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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The U.S. Energy Information Administration (EIA) estimates that during May 2019, Saudi Arabia’s crude oil production approached a four-year low, averaging an estimated 9.9 million barrels per day (b/d). Production declined more than 1 million b/d since its estimated all-time high production levels in October and November 2018 (Figure 1). Although the country’s total crude oil exports are also lower than recent highs, its crude oil exports to some Asia Pacific countries actually increased during the period of declining production. China in particular has increased its crude oil imports from Saudi Arabia, which is partially a result of new Chinese refining capacity. In contrast, U.S. crude oil imports from Saudi Arabia reached a 31-year low in February, with weekly estimates for April, May, and June suggesting even further declines.
Four Asia Pacific countries that publish crude oil imports by country of origin—China, Japan, South Korea, and Taiwan—collectively imported an average of 3.5 million b/d of crude oil from Saudi Arabia in 2018 (Figure 2). Chinese and Japanese 2019 year-to-date crude oil imports from Saudi Arabia are higher than their 2018 annual averages, whereas Taiwan’s are flat and South Korea’s have declined slightly. China’s crude oil imports from Saudi Arabia, in particular, have increased by 0.4 million b/d year-to-date through April compared with the 2018 annual average, significantly higher than Japan’s increase of less than 0.1 million b/d.
In contrast, U.S. crude oil imports from Saudi Arabia have declined year-to-date through March 2019 compared with the 2018 average by more than 0.2 million b/d, averaging 0.6 million b/d for the first quarter of 2019. Weekly estimates through June 14 of this year show continued declines, indicating that imports from Saudi Arabia averaged less than 0.5 million b/d in May and the first half of June. As a result of these shifts in crude oil flows, the U.S. share of total Saudi Arabian crude oil exports fell to 9% in March, and China’s share increased to 24% (Figure 3). Collectively, the United States, China, Japan, Taiwan, and South Korea historically accounted for about 60%–65% of total Saudi Arabian crude oil exports.
These recent changes in crude oil trade patterns are partially because of long-term structural trends within China and the United States, but they are also a result of recent oil market dynamics. From 2010 through 2018, EIA estimates total Chinese petroleum consumption has increased from 9.3 million b/d to 13.9 million b/d, whereas Chinese domestic production has increased from 4.6 million b/d to 4.8 million b/d. As a result, China’s need to meet incremental oil consumption has come primarily from imports. China’s crude oil imports from Saudi Arabia have gradually increased in recent years, and in March 2019 reached the highest level for any month since at least 2004, at 1.7 million b/d. Other countries, including Russia and Brazil, have had larger increases in crude oil export growth to China, however, with Russia overtaking Saudi Arabia as the largest source of crude oil on an annual average basis in 2016.
U.S. crude oil imports, on the other hand, have steadily decreased during this period as domestic crude oil production has increased. In addition, U.S. crude oil imports from members of the Organization of the Petroleum Exporting Countries (OPEC) have declined, in particular, following increases from other countries such as Canada. Canadian crude oil can substitute for certain OPEC grades and have lower transportation costs when shipped by available pipeline capacity.
Saudi Arabian crude oil exports to China increased recently at least in part as a result of the startup of a new 0.4 million b/d refinery in Dalian, Liaoning Province, which has a supply agreement with Saudi Aramco, Saudi Arabia’s national oil company. Saudi Aramco also has a supply agreement with another 0.4 million b/d refining and petrochemical complex in Zhejiang Province, which started trial operations this year.
Other near-term developments, however, could reduce the volume of Saudi Arabian crude oil headed to China for May, June, and through the summer. Saudi Arabia typically increases domestic crude oil consumption in the summer months because the country directly burns the fuel for power generation. Although Saudi Arabia has gradually been increasing the use of fuel oil and natural gas instead of crude oil for power generation, the seasonal increase is dependent on the weather and can still amount to several hundred thousand barrels per day in additional domestic consumption during summer months. The five-year (2014–18) average crude oil burn for electric power generation peaks in July at 0.7 million b/d, an increase of 0.3 million b/d from the April average. In addition, Chinese crude oil refinery demand could be lower in the second quarter of 2019 than in the first quarter of 2019. Bloomberg data suggest that Chinese refinery outages in May and June month-to-date were 2.1 million b/d and 1.7 million b/d, respectively, 0.5 million b/d and 0.6 million b/d higher than their respective five-year averages for those months.
Recent global oil supply issues could keep Saudi Arabian crude oil exports to China, Japan, South Korea, and Taiwan relatively high in the coming months, however, in spite of the previously mentioned seasonal factors. These four countries were all initially granted Iranian sanctions waivers through May 2019. However, because waivers were not renewed, each country will likely need an alternative to Iranian crude oil. This development could keep their crude oil imports from Saudi Arabia near first-quarter 2019 levels for the coming months as a partial substitute for Iranian barrels. Saudi Arabia’s support of maintaining current OPEC production cuts or increasing output levels in the upcoming late-June or early-July OPEC meeting will be a critical determinant for future export flows.
