Colluding on Oil Production Is a Game That Can’t Be Played Anymore
The 2020 Olympics have been deferred, but the Geopolitical Oil Games are full on. Who will stand on the gold podium? Saudi Arabia, Russia or the United States? Will countries like Canada, Brazil or Norway even place?
The rules of this game are simple. Major oil-producing jurisdictions negotiate, form alliances and collude on curtailing production. Winner’s circle members will be those that benefit the most from a propped-up oil price.
This game is playing out as we speak. Tentatively, representatives of major oil-producing nations will meet later week this to try to shore up rock-bottom oil prices that haven’t been seen on a trader’s screen in decades.
But don’t get your hopes up if you’re a western, independent oil company. Colluding to raise price is a tired game that can’t be played anymore.
Oil prices will perk back up, maybe even to pre-pandemic levels, but it will happen mostly as a function of Darwinian forces. Nature doesn’t collude to save the weakest, nor does a competitive, oversupplied market.
Historically, the game has been played by the Organization of the Petroleum Exporting Countries (OPEC), and more recently by the addition of Russia to the arena. But that was short-lived. Darwinists in Moscow got tired of teaming up with the Saudis to make winners out of vulnerable, capital-starved adversaries in North America. And they won’t do it in future either.
A special set of conditions has allowed the collusion game to be played, with two key assumptions prevailing to make an oil cartel work:
- Global oil consumption would rise steadily year-after-year.
- The market share of the colluders would not be challenged by western competitors during curtailment.
These two assumptions were valid for six decades. Neither is extant now.
OPEC, the most successful cartel in history, has used these two assumptions since its formation in 1960. Originally, its members were feeling short-changed on prices and royalties received. As owners of a vital resource, OPEC members wanted negotiating leverage over foreign multinationals.
By the 1990s, OPEC’s role shifted to one of being a “swing producer.” Periodic recessions in the economy created cyclicality in oil consumption and price. During downturns, OPEC helped to shore up prices for its own members’ benefit by self-imposing production quotas.
Yet oil is a global commodity, so the cartel’s curtailment also gave every free-market, non-OPEC oil company a free ride on higher prices too.
Half a dozen years ago, the second assumption, that there be no challenges to the market share of the colluders, was violated. The innovation-enabled growth in large quantities of American shale oil, Canadian oil sands and other sources changed the rules. Suddenly, OPEC wasn’t the only entity that could add surplus barrels to the supply side of the market.
Until a few weeks ago, the first assumption—rising global oil demand—was still intact. But the COVID pandemic has potentially sidelined that principle. Too much supply from too many players, combined with weak consumption, creates a competitive environment that can’t be controlled by a partial cartel.
Looking past the pandemic, we will see oil consumption grow again, but it’s debatable to what degree. Society will decide whether its commuting and travel habits have changed forever. That’s a discussion for a future column. But a bruised global economy with soft oil demand is a foregone conclusion.
On the supply side, the technology genie has long been out of the bottle, and many non-OPEC countries can easily supply the world. The only limiting factor will be availability of capital and the unknown of how much damage the pandemic will do to near-term productive capacity.
Note that the pre-pandemic price war, initiated by the Russians and Saudis, was meant to hinder free-market capacity in the pursuit of squashing challenges to its market share.
OPEC, Russia, the United States and even countries like Canada and Norway are currently working out in the diplomatic gym, flexing muscles to negotiate if and how production can be collectively curtailed. In the near term, the imperative is welcome, if not necessary, to protect vital supply lines from debilitating near-term damage.
But it’s no longer realistic to believe that a 60-year-old game, based on old assumptions, can be played for any longer than it takes to get past the worst of the COVID-19 crisis.
I have a sense of who will win a year out. It won’t be those who rely on a tenuous group of political players that don’t trust one another. Nor will it be western producers who think that countries on the other side of the world will continue to carry them to the finish line, only to see the ingratitude of having their market share taken away.
No, the winners in this game will be as in any other business: producers that have a low-cost, diversified suite of energy offerings with access to multiple markets.