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Photo: Bloomberg
Photo: Bloomberg

Opec’s Vienna failure was always on the cards

Even a production cap deal couldn't have addressed the long-term problems

Times have changed for the Organization of Petroleum Exporting Countries (Opec). A few years ago, one of its biannual meetings in Vienna would have been an exhibition of geoeconomic power, dictating to markets around the world. Its latest iteration on Thursday was a more muted affair—and one that failed to agree on a production cap or take any other step to resolve Opec’s long-term woes.

On the face of it, oil prices seem to be stabilizing. They have recovered over 80% from their January nadir to nudge the $50 per barrel mark. The crude glut is easing and a combination of both those factors eases some of the pressure on Opec members. But underlying realities are not quite so kind.

The recent drawdown in supply is due to exogenous factors such as the wildfires in Canada, militant activity in Nigeria and Venezuela’s economic and political crisis. At least some of these situations will evolve and change; as Venezuelan energy minister Eulogia Del Pino has said, more than three billion barrels are currently out of the market because of such factors. When they return, so will the uncertainty. Then there is the fact that Iran, which has refused to entertain the idea of a production cap, is not yet at full capacity. And it has given every indication that it means to keep going until it hits pre-sanction levels.

The supply-demand mismatch is primarily the result of three factors. The first is the US shale oil boom. There’s no putting that genie back in the bottle. Much of the price fall has been a deliberate move by Opec’s strongest member, Saudi Arabia, to combat the US suppliers—deliberately pushing supply to price marginal producers out. This has worked to an extent. By some estimates, as many as 77% of US producers have been hit hard. According to several analysts, the recent oil rally could, in fact, have been spurred by expectations of a further tightening in North American production levels.

But such tightening, if it happens, is likely to be temporary. The US majors are still hanging in there—and the fundamental law of supply and demand dictates that if prices hit a certain level, American shale companies will boost output again. Nor is that level likely to be in the region of past peaks. Some US producers have already indicated that $50 a barrel is good enough to entice them.

The second factor is the geostrategic and economic rifts within Opec. The Saudi Arabia-Iran rivalry is shaping Opec’s outlook in an entirely unhealthy fashion. To upend Carl von Clausewitz’s aphorism, the countries’ oil policies are merely the continuation of war by other means. From Yemen to Syria, they are locked in a proxy battle for influence in West Asia. Their clash over oil production is a corollary of the shooting war and the reason Riyadh scuppered a likely deal on an oil production freeze back in April. That rivalry is going nowhere.

The economic cleavages are almost as disruptive. Saudi Arabia is feeling the pain of low oil prices to an extent. April was the 15th straight month in which its net foreign assets fell, hitting their lowest level in four years; the budget deficit is rising as well. But its economic strength allows it to take the punches and play a long-term game. Not so the weaker countries in Opec such as Venezuela and Nigeria. The cumulative effect of these differences is to rob Opec of cohesion—and consequently, the ability to deliver coordinated policies. And that, in turn, means a lower chance of working effectively to push up prices.

The third factor—poor economic growth and therefore lacklustre demand globally—is the only area where there is some relief for Opec. The International Energy Agency’s Oil Market Report released last month said that world oil demand had risen by 1.4 million bpd in 2016’s first quarter compared to the same period last year. It also expects the supply-demand mismatch to narrow to 200,000 bpd in the year’s latter half compared to 1.3 million bpd in the first half.

But it has also noted headwinds—and the fact that demand is concentrated in a handful of pockets such as the US and India isn’t helping matters. A broader pickup in demand across Europe, Asia and Latin America is required for a sustainable balance. There is no telling when that will happen with the latter’s political travails and major European and Asian economies caught in a loop where higher oil prices would help deliver the inflation needed for growth, but growth and the subsequent rise in demand are required for higher oil prices.

All of this means that the odds were always against the Vienna meeting being successful at addressing the real problems. And that raises the question: If it fails to deliver what its members need, how long can it continue to stay relevant?

Are oil prices likely to rise or remain low? Tell us at views@livemint.com

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