U.S. average regular gasoline and diesel prices fall
The U.S. average regular gasoline retail price fell more than 6 cents from the previous week to $2.67 per gallon on June 17, 21 cents lower than the same time last year. The Midwest price fell nearly 8 cents to $2.54 per gallon, the West Coast price fell nearly 7 cents to $3.45 per gallon, the East Coast price fell more than 6 cents to $2.56 per gallon, the Rocky Mountain price fell nearly 4 cents to $2.91 per gallon, and the Gulf Coast price fell nearly 3 cents to $2.34 per gallon.
The U.S. average diesel fuel price fell nearly 4 cents to $3.07 per gallon on June 17, more than 17 cents lower than a year ago. The West Coast and Midwest prices each fell nearly 5 cents to $3.67 per gallon and $2.96 per gallon, respectively, the Rocky Mountain price fell more than 4 cents to $3.07 per gallon, the East Coast price fell nearly 3 cents to $3.10 per gallon, and the Gulf Coast price fell more than 2 cents to $2.82 per gallon.
Propane/propylene inventories rise
U.S. propane/propylene stocks increased by 3.3 million barrels last week to 74.5 million barrels as of June 14, 2019, 10.7 million barrels (16.8%) greater than the five-year (2014-2018) average inventory levels for this same time of year. East Coast, Midwest, and Gulf Coast inventories each increased by 1.1 million barrels. Rocky Mountain/West Coast inventories fell slightly, remaining virtually unchanged. Propylene non-fuel-use inventories represented 6.6% of total propane/propylene inventories.
It has been 21 years since Japanese upstream firm Inpex signed on to explore the Masela block in Indonesia in 1998 and 19 years since the discovery of the giant Abadi natural gas field in 2000. In that time, Inpex’s Ichthys field in Australia was discovered, exploited and started LNG production last year, delivering its first commercial cargo just a few months ago. Meanwhile, the abundant gas in the Abadi field close to the Australia-Indonesia border has remained under the waves. Until recently, that is, when Inpex had finally reached a new deal with the Indonesian government to revive the stalled project and move ahead with a development plan.
This could have come much earlier. Much, much earlier. Inpex had submitted its first development plan for Abadi in 2010, encompassing a Floating LNG project with an initial capacity of 2.5 million tons per annum. As the size of recoverable reserves at Abadi increased, the development plan was revised upwards – tripling the planned capacity of the FLNG project to be located in the Arafura Sea to 7.5 million tons per annum. But at that point, Indonesia had just undergone a crucial election and moods had changed. In April 2016, the Indonesian government essentially told Inpex to go back to the drawing board to develop Abadi, directing them to shift from a floating processing solution to an onshore one, which would provide more employment opportunities. The onshore option had been rejected initially by Inpex in 2010, given that the nearest Indonesian land is almost 100km north of the field. But with Indonesia keen to boost activity in its upstream sector, the onshore mandate arrived firmly. And now, after 3 years of extended evaluation, Inpex has delivered its new development plan.
The new plan encompasses an onshore LNG plant with a total production capacity of 9.5 million tons per annum. With an estimated cost of US$18-20 billion, it will be the single largest investment in Indonesia and one of the largest LNG plants operated by a Japanese firm. FID is expected within 3 years, with a tentative target operational timeline of the late 2020s. LNG output will be targeted at Japan’s massive market, but also growing demand centres such as China. But Abadi will be entering into a far more crowded field that it would have if initial plans had gone ahead in 2010; with US Gulf Coast LNG producers furiously constructing at the moment and mega-LNG projects in Australia, Canada and Russia beating Abadi’s current timeline, Abadi will have a tougher fight for market share when it starts operations. The demand will be there, but the huge rise in the level of supplies will dilute potential profits.
It is a risk worth taking, at least according to Inpex and its partner Shell, which owns the remaining 35% of the Abadi gas field. But development of Abadi will be more important to Indonesia. Faced with a challenging natural gas environment – output from the Bontang, Tangguh and Badak LNG plants will soon begin their decline phase, while the huge potential of the East Natuna gas field is complicated by its composition of sour gas – Indonesia sees Abadi as a way of getting its gas ship back on track. Abadi is one of Indonesia’s few remaining large natural gas discoveries with a high potential commercialisation opportunities. The new agreement with Inpex extends the firm’s licence to operate the Masela field by 27 years to 2055 with the 150 mscf pipeline and the onshore plant expected to be completed by 2027. It might be too late by then to reverse Indonesia’s chronic natural gas and LNG production decline, but to Indonesia, at least some progress is better than none.
The Abadi LNG Project:
Headline crude prices for the week beginning 10 June 2019 – Brent: US$62/b; WTI: US$53/b
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