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Last Updated : Dec 07, 2018 10:19 AM IST | Source: Moneycontrol.com

Opinion | This is the beginning of the end for OPEC

The declining influence of OPEC could be a game changer for oil importing countries like India

Ravi Krishnan @writesravi

Elementary economics tells us that cartels collapse because of recessions, breakdown of co-operation between members, and cheating on output cuts, which is the preferred method of price control. When a cartel has to get into a duopolistic situation with another company, things get messier and the collapse gets hastened.

For the Organisation of Petroleum Exporting Countries (OPEC), Qatar's exit, and the obduracy of Russia -- a non-member on whom it is heavily reliant to enforce production cuts to prop up prices -- are clear signs of its diminishing importance.

Indeed, for OPEC, the world is a different place from the heady days of 1973 when the cartel proclaimed an oil embargo in retaliation to the perceived support of some countries to Israel in the Yom Kippur war. Oil prices had shot up four times within a year as a result. OPEC could get away with it then because it accounted for around half of the world's oil output.

Predictably, the rest of the world learnt a lesson and decided to search for new and alternative sources of fuel, and cut down on fuel consumption. Today, OPEC contributes to about a third of the world's oil output. Projections of oil demand reaching 113 million barrels a day by 2025 – which OPEC had predicted in 2005 – are unlikely to materialise anytime soon.

Near-term demand is also not looking good, despite talks of a US-China trade war truce amidst weakening global demand. In its November monthly report, OPEC itself projected world oil demand to grow by 1.29 million barrels a day in 2019, around 70,000 barrels a day lower than its previous forecast.

In such a scenario, the cartel has no other option but to cut production in order to support prices. Brent crude currently trades at $59.78 a barrel, about 45 percent lower than two months earlier. Analysts estimate that OPEC would have cut output by around 1.4 million barrels a day to support oil prices.

However, reaching an agreement will be a challenge because of numerous factors. For one, the cartel – especially Saudi Arabia, its de facto leader – has to be careful about not upsetting the US, where President Donald Trump is reportedly ready to support an anti-OPEC legislation. "Hopefully OPEC will be keeping oil flows as is, not restricted. The World does not want to see, or need, higher oil prices!" Trump tweeted on Wednesday.

Secondly, within OPEC, there are divisions on how any output cut is shared. A large number of members depend on high oil prices and exports to fuel their economies. According to Bloomberg, about 40 percent of the last round of cuts agreed to in 2016 was shared by only two countries – Angola and Venezuela - even though their combined output is only a third of Saudi Arabia's. Venezuela, which is already facing enough problems, wouldn't like to cut production more.

The Kingdom's rivalry with Iran doesn't help things. Iran, which is facing US sanctions, is unlikely to agree to production cuts. Similarly, Libya and Nigeria too would be unwilling participants in output curbs. In such a scenario, OPEC would be heavily reliant on Russia to deliver. News reports indicate that it wants Russia to cut output by 300,000 barrels per day, which the European nation is unwilling to consider. Russia is in a comfortable state and wouldn't want higher prices to hurt its consumers, especially considering the rouble's prevalent weakness.

Thirdly, OPEC's waning influence can also be seen from the fact that even if it manages to cut production, others like the US might just step up theirs. By some estimates, the US has already emerged as the world's largest crude oil producer. Last month, it became a net exporter for the first time in its history. OPEC itself acknowledged this implicitly in its November report, when it said that demand for crude from OPEC members is forecast to decline by 1.1 million barrels a day in 2019.

Thus, even if the cartel is able to hammer out an agreement with Russia later on Friday, the writing on the wall is clear. It can no longer dominate the energy markets as it has done for the last five decades.

What does this mean for India?

A crack in OPEC could well be a game changer for India. If oil prices are left to free market forces, there is a possibility that they would remain depressed. For a perpetual oil importer like India, this will be a shot in the arm as it will help bring down the country's current account deficit and balance its fiscal arithmetic.
First Published on Dec 7, 2018 10:19 am
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