Question

Topic: The Organization of the Petroleum Exporting Countries (OPEC) and Russia have failed to reach the agreement on oil output cut in early March, which triggered the oil price war and the oil price has dropped by more than 50% within a month. Base on your knowledge on Cartel: 1. Suggest the possible reasons to explain why Russia and OPEC failed to reach the agreement. 2. Discuss how the low oil price might affect the major oil supplying countries. 3. Comment on whether the price war would likely to end soon.

Answer 1

Many of the largest oil producing countries in the world are part of a cartel known as OPEC. In the short term, the Organization of Petroleum-Exporting Countries (OPEC) has significant influence on the price of oil. Over the long term, its ability to influence the price of oil is quite limited, primarily because individual countries have different incentives than OPEC as a whole.

As a cartel, the OPEC member countries collectively agree on how much oil to produce, which directly impacts the ready supply of crude oil on the global market at any given time. As a result, OPEC tends to keep the price of oil relatively high in order to maintain profitable operations.

For example, if OPEC countries are unsatisfied with the price of oil, it is in their interests to cut the supply of oil so prices rise. However, no individual country actually wants to reduce supply, as this would mean reduced revenues. Ideally, they want the price of oil to rise while they raise revenues. This issue often arises as OPEC pledges to cut supply, causing an immediate spike in the price of oil. Over time, the price moves lower when supply is not meaningfully cut.

On the other hand, OPEC can decide to increase supply. For instance, on June 21, 2018, OPEC met in Vienna and announced that they would be increasing supply. A big reason for this is because of the extremely low output by fellow OPEC member Venezuela. Russia and Saudi Arabia are big proponents of increasing supply while Iran is not.

In the end, the forces of supply and demand determine the price equilibrium, although OPEC announcements can temporarily affect the price of oil by altering expectations. One case where OPEC's expectations would be altered is when its share of world oil production declines, with new production coming from outside nations such as the U.S. and Canada.

In March 2020, Saudi Arabia and Russia failed to reach an agreement with OPEC and instead boosted oil supply. This happened at a time when oil demand also fell sharply as a result of the global COVID19 pandemic. As a result, the market forces overrode OPEC's desire to keep oil prices high.

Brent Crude oil, as of March 2020, costs around $36 per barrel while WTI Crude oil costs $33 per barrel —a return to the fallout of 2008 and post-oil crisis conditions in 2014-2015 when oversupply caused prices to fall as low as $40-$50 per barrel. Oil price fluctuations created huge incentives for innovation in new production techniques that led to oil extraction and more effective drilling methods.

The Organization of Petroleum Exporting Countries (OPEC) has been the elephant on the world's trading floors, with its oil-producing member nations working together to determine prices by boosting or reducing crude oil production. While OPEC's grip on the market has loosened some in past years, its decisions continue to play a dominant role. OPEC's every move is watched closely by governments, oil companies, speculators, hedgers, investors, traders, policymakers, and consumers.

OPEC's policies are affected, in turn, by geopolitical developments. Some of the world's top oil producers are politically unstable or at odds with the West (issues pertaining to terrorism or compliance with international laws, in particular, have been problematic). Some have faced sanctions by the U.S. and the United Nations.

In the past, supply disruptions triggered by political events have caused oil prices to shift drastically; the Iranian revolution, Iran-Iraq war, Arab oil embargo, and Persian Gulf wars have been especially notable. The Asian financial crisis and the global economic crisis of 2007-2008 also caused fluctuations.

The supply crude oil is also determined by external factors, which might include weather patterns, exploration and production (E&P) costs, investments, and innovations. For example, thanks to advances in technology that allow companies to extract oil from rock—so-called shale oil—the United States became the world's largest producer of oil in 2018 and a major source of global oil supplies.

Strong economic growth and industrial production tend to boost the demand for oil—as reflected in changing demand patterns by non-OECD nations, which have grown rapidly in recent years. According to the U.S. Energy Information Administration,

“Oil consumption in the Organization for Economic Cooperation and Development (OECD) countries declined between 2000 and 2010, [while] non-OECD oil consumption increased more than 40%. China, India, and Saudi Arabia had the largest growth in oil consumption among the countries in the non-OECD during this period.”

Other important factors that affect demand for oil include transportation (both commercial and personal), population growth, and seasonal changes. For instance, oil use increases during busy summer travel seasons and in the winters, when more heating fuel is consumed.

More and more, market participants are buying and selling crude oil, not in its physical form, but in the form of contracts. For example, airlines and oil producers use derivatives, like futures and options, to a hedge against swings in the price of oil, while speculators drive those prices upwards or downwards when there are waves of buying or selling amid incoming news.

Reports on production figures, spare capacity, target pricing, and investments can be a crucial factor in the setting of crude oil prices.

Oil has long been the engine of the world's economy, and even today—as the search for alternative energy sources gains ground—life without crude oil is hard to imagine. Carbon-based fuels are used in heavy and light manufacturing, in the production process (chemicals, textiles, detergents, and medicines), and in every sector of our transportation industries. For now, at least, oil companies and oil-rich nations will surely weather dips, deeper plunges, and sudden spikes in crude oil prices.