Even if OPEC decides to cut, oil prices could still fall in 2019

Some Americans are starting to associate turkey with low oil prices.

On Thanksgiving Day in 2014, OPEC held a meeting in Vienna, the outcome of which set off a dramatic slide in oil prices. The price of Brent crude dropped US$6 a barrel, or eight per cent, in just the 24 hours after OPEC announced the outcome of its meeting. This Thanksgiving, there was no OPEC gathering, but last Friday, the Brent price still slid nearly US$4, or six per cent, to its lowest mark in a year. Although the price has since stabilized, we cannot rule out a further slip in the weeks or months ahead.

The recent decrease in oil prices is what academics like to call “over-determined.” Despite recent jitters about a looming spike in the price of oil, both supply and demand have conspired to bring down prices. New production has come on line in recent months, be it from Clair Ridge (BP’s new mega-oil field in the North Sea), record amounts of shale oil coming out of the U.S., or simply production increases by Saudi Arabia, Iraq and Russia. Other developments — such as the hope to resolve infrastructure bottlenecks in the U.S. and a new agreement between Baghdad and the Kurds to allow the restart of exports from Kirkuk’s contested oil fields — promise even more oil in the months ahead. Unexpected sanctions waivers issued by the Trump administration mean Iranian oil will not be squeezed out of global markets just yet. Meanwhile, the robust growth in oil demand of the past years appears to be easing, especially with trade frictions looking persistent.

Oil’s price could get another knock soon, depending on the outcome of the next OPEC meeting on Dec. 6. Some variant of any of the usual three outcomes is possible: a real deal, rhetoric about a deal, or no deal. But the market will be particularly sensitive to the result, given the other factors weighing down oil right now.

Prospects for a real deal — one that brings significant quantities of oil off the market to boost prices for a sustained period — are not particularly bright. OPEC alone is no longer capable of delivering a real deal.

One of the lessons of the past few years is that, given new forces in the market, particularly America’s shale oil, OPEC countries must join with others if they are going to be able to effect a significant enough cut to oil markets to notably raise prices and restore balance. The much-heralded Declaration of Cooperation of December 2016 brought 11 other countries alongside OPEC’s traditional members. True, OPEC has formally welcomed new members into its ranks since this time, but neither Equatorial Guinea nor Congo bring game-changing cutting capacity to the organization. A real deal requires that the diverse group of OPEC and non-OPEC producers that stood together in 2016 do so once again in two weeks’ time.

Nor, at the other end of the extreme, can Saudi Arabia deliver a “real deal” on its own. In past decades, Saudi Arabia was sometimes willing to bear the brunt of production cuts in order to stabilize the oil price. In the past few years, Riyadh has declared its unwillingness to do this, often invoking its experience in the 1980s when its economy stumbled as a result of it bearing deep and extended solo production cuts. In recent days, the Saudis seem determined to return to the production levels of 2016 — another way of saying they could cut current production by as much as one million barrels a day. The Saudis do have room to execute such a cut; they are now producing at record levels and even a major cut would still leave them with substantial exports.

A real deal requires that the diverse group of OPEC and non-OPEC producers that stood together in 2016 do so once again

Such a more-or-less unilateral move could have immediate costs. First, as widely noted, it could draw the ire of President Donald Trump, just when he has declared his willingness to stand by Saudi Arabia’s Crown Prince Mohamed bin Salman after the CIA linked the royal to the murder of journalist Jamal Khashoggi. In addition, a big Saudi solo cut could erode the sense of joint responsibility for global oil markets instilled by the Declaration of Cooperation. And, as we know from recent years, such a cut will invite other producers to the market — likely in less than a year thanks to American shale — bringing down the price once again, this time at the expense of Saudi market share.

Nevertheless, domestic pressures could induce MBS to prioritize the short term — and favour what is essentially a solo cut — over the medium and longer run. It is difficult to assess the domestic strength of the crown prince in the wake of the Khashoggi murder. But the probable execution of those in his inner circle for an operation he likely sanctioned will weaken his power base. He may have calculated that he cannot compound this situation with an economy that stresses the country with more unemployment and slowed growth. The relatively higher oil prices of 2018 have given Saudi Arabia a reprieve from the economic difficulties and grumblings of 2017, when the Saudi economy actually contracted. The crown prince may perceive it as essential that he has some economic largesse to weather the immediate political storm. Over the medium and longer term, however, Saudi Arabia cannot be expected to sustain solo cuts in the face of a moderating price and a shrunken Saudi market share.

… even a major cut would still leave (the Saudis) with substantial exports

Another option for Dec. 6 is a deal in rhetoric across OPEC and its non-OPEC brethren, but no deal in practice. This is the most likely scenario, and the market will be watching for it closely, with an eye on Russia and Iraq in particular. Before 2016, the Russian government often pledged cooperation with OPEC but never delivered on it. In the recent months, Russia has been producing over 11 million barrels of oil, notably beyond what it was producing before the 2016 production cuts. Iraq has had a quiet but significant boom in recent months, reaching record levels of 4.7 million barrels a day with additional production increases on the horizon. With a new government in Baghdad under pressure from its population to deliver services, and pressure from Washington to sever energy ties with Iran, Iraq will resist reining in its oil production now.

The final option for Dec. 6 is, of course, an overt no-deal scenario. It is the least likely of the options, but it is not impossible. Tensions are running high in the region, and confidence in Saudi leadership — generally perceived to be the responsible actor of OPEC — has been shaken. Should an obvious no-deal situation materialize, expect the price of oil to plunge quickly, particularly in light of current market expectations. An overwhelming majority of analysts expect a supply cut, according to a recent Bloomberg poll.

We will most likely see some sort of action in Vienna on Dec. 6 and even before. Yet anything short of a re-enactment of the Declaration of Cooperation moment of 2016 should be seen as only a short-term boost to prices in early 2019 and a likely precursor to an eventual price drop as 2019 progresses. A go-it-alone approach by Saudi Arabia is not sustainable, just as an agreement to cut without Russian and Iraqi enthusiasm is likely to be an empty promise.

• Meghan L. O’Sullivan is a Bloomberg Opinion columnist and a professor of international affairs at Harvard’s Kennedy School, and a senior fellow at the Council on Foreign Relations. She served on the National Security Council from 2004 to 2007.

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