The Organization of Petroleum Exporting Countries (OPEC) announced last week tentative plans to cut oil production by 200,000 barrels per day. This represents a decrease of nearly 20% in production. Markets immediately seized on the news, as oil prices shot up to $50 per barrel. That OPEC announcements can influence markets is a shock to no one. The larger question is whether or not OPEC still has the political and economic clout to make a measurable impact in the global oil market.
Immediate signs point to no. Many other oil producing nations, including Russia, Brazil, and the United States, have continued to increase production. A production cut may send a slight positive price signal, making it more lucrative to pump more oil in these countries. The vacuum created by OPEC’s reduction will easily be absorbed by increased production from other nations.
Additionally, OPEC’s announcement doesn’t reverse the global trend of an oil oversupply. Currently, there are about a million extra barrels of oil produced each day (94 million pumped versus 93 million used). Even after the 200,000 barrel reduction, most of that million barrel surplus will still exist, continuing to exert a downward force on prices.
This decision could represent a capitulation by the cartel to international political realities. OPEC had been maintaining such a surplus of production for a variety of reasons, including an effort to slow down the Russian economy. OPEC nations attempted to keep the price of oil low to starve the Russian export market, making expensive foreign occupations too costly to maintain.
Moreover, the high production level may have been an effort by OPEC to regain control over the oil sector. Shale rock and tar sands extraction in America and Canada are expensive processes, only made economically viable by the high price of oil. Cheap oil could drive investment away from these industries, preventing needed infrastructure upgrades and forcing companies to keep production low in the near-term. Essentially, OPEC was keeping the price low to keep countries new to the oil export business from making much money, hoping they would quit.
It was a dangerous waiting game; the longer production exceeded demand, the longer it would take for prices to rebound. OPEC member states appear to have lost patience with the strategy, and have tried their best to reverse course. This cut in production, though, may be too little too late.
While demand for oil does generally grow over time, it will take quite a while for industry to eat up the surplus that’s been generated during the past two years of overproduction. The primary driver of the long-term price of oil will be that level of demand, and it faces considerable pressure from many angles. Concerns over the sustainability of the oil economy continue to push capital toward greener technologies. It will be a while before the price of oil returns to its pre-glut peak, assuming it ever gets there.