OPEC Split May Threaten Oil Market Management

By Richard Johnson

Although there have been no serious threats to global supplies since the Arab uprisings started more than one year ago, a new study predicts that oil prices will remain volatile as political developments combine with global economic gloom, and surviving regimes spend to pacify populations.

The report titled ‘The Arab Uprisings and the International Oil Markets’ has been authored by Professor Paul Stevens who is Senior Research Fellow, Energy, Environment and Development Programme at the Chatham House, a prestigious UK think-tank.

Stevens cautions in a 16-page ‘briefing paper’:

• Physical oil markets managed the loss of Libyan crude exports well. However, in the paper markets, concerns over major Gulf Cooperation Council countries caused prices to strengthen.

• Under two long-term scenarios – ‘Business as Usual’ and ‘Democracy Develops’ – governments will seek higher production to provide more revenue. This could open the upstream to foreign investment, although democracy could create a nationalist backlash. There are also questions over whether democracies choose faster rates of depletion.

• With democracy, there will be a greater role for the private sector, with important implications for the reform of the upstream and the role of national oil companies.

• A growing Sunni-Shi’a split within OPEC may threaten the management of the oil market in the event of downward pressure on prices if the global economy reverts to recession.

• Ultimately the Arab uprisings could lead to an increase in oil supplies if depletion policies change and there is a greater role for the international oil companies.

Stevens points out that OPEC (Organization of the Petroleum Exporting Countries) has played a key role in the oil market for the last 40 years, although what that role has been is quite controversial.

OPEC’s one undoubtedly crucial function, he says, has been to rescue or protect prices from over-supply in the market. Since 1982, this has been achieved by agreeing on what the ‘call on OPEC’ might be to prevent over-supply, and then allocating that ‘call’ to members according to quotas.

But the system suffers from the poor quality of available data and from the fact there is no mechanism to detect or deter cheating on quotas. “Some failures have resulted most noticeably in 1986 and 1998,” writes Stevens, “but often when the system looks close to collapse members have stepped back from the brink, agreement has been reached and the price has been retrieved. This ability ultimately to agree a course of action and stick to it, at least for a period of time, is central to OPEC’s role,” avers Stevens.

“Traditionally, and long before the Arab uprisings, there have been divisions between OPEC members. Countries with small reserves tend to favour higher prices now, whereas those with large reserves may prefer to protect their future markets by maintaining lower prices to prevent oil-demand destruction,” notes Stevens.

“There are also divisions between pro- and anti-Western members, which have tended to replicate the division between those favouring pricing oil in dollars and those preferring an alternative currency such as the euro. Finally there is the division between countries that can easily produce more than their quotas and those struggling to meet their quotas.”

Stevens recalls that the oil price collapse of 1986 was reversed by Saudi Arabia and Iran working together, as was the 1998 collapse when King Abdullah decided good relations with Iran were more important for Saudi interests than insisting on pursuing an OPEC policy of non-cooperation with that country.

However, the recent intervention of Saudi Arabia in Bahrain has brought relations with Iran to an extremely low point, says Stevens, adding: “This is likely to last as the Arab uprisings deepen divisions between Sunni and Shi’a regimes in the region. It aggravates the already poor relationship between King Abdullah and Nouri Al Maliki’s Shi’a government in Iraq.

But at the OPEC meeting on December 14, 2011, a couple of days after a meeting in Riyadh between Saudi Arabia’s Crown Prince Naif and Iran’s Minister of Intelligence and Security, agreement was reached very quickly and with little acrimony on maintaining OPEC output at 30 million b/d, although there was no discussion of the quota distribution.

Observers noted that the Iranian delegation seemed subdued. This is not so surprising, as in the past deep divisions have been put aside when both countries faced the prospect of much lower oil prices.

“However, this situation has been further complicated by the announcement by the European Union on January 23, 2012 of an oil embargo imposed on Iranian oil imports into the EU. What the effect of this embargo might be is still to be seen. However, many are expecting Saudi Arabia to step up and replace Iranian crude. If this happens on a large scale this would certainly greatly aggravate the poor relations between Riyadh and Tehran,” writes Stevens.

Future OPEC meetings could well be like that of June 2011, he adds. Whether this matters depends upon the prospects for the development of surplus capacity to produce crude oil in a significant number of OPEC members.

“The key to this will be what happens to capacity expansion plans, but above all in the near term what happens to oil demand. The latter will be influenced by the global economic climate, which is currently extremely uncertain. The former will depend upon the equally uncertain longer-term outcome of the Arab uprisings and their impact on the depletion policy of the major exporters,” says Stevens.

Another issue that would affect OPEC in the longer term is that, says Stevens, if members move towards a greater use of markets and the private sector under a ‘democracy develops’ scenario, enthusiasm for OPEC membership may dampen.