(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON, July 16 Sooner or later OPEC members
will have to reduce output to reflect their reduced share of the
global oil market.
The organisation's members must come to terms with
diminished demand for their crude as a result of booming shale
oil production in North America and strong production growth in
several other regions.
The only real questions are how much of the burden of
cutting production will fall on Saudi Arabia and whether they
will be implemented through the framework of OPEC or
SAUDI FIRST CUT
The first cut, whenever it comes, should be fairly easy. It
will probably fall almost entirely on Saudi Arabia and its close
allies Kuwait and the United Arab Emirates. Contributions from
other OPEC members are likely to be fairly token.
The first cut would merely go some way to reverse Saudi
Arabia's increase in market share at the expense of other OPEC
members in recent years.
Saudi Arabia's share of OPEC exports has risen sharply as
the kingdom has replaced a drop in Iran's oil shipments
resulting from sanctions. Output has also fallen in Nigeria and
Libya because of production problems, security concerns and
increasing competition from North American shale producers.
Other OPEC members will expect Saudi Arabia and its close
allies to make all or most of the first round of cutbacks. The
kingdom should be able to absorb them without too much impact on
For this reason, it makes little difference whether the
first round of cuts is implemented unilaterally, through quiet
adjustments to Saudi Arabia's export volumes, or via an OPEC
The problem is that the first set of cuts is unlikely to be
the last. Future rounds will be much harder to agree upon as
members differ over how to share them out.
Competition from shale oil threatens to revive all the old
divisions over how to divide output among the organisation's
members amid declining market share for OPEC as a whole.
The Organization of the Petroleum Exporting Countries has
never managed to function as a very effective cartel in the
formal sense of a group that shares out production capacity or
Member countries have normally found it easier to agree on a
target price than on how to divide production up among
themselves. The organisation did not even set production
allocations until 1982.
In recent years, OPEC has given up trying to set allocations
altogether, instead announcing an overall production target but
no distribution among members, and even this has largely been
OPEC has been rescued from the internal squabbles about
quotas and cheating by strong growth in demand for its oil, and
a series of wars, sanctions and production problems that have
led to output declines from Iraq, Iran, Nigeria, Libya, Algeria
and Venezuela at various times over the past decade.
The past 10 years have been a golden age for those OPEC
members that could increase output - basically Saudi Arabia and
its close allies plus latterly Iraq but not Iran and most of the
African and Latin American members.
That golden age is now drawing to an end. OPEC's stronger
producers must now confront the reality of sustained declines in
demand for their output for the first time in a decade.
Oil prices are well above the levels Saudi Arabia and its
allies need to balance their national budgets, so there is
plenty of scope for them to accept some combination of lower
prices and/or lower output.
Prices are also well above the marginal cost of developing
alternative supplies. Competition for market share can therefore
only worsen while benchmark Brent and WTI prices remain above
$100 per barrel.
Elevated oil prices are continuing to send a strong signal
to consumers about the need to reduce demand, which is worsening
the predicament for OPEC.
If Brent remains above $100 per barrel, the market will
remain potentially oversupplied. OPEC's secretariat has already
warned that its forecasts, based on current supply, demand and
prices, "imply a further build in global crude inventories,
which currently stand at high levels".
Saudi Arabia and its allies thus face a difficult decision.
If they cut production and prices remain high, the market will
remain out of balance, and they could be forced to cut again
repeatedly, gradually eroding their market share, revenues and
TURNING UP THE HEAT
Saudi Arabia might try to spread the burden by marshalling
support from other OPEC members, notably Iraq, for a policy of
restricting production. But OPEC has never found it easy to
reach an output agreement until prices start to fall sharply.
If the organisation is like a tea bag because it only works
in hot water, the water has to be heated first. Prices are still
nowhere near the level that might encourage cooperation among
members or shut down surging supplies from shale formations in
It is often said that the only cure for high prices is high
prices (meaning that high prices are necessary to stimulate more
production). But it is equally true that the only cure for
oversupply is a period of lower prices to stimulate demand and
switch off the cash flow and incentives for developing
Whether OPEC decides to cut output this year or Saudi Arabia
adjusts its exports unilaterally, the first round of cutbacks is
unlikely to be the last. The policy of supporting prices will
only get harder.
(editing by Jane Baird)