Samuel Johnson on OPEC

Samuel Johnson and then Oscar Wilde observed that second marriages are a triumph of hope over experience. That observation can also be applied to OPEC agreements to cut production.

The history of OPEC agreements on production quotas is that they haven’t lasted much longer than it took for the ink on them to dry. The reason is quite simple. As long as member nations have spare production capacity, they have a strong financial incentive to cheat. Saudi Arabia in the past has been the swing producer and its reductions in production have been offset by other members cheating and increasing theirs. As long as demand exceeds supply and some OPEC member can increase its production, that will continue to be the case.

Earlier this week, oil markets firmed up for a brief time when it was reported that OPEC had reached an agreement to reduce production from around 33.2 million barrels a day. Then reality set in and markets slipped back down.

Agreeing that production should be reduced is different from agreeing on  the size of a reduction and how it will be allocated. It is highly unlikely that Saudi Arabia will agree to a reduction as long as Iran is pushing to increase its production to at least 4 million barrels a day. The Wall Street Journal recently reported that Iran’s “ability to reach pre-sanction levels above four million barrels a day is now in question. Iran has been pumping 3.85 million barrels a day.” but IEA has reported that Iranian production had slipped back to 3.6 million barrels a day.  What Iran can do in the near term is not at all clear.

There also have been reports that with Libya and Nigeria production recovering, actual OPEC production could be 1 million barrels above the suggested range of 32.5 to 33 million barrels.

So, where will cuts come from and how will they be enforced? Those two questions have bedeviled past agreements and in the end OPEC agreements have turned out to be triumphs of hope.   In the current situation, it appears that most members are producing at or near capacity, so the ability to cheat this time may be constrained, unless Libya and Nigeria can substantially increase theirs. In addition,the proposed reduction is not large–2% at most–, so it is unclear how much impact it would have on price?  In reality, the impact is likely to be small at best.

What is different today is US production, enhanced by “fracking” and horizontal drilling. Shale oil producers have been able to withstand the price reduction better than had been estimated, so any reduction by OPEC will be offset by increased domestic production.

This time hope will triumph and the US economy benefits if it is.

Author: billo38@icloud.com

Founder and president of Solutions Consulting which focuses on public policy issues, strategic planning, and strategic communications.

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