Economists will tell you that cartels are hard to keep alive. They work when everyone in the cartel holds down production to keep the price artificially high (and punish customers). But there’s a huge incentive to exceed one’s quota.
What’s happening to OPEC right now is even worse than typical quota cheating. The overproduction is coming from outside of the cartel, mostly in the U.S. That puts the colluders in a no-win situation: Cut their own production even more in a desperate attempt to prop up the price, thus yielding market share to the Americans. Or allow the price to fall, which essentially means giving up.
This chart shows what OPEC is up against.
The price of Brent crude oil dropped to a four-year low on Tuesday, with futures falling more than 2 percent in London. United Arab Emirates Energy Minister Shail Al Mazrouei stated the obvious: The oil market is oversupplied, partly because of rising U.S. output.
An analysis of the oil market in Bloomberg News quotes Mike Wittner, Societe Generale’s head of oil market research in New York: “We’ve not seen a turning point like this in decades,” he says. “Is OPEC going to abdicate its role in the market? If the Saudis do exactly what they’re signaling, and just let the market take care of the overproduction, then it could certainly become irrelevant.”
Saudi Arabia, the hub of the oil cartel, seems to be betting on letting prices slide. It has lower production costs than countries like Iran and Venezuela, so it’s less harmed by the price drop and has a strong interest in maintaining market share. The Saudis may be betting that lower prices will force some American producers of shale oil out of the market.
If so, the market is in for a long period of low prices that will devastate some OPEC nations. As Bloomberg’s Grant Smith and Maher Chmaytelli write:
Preserving market share by letting oil fall to a level that undermines U.S. shale production isn’t a practical option for many OPEC members, Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA, said by phone from London on Nov. 6. The strategy would require a Brent price of $70 a barrel for a prolonged period, a level too low for most members to cover government spending, Tchilinguirian said.
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