OPEC’s Place in a Changing Oil Industry

By Michael Jones (michael.jones@tsiglobalconsulting.com)

The recent death of Saudi Arabia’s King Abdullah highlights the awkward crossroads that the Kingdom currently finds itself at. Of course, in terms of politics, the course is clear; the next in line for the throne will step up and business will likely continue as normal. However, in terms of economics, Saudi Arabia’s struggles are quite apparent – oil prices are dropping and foreign reliance on its product is following in much the same way. Other countries that make up the Organization of Petroleum Exporting Countries are starting to feel the pinch too as the international order starts to change. But, perhaps we have seen the same situation before; energy booms have happened before, and OPEC always manages to find its way back to the top somehow. Will OPEC simply have to wait out the storm, or does the current geopolitical order signal an end to this somewhat-infamous cartel? This article will look at the causes of the current shift and ask the question, does OPEC have a place in a changing oil industry?

First of all, a bit of background on why OPEC’s ground is starting to look shaky. In general, the main reason comes from the recent Shale Oil boom in the U.S. Most of my American audience will already be familiar with what this means – we can see it in our dropping gas prices. In the second half of 2014, new processes such as hydraulic fracturing gave U.S. and Canadian oil and gas companies access to previously inaccessible oil reserves along the U.S.-Canada border. By rapidly developing these new oil wells, American companies were able to step up domestic production to levels which rivaled those seen throughout OPEC countries, and as more oil flooded the market, oil and gas prices (at least in the U.S., anyways) began to plummet. Additionally, since this oil was domestically produced in the U.S., due to a combination of nationalism and xenophobia, more Americans were comfortable with purchasing it. These factors have led to the huge success (so far) of the American shale boom, and, when coupled with factors like further instability in the Middle East (where most of OPEC’s members reside) and Russia (another major oil exporter), OPEC finds itself unable to compete.

What has OPEC done to solve this problem for its members? First of all, a little background on what OPEC actually is is necessary. While officially, OPEC is an “intergovernmental organization,” in reality, it behaves more like a cartel. In this case, a cartel fixes prices by dividing the market, but this requires the members of the cartel to have full control over that market. In the past, when OPEC held the majority share, OPEC was able to limit its output in order to pursue the economic and political goals of its members – for example, during the Oil Crises of the 1970s, OPEC limited exports to the west in order to discourage their support of Israel. However, without absolute control of the market, OPEC can no longer exercise that power. As a result of the Shale Boom and resulting falling oil prices, OPEC’s response has been mixed. Some members of the group suggested limiting output in order to wrangle in markets in Europe and other regions, while others refused to budge. Ultimately, at their last meeting, the group was unable to come to a conclusion, allowing the market to dictate its prices. Functionally, this has put OPEC into a price war with the U.S. and other new oil producers – one that, so far, OPEC appears to be losing.

So what does this mean for the future of OPEC? While many in the west may hope that the shift in production towards the U.S. signals the end of OPEC’s control over the industry, the actual future of the organization is less clear. In this author’s opinion, OPEC will continue to struggle and be forced to compete as long as the U.S. continues its shale oil production. However, the key words here are “as long as”: many experts estimate that the U.S.’s shale oil supply will run dry much, much sooner than the reserves of any of OPEC’s members. Now, should the U.S. temper its production of this oil so that it will last more in the long term, OPEC could be in serious trouble, but if it stays the course (which it may have too, due to the potential economic and social expenses of long term shale oil drilling), then OPEC will likely only have to sit back and wait for the U.S. to falter.

While OPEC’s position might look like it is weakening now, perhaps a long term price war will ultimately be in its best interest: only time will tell. However, it is important to potentially plan for a contingency – should OPEC begin to fail, global business could be changed forever, and those in international business need to be prepared. If you have any questions, or want to look into doing international business yourself, feel free to give TSI Global Consulting a call at 210-757-0618 for a consultation.

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