Two years ago, global oil prices crashed after the world started pumping out far more crude than anyone needed. That plunge, from $100 per barrel down to $45 per barrel, completely upended the global economy — and cost oil producers like Saudi Arabia billions of dollars in lost revenue.
Now those oil producers have had enough. This Wednesday in Vienna, the Organization of the Petroleum Exporting Countries will try to reach a deal to cut back sharply on oil production in order to raise global prices. (OPEC is a cartel of 14 major oil exporters, including Saudi Arabia, Iran, and Iraq, that account for 40 percent of global production.)
It’s far from clear that OPEC will succeed. Back in September, the cartel agreed in principle to restrict production, but now it actually has to divide up concrete cuts among members. And that’s the trickiest part: While all OPEC members would benefit from higher prices, each country is hoping someone else will take on more of the burden of cutting. Meanwhile, two of the cartel’s most important members, Saudi Arabia and Iran, are bitter rivals fighting proxy wars around the Middle East.
The stakes are surprisingly high: Global oil prices are currently hovering around $46 per barrel. A successful OPEC deal to throttle production could raise that to $55 per barrel, analysts say. A failure to coordinate could cause prices to crash below $40:
On Tuesday, for instance, global prices dropped almost 4 percent over reports that Iran and Iraq were resisting pressure from Saudi Arabia to take on major cuts. Everyone’s watching closely for rumors and tidbits.
So it’s a meeting that could have major ripple effects around the world, driving up or down the price of gasoline for drivers, moving markets and economies. We’re about to see whether the world’s most famous cartel can still sway global oil markets — or whether it’s lost all control over the past two years.
Why OPEC wants to cut back on oil production — after doing nothing for two years
For the past two years, as oil prices have been falling worldwide, OPEC has mostly stood by and watched, unable to reach a decision on how to react.
The cartel's most important member, Saudi Arabia, famously refused to cut output in 2014 when prices first began sliding, because officials were hoping the resulting price crash would drive large swaths of the US fracking industry — with its higher production costs — out of business. The fracking boom in North Dakota and Texas, after all, was a big reason the oil market was oversupplied.
“At the time, that decision to let oil prices drop made sense,” explains Jason Bordoff, founding director of Columbia University’s Center on Global Energy Policy. Saudi Arabia didn’t want to cut back on production and lose market share only to see other producers reap the benefits — a “historic error” the country made when prices fell in the early 1980s.
But the world has changed a lot over the past two years. US production has fallen from 9.6 million barrels per day down to 8.6 million barrels per day amid the price crash. Nearly $1 trillion in oil investment has dried up. Iran returned to the oil market after EU and US sanctions were lifted as part of the nuclear deal. Meanwhile, Saudi Arabia has been hurt badly by the price crash. The country has already burned through $160 billion worth of foreign exchange reserves and has been forced to cut social services and salaries to compensate for lower oil revenues, threatening stability in the kingdom.
So the Saudis are shifting their stance. In September, OPEC’s 14 members agreed to set a short-term ceiling on their overall output between 32.5 million and 33 million barrels per day — down from the current level of about 33.64 million barrels a day. The hope was that by cutting output, OPEC countries could boost prices and ease the pain on their budgets without immediately triggering a massive surge in new oil investment that would lead to another glut and crash.
But it’s far from clear that OPEC will succeed in cutting production
That said, it’s not at all certain these cuts will materialize. So far, OPEC's members have only agreed to a broad ceiling. They haven’t made the truly difficult decisions of precisely who will cut, when the cuts will go into effect, how long the cuts will last, or how compliance will be enforced. That’s what Wednesday’s meeting in Vienna is all about.
The trouble with coordinating a cut is that every OPEC country is in a slightly different situation with different interests, says Jim Krane of Rice University's Center for Energy Studies. Iraq and Libya are emerging from civil wars and trying to increase their output, and tend to argue that other countries should bear the burden. Saudi Arabia doesn’t want to go it alone on cuts and lose too much market share. Iran is trying to attract new investment to rebuild its sanctions-ravaged industry and is worried that too steep a cut might scare off investors.
OPEC faces one hell of a coordination problem. All of its members would benefit from higher global prices, because that would mean more revenue for their budgets. But no individual country wants to be the one to cut output — because it would then lose market share and revenue. They’d all prefer if someone else to bear the burden.
What’s more, even if OPEC's members agree to detailed production cuts, countries could always cheat and fail to reduce output in practice. “That’s something we’ve absolutely seen in the past,” says Bordoff.
The US fracking boom makes OPEC’s decision much more complicated
OPEC also faces another, more serious quandary. Over the past two years, the fall in oil prices has put a damper on project investment in places like the United States and Canada and Brazil, because fracking and oil sands and deepwater companies need relatively high prices to make investing in costly new projects worthwhile. That crimp in investment has helped stabilize prices around their current level.
But if OPEC successfully throttles back on production and hikes prices, that could induce some fracking companies in Texas or North Dakota to start drilling again. At that point, supply would rise and prices would fall. OPEC would be right back where it started — except it would have lost market share.
The tricky part is that no one knows exactly how this dynamic would play out. Bordoff notes that forecasts vary wildly on how much US oil production could grow again if prices rise to, say, $60 per barrel — some analysts suggest an extra 300,000 barrels per day, others 900,000 barrels per day. “It’s a big uncertainty range,” he says.
Part of this is uncertainty about the “break even” point for many projects in the United States — the price at which it’s profitable to drill. During the price crash, many fracking companies managed to slash costs and reduce their break-even price, but it’s unclear if that was due to sustainable efficiency improvements or unsustainable moves like squeezing suppliers or focusing only on the most productive wells (which they can’t do forever).
“The uncertainty about US shale is a huge game changer for OPEC,” Bordoff says. “If prices rise to $60, and a large volume of oil can come back quickly, that’s a very significant constraint on the ability of OPEC to manage the oil market that we haven’t seen before.”
The popular view of OPEC is that its members can sway the global oil market with a single utterance. We saw this in 2008, when prices were plummeting amid the financial crisis and OPEC stepped in to halt the slide. But OPEC doesn’t have the same power it used to. Over the past two years, the cartel has been paralyzed by indecision, watching as US shale drillers flood the market and swing global prices. Saudi Arabia is now trying to reassert its grip.