The Death of OPEC

IRVING, TEXAS – The Organization of the Petroleum Exporting Countries is dead. Saudi Arabia killed it. Now, OPEC is just a toothless zombie, attracting attention, but without having any impact on the living.

Few have noticed OPEC’s demise for a simple reason: it never really had the impact that it was widely perceived to have. It was never actually a cartel, possessing monopolistic market power. Anyone who thought otherwise was mistakenly attributing to it Saudi Arabia’s market power.

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And Saudi Arabia’s power is expansive. It remains the dominant producer in world oil markets, and its political and economic decisions shape global energy economics. This impact will be intensified if the Kingdom resurrects Arab Light as the global benchmark crude.

Of course, new players in the energy-production game could conceivably deal a blow to Saudi Arabia. But, so far, the Kingdom has managed to avoid serious injury.

The shale-energy revolution in the United States, for example, has had a far-reaching international impact – far greater than expected. The Atlantic Basin ran an oil surplus – producing more than it consumed – for the first time in a half-century, while the Pacific Basin became the only dumping ground for crude. The surge in domestically produced shale oil caused OPEC members Algeria, Angola, and Nigeria to lose significant market share in the US.

Yet that revolution has had little impact on Saudi Arabia, Iraq, or Kuwait, owing to crude quality. Algeria, Angola, and Nigeria were exporting to the US a kind of light sweet crude that is comparable to shale oil. Yet many US refineries are still geared toward the heavier and more sour types of crude that the country imports from the Middle East. As a result, Saudi Arabia’s market share in the US seems relatively secure.

This is not to suggest that Saudi Arabia is invincible. On the contrary, it has lost market share among the largest oil importers in Asia, which have increased their purchases of West African crude (diverted from the US). Perhaps most painful, the Kingdom has lost substantial market share in China to Russia.

Russian penetration of the Chinese market was spurred by the imposition of Western sanctions after Russia invaded Ukraine and annexed Crimea in 2014. China took full advantage of the Kremlin’s desperation, securing rock-bottom rates for Russian energy resources. Once the door to Asia was open, however, Russian companies seized the opportunity to enter the downstream markets of India and Indonesia – two countries that are critical to the Saudis’ own strategy.

Over the last two years or so, Saudi Arabia has made starkly clear that it will not easily give up its market share – to anyone. It has pursued a campaign to recover its former position not just in crude, but also in petroleum products, natural gas liquids, and petrochemicals. To this end, it has sustained a price war, supported by a boost in production, aimed at pushing out weaker competitors.

At first, Saudi Arabia took aim at the shale industry. But its strategy for asserting its dominance over global energy markets evolved over time, adapting to new economic information and political circumstances. Ultimately, Saudi Arabia dragged all of OPEC into the price war. Countries increased their production for as long as they could, causing prices naturally to drop. When production peaked, the bottom fell out of the market, because OPEC members were forced to enter into direct price competition with one another.

The permanent internal rifts that all of this has produced were painfully apparent at this April’s OPEC meeting in Doha, where a deal to freeze output fell apart. Saudi Arabia refused to cut production unless Iran would do likewise. But Iran – which, like Russia, had lost considerable market share as a result of Western sanctions – refused to cut production outright. Producers that lost market share in the US will not cut production, either.

By now, Saudi Arabia recognizes that low oil prices will not fully restore its market share in Asia and Europe. But it also sees that it has no more use for OPEC, an organization that it foisted on the world with the first Arab oil embargo in 1973 and has since used as a shield for its oil policies. With the US shale revolution having rendered OPEC useless, Saudi Arabia has decided that its creature is not worth keeping alive.

But this does not mean that there is no hope for energy cooperation. Saudi Arabia is now pursuing a major shift in its foreign, economic, and energy policies, exemplified by the impending privatization of a portion of Aramco, its national petroleum company, which is set to expand its refining capacity.

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All of this suggests that competition in energy markets may shift from crude oil to refined products. That would create new opportunities for cooperation: producers with large refining and storage capacity could purchase surplus oil from producers lacking such capacities.

A shift from competition in crude to competition in petroleum products would have a profound effect on global oil markets and related industries, like shipping. Ultimately, it would most likely boost the overall efficiency of the oil market and strengthen producers’ capacity to weather market volatility. The producers and refiners with the most sophisticated technologies would dominate – beginning with Saudi Arabia.