs, there is a very tempting target for creditors to seize – Citgo, PDVSA’s crown jewel that operates downstream in the USA, which remains profitable. And that would be an even bigger disaster for PDVSA, even by current standards.
Infographic: Venezuela oil nationalisation dispute timeline