THE BLOG

How OPEC'S Production Cut Will Impact The World And The Cartel

03/10/2016 3:51 PM IST | Updated 04/10/2016 8:20 AM IST
NEW! HIGHLIGHT AND SHARE
Highlight text to share via Facebook and Twitter
Ramzi Boudina / Reuters

For the first time in eight years, the Organization of the Petroleum Exporting Countries (OPEC) decided to cut oil production, resulting in an increase of about 8% in crude oil prices. The decision to cut production was made on 28 September 2016 at the International Energy Forum meeting of OPEC held at Algeria where the 27-member cartel have agreed to limit their cumulative oil production between 32.5 million barrels per day (b/d) and 33 b/d starting November. This reflects a production cut of about $240,000 from the production level of 33.24 per day in August this year, and eventually amounts to cutting 70,000 barrels per day. The share of production cut for each country will be defined by OPEC in their next meeting to be held Vienna by the end of November. As the oil producers get ready to encash the higher price for their output, import-dependent countries are concerned about an economic shock in the making due to the higher oil bill. While it is too early to predict a clear trend of the price fluctuation, a possible sustained production cut or price rise appear highly unlikely.

Though the production cut strategy has the potential to increase oil price it can have varying levels of adverse economic impacts on smaller producing countries...

After the continuous fall of oil price for the past several years, many experts have begun to believe that a rise in global oil price is nearly impossible unless there's a sudden geopolitical turbulence in the Persian Gulf area or a natural disaster in any of the major oil-producing regions. A visible lack of unity among OPEC members in deciding about production levels was often cited by experts as a perennial stumbling block. Saudi Arabia, being a leading oil producer, has always enjoyed an upper hand in shaping the cartel's decision. Several times in the past, Saudi Arabia has made it clear that it is not interested in any production cut as part of its strategy to keep the high-cost oil producers away from the global market. Iran too had objected to any production cut with the argument that it should at least be allowed to revive its economy from the impact of long-term economic sanctions.

With the decision to cut production sending a clear signal of rise in energy prices worldwide, four questions remain unanswered. First, can OPEC continue to influence the global energy market and price trajectory in the year ahead? Second, what will be the immediate and long-term implications on import-dependent countries? Third, does this new trend indicate the birth of a collaboration between OPEC members and lead the way to a new polarization in the energy market? Fourth, what major changes is the global energy landscape set to face in the backdrop of the oil cut announcement?

British Petroleum estimates that roughly 56% of the total commercially traded primary fuels in the world in 2015 were petroleum fuels—i.e. oil and gas. Oil constituted about 33% of the primary energy consumption of which 40% comes from OPEC. The Energy Information Administration (EIA) of the US Department of Energy estimates that OPEC is responsible for about 60% of the total petroleum traded in the global energy market and has an undeniable role in deciding the oil price. Current estimates by OPEC show that more than 80% of the proven oil reserves in the world are with its member countries. In this backdrop it is important to note that OPEC has the potential to continue to drive the price trend.

An 8% rise in the oil price indicates that import-dependent countries will have to face a higher oil bill in the immediate future.

As the past several years' decision to keep the oil production flat has proven economically damaging for many OPEC countries, the recent decision for production cut undeniably builds greater collaboration among each member country. However, there can be hurdles further in the future. First of all, though the production cut strategy has the potential to increase oil price it can have varying levels of adverse economic impacts on smaller producing countries within the cartel. Iran has been insistent that it should be allowed to produce a minimum of 4 million b/d of oil. It considers this level of production as vital for its economic revival and may not welcome a sustained production cut. Moreover, countries with smaller production capacities and share of reserves will feel more threatened by this decision than bigger players such as Saudi Arabia. The smaller oil producing countries that are heavily dependent on oil price for revenue are also set to suffer with longer term sustained production cut.

Irrespective of whether the member countries will be able to continue with a production cut or not, an 8% rise in the oil price indicates that import-dependent countries will have to face a higher oil bill in the immediate future. India, for example, has been benefiting from low oil price for the past few years and has been importing more in the recent past. The Energy Statistics-2016 of the Central Statistics Office notes that more than 70% of crude oil requirements are being met by imports in India. Lower oil price has also been a boon for the current government which has felt confident in planning greater economic activities. The domestic economy may face serious challenges if the price surges beyond a certain point. Prominent economist and BJP MP Subramanian Swamy, for example, has opined that a price above $60 per barrel could set off a crisis for India's economy.

Losing market and losing the confidence of the international community are what OPEC should be concerned about rather than attempting to control the global economy.

OPEC's oil cut announcement could be a critical turning point for the energy industry worldwide. Many of the large-scale energy exploration projects that have been temporarily shelved due to lower oil price may revive soon. Experts have noted that by the first quarter of this year the operating oil rig count in the US alone plunged sharply from that of mid-2014. It has also been posited that sustained low oil price can be detrimental to the US oil industry. The price rise that has been witnessed as an immediate effect of the OPEC decision will undeniably give a new lease of life to these industry players, especially the fracking industry. It will also turn out to be advantageous for the alternative energy sector worldwide. Solar and wind industry that have been witnessing a positive growth owing to climate concerns will also set to gain remarkably from the price fluctuation. Ultimately, though, OPEC's decision could in the long run adversely affect the cartel. Losing market and losing the confidence of the international community are what OPEC should be concerned about rather than attempting to control the global economy.

Memento Mori by Pablo Bartholomew

More On This Topic