Happy Belated Birthday OPEC?

Yesterday was OPEC’s 50th birthday.  The occasion is being met with celebration in Vienna, the host of the OPEC secretariat, and in OPEC capital cities (see FT beyond BRICS for more).  Production still remains well below the 2008 peak, or even the average of 2006-8 (despite oil averaging around US$75 per barrel for most of the last year), but was inching up until mid-year and is currently at a price level where all but OPEC’s overspenders can balance their budgets.  All in all, assume status quo of unchanged production at OPEC’s next meeting in October, as the prospects for oil demand growth cool along with the global economy. In the longer-term demand, particularly from EM Asia (and oil exporters themselves), should keep prices high.

Ahead of the celebration, OPEC released a series of 50thbirthday achievements which deserve some further scrutiny given that OPEC’s role in the global oil market is likely only to become more significant in the next 50 years.  Despite new techniques, that make unconventional oil extractable at a cost, OPEC still accounts for the lion’s share of global oil reserves and future production growth. And other countries, like Russia and Kazakhstan that, like OPEC want an oil price above US$70 per barrel or like Brazil and Canada whose costly supplies require a high price, account for a lot of the rest.

Of the achievements, most interesting is the last – support for national oil companies, which have blossomed in the half decade of OPEC’s existence, both within and outside the cartel. Many non-OPEC members like Brazil, Russia, China and Norway have active national oil companies, which have become major international players, albeit with very different management practices.  How these companies are managed makes a big difference for the global economy as they are increasingly investing far beyond home markets, setting up partnerships with international oil companies and with other NOCs.  Some continue to struggle given their role as major financing vehicle for local governments, but most are trying to undergo rapid transitions.

There are several challenges lurking for OPEC members though:

1)      Maturing fields with few new large finds in recent years

Moreover, most OPEC members official reserves estimates have remained constant for over a decade, even as production has been strong, meaning that leaders, like Saudi Arabia have to convince the world, that their reserves are still as large as they claim.

2)      Reliance on a higher and higher oil price to balance budgets and pay for imports

Calculating fiscal break-even costs for OPEC members is notoriously difficult, given opacity of production cost structure and the transfer between national oil companies and the domestic government.

3)      Rising production costs

OPEC countries have not been immune to rising global costs of production. With few new large oil discoveries in recent decades, continuing to extract oil from aging fields requires new techniques, and often scarce water or natural gas for oil recovery.  (hence the Saudi interest in unconventional gas). Meanwhile broader commodity price inflation has raised the cost of oil extraction.

4)      Domestic Subsidies are reducing net exports

OPEC members tend to heavily subsidize domestic fuel, often as part of a domestic bargain that keeps the population from questioning the lack of democratic freedoms in many members. These subsidies distort prices, as they encourage overuse. In some cases (Iran, Nigeria) OPEC members have been forced to import costly fuel to meet these needs given their lack of refining capacity (to some extent some of these pressures are being eased).  Others, while oil-rich are naturally gas poor and are forced to import natural gas to meet power needs to meet domestic economic diversification goals.

5)      Supply chokepointsRising tensions between Iran and its GCC neighbors, particularly Saudi Arabia

With much of the world’s oil transiting through the straits of Hormuz, a blockage (temporary, most likely) remains a risk. Moreover, oil cargoes, like other shipping, remain vulnerable to pirates and transit     chokepoints. For now piracy attacks off the Gulf of Aden have subsided as international forces have increased their efforts, but the higher shipping costs are there for the future. (Not to mention the increasing role of financial markets in driving the oil price (which some of my RGE strategy colleagues have been touching on of late.)

One of the biggest tests for OPEC will come from Iraq. The country, a founding member, is not currently bound by OPEC production limits, but should even the more bearish estimates of potential oil output growth come to pass, it could rival some of the largest oil producers.   RGE continues to be skeptical about Iraq’s production in the near term given the political stalemate and the risks of delayed infrastructure projects. In the mid-term, it should climb.  Iraq’s balance sheet implies that it may like other OPEC members prioritize a high oil price rather than high oil production (See more in our Iraq outlook due out next week).

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3 Responses to "Happy Belated Birthday OPEC?"

  1. 3028516   May 30, 2011 at 2:03 pm

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