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Energy Update: OPEC oil cartel decides not to change quota

Good news and bad news for OPEC

The Saudi strategy of lowering oil prices to regain market dominance appears to be on the road to success in 2016, though fissures are emerging within OPEC

Yesterday the OPEC oil cartel decided not to make meaningful change to its current production quota levels. The only interesting development coming out of the meeting was the return of former OPEC member Indonesia. While no production target was officially announced at the meeting, OPEC’s current 31 million production quota level (which has seen some minor, unofficial, increase over the last few months) will now be increased to around 31.9 million barrels, to include Indonesia’s production of 890,000 bpd. The oil market reacted slightly negatively, leading to a further erosion of crude oil prices at the WTI and Brent markets.

Some analysts are heralding this as the end of OPEC’s market dominance. The analysis is based on the fact that Saudi Arabia’s strategy of increasing production to regain market share (and quell the growing power of non-OPEC producers) has not yet achieved its goal and has in the meantime exacted great damage on the economies of OPEC members.

Saudi strategy on path to success

But this analysis is overly simplistic. While new production markets are indeed suffering, especially the US shale, Canadian tar sands, Artic and North Sea producers, most of the financial pain, (especially for US shale producers), has been mitigated up to now by a combination of technical development (which has dramatically reduced overall production costs) and financial instruments such as hedging.

However, technical innovation and financial tools can no longer stave off the inevitable, and US shale operators have been hit by tens of billions of dollars of write offs and deficits. At the same time, other producing regions, such as Europe’s main oil producing region, the North Sea, have witnessed a dramatic reduction in investment, production volumes and concomitant large workforce lay-offs. Overall production across all regions is expected to reduce through 2016. Large volumes of crude oil will thus be removed from the world market. West Africa’s deep water producing regions, such as Angola, are also expected see a near term reduction in production.


No discussion of the world oil market would be complete, however, without mentioning two remarkable markets – Russia and Iraq.


Vladimir Putin’s Russian economy, which is being hit by US-EU economic sanctions, is not only simply surviving. Indeed, Russia’s crude oil production levels are at almost record highs. Many have predicted the demise of the Russian economy, yet the Kremlin is managing to keep it afloat. Putin’s success has been based on the vast financial reserves held in Russia’s sovereign wealth funds, the fact that domestic demand for energy is still increasing and (mostly unrecognized by analysts and the international media), that oil and petroleum products are still highly competitive inside Russia due to the immensely positive effect generated by the lowering of the Ruble exchange rate.


Iraq also has been a bright light on the horizon, if one only looks at production levels. Instead of being unable to increase its production overall, Baghdad has been able to raise levels from around 3.2 million bpd in 2014 to above 4.1 million bpd in 2015. This optimism should however be tempered. Iraq is facing a financial crisis. And, at the same time, operators are increasingly reluctant to invest in upstream-midstream operations in Iraq due to delays in payments, political chaos, and the military campaign against the Islamic State. Hence, further production increases in 2016 look unlikely.

Tipping point 2016

Saudi Arabia’s strategy, which is fully supported by several other GCC member countries, mainly the UAE, Kuwait and Qatar, seems to be heading towards a climax in 2016. 2016 will be the year in which OPEC will regain its market dominance (leaving non-OPEC to pick up the pieces), or oil the oil industry will have to face the prospect of long term low prices.

There are signs, however, that the Saudi strategy might be working. US production overall is flattening out, Canadian oil sands producers are looking comatose and North Sea production (one of the most expensive in the world) is facing an almost unprecedented financial crisis.

At the same time, global demand for crude oil (and derivative products) is increasing. Even during the financial crisis of the last few years, demand increased, albeit sometimes slower than predicted. The International Energy Agency (IEA) in Paris, the watchdog of the OECD countries, and OPEC, both expect increased calls on OPEC crude. We believe that total demand growth will be somewhere between 1.1-1.3 million bpd in 2016. Traders, hedge funds and pension funds, and investors are already showing a tendency to expect higher oil prices. The amounts invested in ‘long’ have increased tremendously, even though prices are still showing slightly negative sentiments.

With over US$200 billion in investments being put on ice in 2015, shortages in production are inevitable. The industry is already slowing, but 2016 will be clearly a watershed year during which increasing demand will meet decreasing production and increased OPEC market dominance. With low oil prices at present, most operators and service companies will continue to decrease their investment budgets, leaving no room for growth in production for the next couple of years. OPEC countries, such as Saudi Arabia, UAE and Qatar, will be the main beneficiaries, as their investment levels have been kept almost at the historic levels.

Hence, in the near future, we expect the Saudi strategy of squeezing the more expensive producers may start to pay off. We expect the tipping point to be around Q4 2016.

OPEC’s internal tensions

Things look positive for OPEC, when you look at it from the perspective of market share, but there could be a major conflict brewing under the surface. Since the end of the 1990s, especially since the 2nd Heads of State Meeting of OPEC in Riyadh, a major fault line has been growing between the so-called Iranian block (Iran, Venezuela, Ecuador) and the Saudi block (Arab countries and Nigeria). Both sides have different strategic targets: Saudi Arabia wants to increase the power and market share of OPEC, while Iran and its supporters need higher prices to sustain their own economies and political goals. The indecisive approach of OPEC in Vienna has shown us again that the oil cartel is not a single block. There was no change in policy in Vienna because no party was willing to budge, not because there was consensus on policy. If Saudi Arabia wants to continue its current course (which we believe it is able to maintain for at least another 24 months), it could potentially face a situation in which Iran (and its supporters) break OPEC unity and line up with Russia. Moscow is already on a confrontation course with Riyadh, as Russia aims to increase its market share while also increasing oil and gas revenues at the same time. And the increasing Russian-Iranian coordination on military and political issues in Syria, could lead indirectly to new conflicts inside OPEC. Iran does not want Saudi Arabia to lead the cartel and thus ensure that Iran is not allowed to increase its export volumes.


Global economic growth could prevent the internal OPEC conflict reaching a head if increasing demand is sufficient to give Iran some leeway inside the cartel. If not, Riyadh and Tehran could end up in a confrontation, an outcome no one wants to see. While a breakdown of internal OPEC discipline or a break up of the cartel will lead to greatly increased production and lower oil prices across the world, it will further destabilize the Middle East. Either way, 2016 will likely be the year in which will see the success of the Saudi strategy of lowering prices to regain market dominance.

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