OPEC: entelechy for a perverse game

Posted in Global Energy April 2020

Market scholars and price analysts have recently commented that OPEC ceased to be the regulatory anchor for prices by using supply manipulation; meaning to say, to close or open production at will. Experts explain that the real regulator is now the market itself. The effect of the coronavirus has been equivalent to a production cut close to close to 6 MMBPD, and it will take at least a year to recover this market. Therefore, the combination of this production cut-  “de facto”-  due to the impact of the coronavirus, and the price and volume war unleashed by Saudi Arabia and Russia, which caused the opening of production and the offer of discounts for the Arabs to the market, was more than enough to get to where we are with the prices collapse.

Taking a look back into the OPEC history, when Romulo Betancourt was elected as President of Venezuela in 1958, he was very clear in his message to the international community regarding his interest in promoting Venezuela’s leadership worldwide, to bring together the largest oil-producing countries. His visionary objective was to create an organization that would watch over the oil interests of those countries, but also that could keep an eye on the market, that had been controlled by international companies, which exploited the reserves of different countries from Africa to Latin America.

With the support and leadership of his Minister of Mines and Hydrocarbons – Dr Juan Pablo Pérez Alfonzo, Venezuela made a proposal for oil integration to the Arab countries – which in those years led the world production of hydrocarbons together with Venezuela – so it was that September 10, 1960, in a meeting held in Egypt where Venezuela and four Arab countries: Saudi Arabia, Iran, Iraq and Kuwait, hold the historic “Baghdad Pact”, which was the OPEC origin.

Ever since, the OPEC began to play a determining role during the different historical crises of the oil market, based on its extraordinary production capacity to satisfy market demands, and also its discipline to control excesses. Some of these crises were caused mainly by geopolitical events that always affect demand and impact world economic growth.

These days, with the appearance of this modern plague called the coronavirus – COVID 19 – that has directly affected the stability of the oil market, OPEC once again appears trying to play a critical role, becoming, firstly, the offender and the main cause of the fall of the prices at catastrophic levels, and whose consequences are already considered the worst crisis that could have existed in world oil history, and then in recent weeks, he appears as a savior, whose leadership and decisions seek to bring normality to the market and thus end with the explosive volatility it is in.

Let us remember that beginning in March the world was already experiencing the effects of the coronavirus. China accumulated an impressive number of infected cases and deaths, and in Europe, mainly in Italy and Spain, there was an accelerated growth in the number of infected people. Just in that second week of March, the breakdown occurred in the talks between Saudi Arabia and Russia about possible additional production closings for both countries, and that affected their positions in the market.

That rupture promoted by Saudi Arabia, unilaterally, without consulting the other OPEC member countries, the product of an emotional reaction of the Saudi crown prince and strongman: Mohammad bin Salmán bin Abdulaziz Al Saud, detonated the price chaos because among both countries had a closed production of the order of 2.5 MMBPD, which was supposedly open. As if this were not enough, the Arabs communicated to their clients that they would have a price discount on future purchases, which could be extended to other clients in the “spot” market. On March 11, prices for a barrel of Brent lost about 30%, reaching $ 31  and the WTI at $ 30 / bl, to continue its downward trend and, in the following two weeks, drop below the 20 USD / bl. So far, no agency or company has reported on the volume of barrels they opened, but the market works based on information and expectations, hence the downward reaction it has had.

These price levels had to be reached – unthinkable a few months ago – for Arabs and Russians to feel the impact of the outrage committed a few weeks earlier. Once they understood this, they reviewed the subject of inventories, they saw that they are fully saturated, because they filled all the available spaces: storage yards, boats, and any other void they could find, in order to ensure a quick response to any change in the market. , so any closure will not affect them, as they will continue to drain from those inventories. That will not allow prices to recover as quickly – as is the general expectation – because a flow of barrels that will be drained from inventories, will get to the markets, and will not allow the rise in prices.

Once they have this homework done, Arabs and Russians considered that time was right to involve the other OPEC “partners”, who had obviously suffered the onslaught of the coronavirus, and their irresponsible actions of excessive production supply. I was the time to seek solidarity from them and the world, which sees them – once again – as “saviors” of the market and drivers of the rise in prices when in reality they have been to blame for the sharpness and unprecedented impact of this new crisis price and market.

In these days of reflection, we think that, once this crisis is over, perhaps the time has come for the relationship between supply and demand to have a different reading by different actors. Perhaps a more hemispheric relationship that takes into account the realities of the regions on this side of the world; an American organization of oil-exporting countries led by the United States, Mexico and Brazil, with sufficient reserves and technologies, that is a new option, to a decrepit OPEC, with an authoritarian or hegemonic leadership of Saudi Arabia, which uses it as they please, and based on their interests, not necessarily the interests of their partners in the organization, and less the needs of the world. Without a doubt, an interesting future after the reflections and learnings that the impact of COVD19 will leave us all.