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Will OPEC cut oil production?

A 25% slump in oil prices has led to speculation that the oil cartel OPEC will reduce production when it meets on 27 November, which would shore up prices and benefit the group’s member states and other oil exporting countries.

Whatever OPEC chooses to do, the impact will be felt around the world. Net oil importers such as India and China are benefiting greatly from the slump, but a recovering price would be good news to producers like Russia and Kazakhstan. Russia’s hydrocarbons sector has been boosted by a $400bn gas deal with China signed in May, and higher oil prices could encourage more investment and higher spending on projects, including in the growing Russian Arctic exploration sector where there is an estimated 225bn boe of oil and gas resources.

There are strong arguments for either course of action – but which is more likely? With the International Energy Agency predicting that low oil prices could continue into 2015, will OPEC scale back its output to defend prices?


Yes

Each member of OPEC has a minimum oil price that it needs in order to balance the books and fund public spending, and the price drop has caught a lot of them out. Of the OPEC members, Venezuela and Nigeria need oil prices of $121 and $119 per barrel respectively to make production viable, while the Algerian, Libyan, Iraqi and Ecuadorean budgets are all calculated on oil prices staying north of $100 per barrel. Even Saudi Arabia, which has been the main driver behind OPEC’s refusal to cut production thus far, needs $91 per barrel, a price well above current levels.

While the enormous Saudi foreign currency reserves ($750bn as of this September) should be able to withstand a sustained low price, other members would be in a more difficult position – Venezuela, for example, has been predicted by economist Alejandro Grisanti to suffer a $16bn cash flow reduction if oil prices stay down. The longer prices remain low, the more pressure the budgets and economies of these countries will come under, and the more likely OPEC would be to act.

OPEC’s refusal to defend the oil price so far could be a tactic to make US unconventional production (where operating costs are high) unprofitable, but this shale and tar sands industry would not grind to a halt overnight. Research by BNP Paribas suggests that it could take up to a year of low prices to force US shale producers to pack up their equipment, and while the Saudis have the reserves and market share to withstand this, can the same be said for the rest of OPEC?


No

There are also several factors that might dissuade OPEC from a production cut. Saudi Arabia may have learnt from the mistakes it made in the 1980s, when a 60% slump in crude prices led to the kingdom reducing its output from 10 million barrels a day in 1980 to fewer than 2.5 million by 1985. However, other producers failed to follow suit, which led to a sustained slump and years of Saudi budget deficits that only turned the corner when Riyadh switched tactics and boosted output.

As analyst Yasser Elguindi of Medley Global Advisors explained: "The big mistake was that they continued to cut production to try to prop the prices and the price fell anyway. They should have fought for market share, allowing higher cost producers to shut in as the price fell." With this experience fresh in the memory, Saudi Arabia may well encourage other OPEC members to let the market find its floor and tolerate lower prices.

There are good reasons for other OPEC members to resist a cut in production. While Algeria, Libya and Iran need high oil prices to fund public spending, the UAE’s budget is calculated on an oil price of $73, and Kuwait only needs to fetch $53 a barrel to break even. Combined with a desire to protect market share in a time of weakened global demand, this could see OPEC maintain production until low prices wipe out the margins of US shale players and force them from the market.


Related Events

Event16 May

OGU Conference 2..

16-17 May, 2018
UZBEKISTAN

TASHKENT, UZBEKISTAN
Venue: UZEXPOCENTRE

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