This Isn’t Your Father’s OPEC Anymore

Judging from its series of consequential meetings last week in Vienna, OPEC seems to have confirmed that the rumors of its death have been greatly exaggerated. The important thing to recognize is that it also has a new identity that may reshape oil geopolitics for years to come.

Commentators have been writing OPEC’s obituary for years. Most recently, they did so in the wake of a pivotal November 2014 OPEC meeting, when oil prices cratered after Saudi Arabia decided against cutting production. Countless analysts, experts, and scholars mused that Riyadh’s hand had been forced by the rapid rise of shale oil in the United States; since shale output is much more responsive to oil price changes than conventional oil production, any attempt by OPEC to cut production and push up prices was expected to simply be offset by a rapid rise in U.S. output. “OPEC is now relinquishing its pricing power,” explained no less prominent a voice than former Federal Reserve Chair Alan Greenspan in early 2015.

But shale supply could not swing enough. Oil prices hit a low of $27 per barrel at the start of 2016. In response, OPEC member states met in November 2016 with several non-OPEC oil-producing countries (collectively called OPEC+) to make a show of force by agreeing to cut production. But again, despite the agreement to cut supply, skeptics warned that shale’s dominance, along with mistrust among OPEC and its coalition of nonmembers, would undermine the deal. One prominent commentator predicted in the Financial Times that the Algiers deal “will come to symbolize the passing of one of the world’s most powerful cartels.”

Just two years after trying to put a floor under prices, OPEC+ last week was called on to put a ceiling on prices. As oil spiked above $80 per barrel following U.S. President Donald Trump’s announcement that he would reimpose sanctions on Iran oil sales, the United States along with other consuming countries like India and China publicly and privately pressured OPEC+ to open the taps back up. High prices have done more than agitate President Trump on Twitter; protests have broken out in China, Brazil, and Jordan in recent weeks over high pump prices, exacerbated by a strong U.S. dollar that makes prices even higher in local currencies. High oil prices can also be just as much of a concern as low oil prices for producer countries because they curb demand, give momentum to substitutes like electric vehicles, and encourage development of high-cost resources like Arctic and ultra-deepwater oil. (Indeed, it was a prolonged period of high oil and gas prices that gave rise to the shale boom in the United States.)

Part of the rise in prices owes to OPEC’s oil production falling far more since November 2016 than producers pledged in their agreement, largely because of involuntary production cuts from Venezuela. This 147 percent “overcompliance” offered OPEC+ an elegant solution to ease the pressure on prices without undermining its production agreement. OPEC and its partner countries thus pledged last week to return to 100 percent compliance with the original 2016 cuts.

The problem with promising to increase supply by returning to 100 percent compliance with the original cuts is that only Saudi Arabia, Russia, Kuwait and the United Arab Emirates have the ability to increase production. If the volume of overcompliance were shared among producers proportionally, that would imply an increase of about 600,000 barrels per day. If the production increase were allocated entirely to those able to boost output, so that the total volume of excess cuts were brought back to the market, that would imply a production increase of about 1 million barrels per day. That difference can have an outsized impact on price. In its press conference, OPEC refused to officially clarify, with different countries offering different interpretations to reflect their own concerns and interests. Despite the ambiguity, OPEC reasserted its relevance in Vienna through its willingness to cap prices, underscoring its reputation as a responsible supplier to the market. In his remarks in Vienna, for example, al-Falih emphasized the importance of protecting consumers.

But, even as OPEC reasserts its traditional role, the organization has been reincarnated in new form.

First, Saudi Arabia’s role in the organization is bigger than ever. The price-capping decision in Vienna was effectively taken by Saudi Arabia, not OPEC. Only Saudi Arabia has any meaningful amount of spare capacity because it is the only country that chooses, at a cost to itself, to produce significantly less than it otherwise could. Iran understandably opposes a production hike, viewing efforts to curb high oil prices as facilitating President Trump’s aggressive foreign policy toward Tehran. But Iran had little choice but to go along with Saudi Arabia’s preferred outcome.

Even as Iranian Petroleum Minister Bijan Zanganeh downplayed how much oil would be coming back to the market, his Saudi counterpart said he would do “whatever is necessary” to keep the market well-supplied and that an additional 1 million barrels per day would come to the market. Moreover, by interpreting the agreement to mean total output, rather than output by individual countries, would comply with the November 2016 deal, Falih gave himself the flexibility to increase output further if needed to cap prices. Importantly, Russian Energy Minister Alexander Novak said he was fully aligned with Falih.

