OPEC’s Changing Role in Global Price Dynamics

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Crude oil is the most widely traded commodity in the world, primarily because it is used to create a wide portfolio of transport fuels, like gasoline, diesel, and jet fuel, and it provides critical refined products for other industries such as petrochemicals and asphalt. All of this production amounts to roughly 100 million barrels per day in the market. Due to this versatility, fluctuations in its supply and demand dynamics influence price changes across a long list of commodities and equities markets.

For this reason, an intergovernmental alliance called the Organization of the Petroleum Exporting Countries (OPEC) was formed to purposefully and strategically facilitate more balanced market prices using supply and demand as its mechanism.

 OPEC’S HISTORY OF PRICE CONTROL

The purpose of OPEC is to unify producing member policies to ensure “the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry” according to their mission. Ultimately, the group controls prices by forcing the market with economic fundamentals to secure economic and political gain.

Since its inception, OPEC has been the single largest player in the global crude oil production equation holding roughly 30 percent of the market share. Historically, when other much smaller players deviated production from the plan, the impact was muted, and markets continued to behave in close alignment to expectations. Overarchingly OPEC decisions have played a nearly independent role in driving not only the cost of crude oil and its refined products – particularly diesel and gasoline. This makes it imperative for shippers and transportation professionals tasked with managing budgets to pay attention to OPEC dynamics.

While OPEC controls oil prices as the single, consolidated source of organized players, they are now one among several other large and emerging producers that dilute their ability to move the market in a silo. Increases in U.S. and Russian crude oil production have begun to offset cuts and decisions made by OPEC. As the global crude oil landscape becomes more fragmented and diversified, the process of controlling prices is becoming more complex.

With this more diluted distribution of power taking center stage, OPEC’s thirteen member countries have added a “Plus” contingent of countries to their cause (OPEC+). The “Plus” is made up of ten additional countries that agree to help balance the market but are not required to operate under full membership terms. This addition illustrates OPEC’s need to reclaim market share by having more allies join its forces to support their ability to control prices.

INTERNATIONAL OIL MARKET SHARE IS EVOLVING

U.S. energy abundance from quickly growing domestic production has positioned them as a prominent player in the crude oil landscape. As such, the political and strategic decisions made by the U.S. create far-reaching shockwaves in crude oil dynamics. This market presence can sometimes overshadow OPEC’s decisions because they are no longer the only large player. In some cases, OPEC appears to respond to U.S. production news, rather than driving their own narrative.

Additionally, increased U.S. foreign policy—like Iranian sanctions and policy related to Venezuela—is starting to naturally cut production for OPEC. Deficits coming from Iran and Venezuela and rising tensions among member countries suppress the supply side of the equation, which eliminates the need for OPEC to force cuts among their remaining members.

WHY IS IT IMPORTANT FOR SHIPPERS TO PAY ATTENTION TO OPEC MEETINGS?

Collectively OPEC+ produces over 40 percent of the world’s crude oil, so any decisions made by these exporters continue to impact global commodities and equities markets. Saudi Arabia and Russia anchor this group, accounting for just under half of OPEC+ production. The swift pace of US oil production growth has represented the most significant challenge to OPEC+ agreements. Source: International Energy Agency, US Energy Information Administration

To determine the optimal amount of production needed to control prices, OPEC+ evaluates the current state of global crude oil supply and demand to predict how that balance will fluctuate in the future based on how they expect market events will unfold. Disruptions to crude oil infrastructure, crude oil transportation, foreign relations, and changing policy could all impact the decisions of the organization.

For shippers, these production decisions and market disruptions ultimately have an impact on the price of diesel and other refined products that contribute to their bottom-line transportation spend.

So far in 2020, the energy market has been faced with major disruptions, both on the supply side and demand side of the equation.  The COVID-19 pandemic has led to demand destruction for crude oil and refined products.  

At the same time, the collective OPEC+ group could not agree on a new production cut amid dropping demand.  This led to Saudi Arabia opening up a price war with Russia in a fight for market share.  All OPEC+ countries were allowed to produce as much as they wanted, which flooded the market with oil and, in concert with COVID-19’s demand destruction, caused West Texas Intermediate (WTI) prices to go negative

The price war was short-lived when the cartel eventually came together again in April to agree on a deal that ended with the largest production cut in the history of OPEC.  The group managed to agree to reduce crude oil production by 9.7 million barrels per day (mmbd) for May and June 2020.  The cut quota will then reduce throughout the next two years.

The April OPEC+ meeting allocated crude oil cuts to individual members, including 2.5mmbd for Saudi Arabia and Russia, 0.1 mmbd for Mexico, and the remaining 4.6 mmbd to the rest of OPEC+ members.

The OPEC+ group also met on June 10 to discuss the output cuts as COVID-19 continues to disrupt the global economy and crude oil prices remain low.  The meeting identified which OPEC+ members were not meeting their quota.  

Ultimately, the group decided to extend the current production cut of 9.7 mmbd through July.  Additionally, member countries that did not meet its quota in May – like Iraq and Nigeria – will be required to cut further to make up for the noncompliance.  This has brought upward price pressure on crude oil prices and therefore diesel prices as a result.  

LOOKING TO THE FUTURE OF CRUDE OIL PRICE DYNAMICS

Despite this natural balancing act caused by U.S. foreign policy, the landscape remains volatile, and predicting the next moves is becoming increasingly difficult. Because of this uncertainty, countries, and companies are less likely to make significant investments in infrastructure, manufacturing, and trade, which dampens economic outlook and ultimately weakens demand.

All these stipulations do not negate the relevance and power of OPEC+ in terms of driving global prices, but they do change the conditions under which they operate. They are no longer the market-driving force they once were, and now must be reactive as the U.S. claims greater market share.

Listen to an Overview of OPEC’s Role in Crude Oil Price Dynamics:

 

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