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Defensive OPEC alliance has 'no clear endgame' in an era of abundant supply, expert says

Key Points
  • OPEC announced Tuesday that it and its non-member allies including Russia would extend oil production cuts of around 1.2 million barrels per day, until March 2020.
  • The alliance between OPEC's 14 member countries, and 10 other non-OPEC producers, is known as OPEC +.
  • OPEC+ is facing competition from U.S. shale oil producers.
Saudi Arabia's Energy Minister Khaled al-Falih (L) talks to the press on the sidelines of the 176th meeting of the Organization of the Petroleum Exporting Countries (OPEC) conference and the 6th meeting of the OPEC and non-OPEC countries on July 1, 2019 in Vienna, Austria.
JOE KLAMAR | AFP | Getty Images

There's only so much that OPEC and its oil-producing allies can actually do in a world filled with "factors beyond their control," Citi's Global Head of Commodities Research Ed Morse told CNBC.

The U.S. trade war with China and the resultant slowing global economy, sanctions on Iran's oil sector and political turmoil in Venezuela and Libya, are all combining to destabilize crude markets. And these factors that are decisive in the direction of the oil price, are largely beyond OPEC's control.

"What continues to drive the OPEC+ countries is their vulnerability to low prices and less-than-adequate revenues. Their actions are largely defensive," Morse told CNBC Tuesday.

"The countries involved have no clear endgame other than to push back the inevitable time in which the age of supply abundance can no longer be held back."

OPEC announced Tuesday that it and its non-member allies including Russia would extend oil production cuts of around 1.2 million barrels per day, until March 2020. The alliance between OPEC's 14 member countries, and 10 other non-OPEC producers, is known as OPEC +.

The group agreed in late 2016 to cut their production in order to stabilize oil prices that had plunged from a high of $114 a barrel in June 2014 to a low of around $26 a barrel in early 2016, due to rising supply (largely as a result of U.S. shale oil production) and lackluster demand.

The sharp drop in price caused problems for many OPEC producers reliant on oil exports for much of their government revenues. Citi's Morse noted that OPEC+ countries largely need a price above $70 or $80 per barrel to balance their budgets.

He said price stability was being affected by factors including poor governance in key producing countries in Latin America (Venezuela, for instance) and North and West Africa (Algeria, Libya and Nigeria, for example) and the increased use of sanctions by the U.S. as it becomes an oil-producing giant itself. "The factors are all beyond OPEC's control," Morse noted.

Joker in the pack

The strategy to restrict supply by OPEC+, which aimed collectively to cut production by around 1.8 million barrel a day (m/bpd) in the early days of their alliance, was hailed as a success and oil prices increased over 2017 and 2018. Prices dipped in late 2018, however, as concerns of an oversupply took hold amid rising inventories in the U.S.

In addition, President Donald Trump's tariff war with China began to impact global growth and the demand outlook for oil started to look more uncertain. Even the U.S.' re-imposition of sanctions on OPEC member Iran in November, and political turmoil in Venezuela, failed to boost prices.

U.S. shale is the joker in the pack for OPEC and its allies. While producers in the U.S. were also badly hit with the price plunge, many have re-ignited production as OPEC+'s strategy to curb supply helped boost prices.

OPEC Secretary General Mohammad Barkindo told CNBC Tuesday that "we are faced with a surge of supply from non-OPEC, in particular the United States in the shale basins, but it's also positive in the sense that we have to ensure that there's ample supply." "But we have also started seeing stocks beginning to build up both in the U.S. and globally," he told CNBC's Dan Murphy in Vienna where OPEC+ met earlier this week.

Citi's Morse noted that the "most significant change" in oil market dynamics has been the impact of unconventional shale oil, adding OPEC+ countries hoped for the so-called "shale revolution" to end.

The prospect of that is unlikely — the U.S. has become the largest crude oil producer in the world, having overtaken Russia and Saudi Arabia in the latter half of 2018, according to data from the U.S. Energy Information Administration.

"They (OPEC+) instead hope for the shale and deep water supply revolutions to end and reverse course, for oil demand to start growing again at much higher levels," Morse said.

"So far, despite actions taken since 2014 the unconventional revolution has instead ushered in an age of supply abundance that looks to span decades ahead, unless climate change policy regulations chokes it off."

On Wednesday, Brent crude futures were trading around $62 per barrel; while U.S. crude stood around the mid-$56 level.