That brings us to the second major change in OPEC: Its second-most important player, after Saudi Arabia, is now Russia, despite not being an official member of OPEC at all. Last week’s OPEC deal reaffirmed the newfound role of Russia, the world’s largest crude oil producer, in managing world oil prices with Saudi Arabia. Falih even told the press that Russia was considering joining OPEC as an associate member, and both Saudi Arabia and Russia took pains to signal that the close working relationship they have forged on oil policy would persist.

This new alliance between Saudi Arabia and Russia in managing world oil markets marks an important shift. While OPEC represented half of world oil production throughout the 1970s, its share of global supply declined below one-third in the 1980s, and now accounts for just over 40 percent. Effective market management thus requires bringing more global producers into the cooperation framework. Deepening and possibly formalizing the Saudi-Russian oil alliance marks a potentially historic shift for OPEC, as past attempts to cooperate with Russia have consistently failed. Indeed, in his 2016 memoir, former Saudi Oil Minister Ali al-Naimi wrote that he thought there was “zero” chance that countries outside the group, notably Russia, would join production cuts.

Russia’s new role in managing global oil prices gives President Vladimir Putin another prominent platform on the global stage and strengthens his hand in diplomatic engagements with large oil-consuming countries, including the United States. For decades, the oil price has been central to the U.S. relationship with Saudi Arabia: presidents of both political parties, going back decades, have requested at various times that the kingdom provide relief on oil prices, and the kingdom’s ability and willingness to oblige has been a key point of leverage in its diplomatic relationship with the United States. Riyadh’s current refusal to curb output alone and the creation of a new cooperation framework with Russia means Moscow may have an increasingly important voice in years to come in oil price management. That would mark a new point of influence for Moscow in its strained relationship with Washington.

This brings us to the third major message from last week’s OPEC meeting, that America’s shale energy boom hasn’t increased U.S. influence over global oil markets. Indeed, what was striking about the OPEC+ agreement is that the United States needed OPEC and non-OPEC countries to do it all. Despite talk of peak oil demand and U.S. “energy dominance,” the direct impact of last week’s deal on U.S. gasoline prices is a reminder that oil remains a geopolitical vulnerability for the United States and that talk of its “energy dominance” has been overhyped.

Despite surging U.S. oil production and plunging imports, pump prices are still determined by the global oil price. The mistake some commentators have made is in assuming the U.S. oil market would be able to have an outsized say about that global price, because U.S. shale oil production is more responsive to price changes than conventional oil supply; many prominent analysts proclaimed shale the new global “swing producer.” Yet recent experience — not to mention that the United States needed to ask OPEC to keep a lid on oil prices last week at all — has revealed that shale oil is not an elastic source of “swing supply” that can balance the world market.

U.S. monthly crude oil production is up by 2 million barrels over the past two years, but shale still takes time to ramp up and down. Shale output reflects the decisions of thousands of private firms, and its flexibility is likely is to decline as the sector consolidates among larger companies with stronger balance sheets. Additionally, shale output is constrained for some time by pipeline congestion, along with shortages of workers and equipment, which is already forcing U.S. oil to trade at a steeper discount to the global price of crude.

American consumers are still vulnerable to oil supply disruptions anywhere in the world regardless of how much or how little oil their country imports. Oil thus remains a key geopolitical consideration for U.S. foreign policy, despite America’s nearing the point where it will be oil “independent” on a net basis. Consider how President Trump had to ask Saudi Arabia to boost supply so that the United States could curtail Iranian oil sales without hurting U.S. consumers. Or that while President Trump would like OPEC countries to lower gasoline prices, OPEC countries would also like President Trump to block the legislation moving through Congress that would allow antitrust action to be brought against OPEC. The NOPEC bill, as it’s known, has been introduced in years past.

To be sure, although OPEC reasserted its relevance in Vienna, it also revealed its limitations. A deal to keep current prices in check is a far cry from the ability to truly be a source of swing supply and provide market stability. An output hike would leave OPEC with a very small buffer of spare capacity, so there is a limit to what OPEC can do to keep prices from spiking if Venezuelan production plummets, Iranian sanctions bite, or countries like Libya and Nigeria see further unrest. This is the dynamic that played out in the boom years prior to the 2008 peak, and OPEC lacked the ability, even if it had wanted to, to rein in prices when oil prices then ran up to $147 per barrel. That’s just one of several reasons the United States should maintain its strategic oil stockpile notwithstanding its reduced import dependence.

Since the 1973 Arab oil embargo, the United States has complained about OPEC’s manipulation of oil prices even though its true willingness and ability to do so has been far more limited. The decision last week to provide oil price relief, reflecting newfound oil policy partnership between Saudi Arabia and Russia, marks a potential turning point in the global oil order and a reminder that despite the shale boom or a possible energy transition, oil geopolitics is alive and well.