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OPEC decision on production driven by hard economic realities

PUBLISHED : Monday, 14 December, 2015, 7:45am
UPDATED : Monday, 14 December, 2015, 4:43pm

The decision by the Organisation of Petroleum Exporting Countries (OPEC) offers major importers of hydrocarbons, such as China and Japan, the opportunity to benefit from lower energy import bills, but OPEC’s decision is hardly altruistic.

In fact, there are logical reasons why OPEC should have adopted such a stance at this point in its history and with what is happening in the world economy.

On a generic level, OPEC members are fully aware that the burning of hydrocarbons to produce the energy that drives the global economy is also closely linked to the issues debated at the United Nations Conference on Climate Change over the weekend.

While the momentum towards greater global reliance on renewable energy sources will continue, OPEC members are not oblivious to the fact that, notwithstanding climate change concerns, everyone loves a bargain.

Also, if, in the long term, the global economy seeks to wean itself off its dependency on hydrocarbons as an energy source, OPEC might as well seek to sell as much as it can now and in the coming years.

Of course, the lower the oil price, the greater the discomfiture of higher cost producers such as Canada and the United States but while the Canadian dollar has undoubtedly been negatively affected by the falling oil price, the US dollar has stayed strong.

Indeed, the United States itself, a key ally of Saudi Arabia, might anyway take a more sanguine view of events.

Firstly, despite the expansion of US shale oil production in recent years, financed by cheap dollar debt, the United States remains a net energy importer and so US consumers are net beneficiaries of a lower crude price.

Secondly, there is the issue of US geopolitical interests.

Would the reopening of diplomatic relations between Cuba and the United States have been achieved if Havana’s main financial backer, Venezuala, had not seen its own finances squeezed by the oil price fall?

Equally, Washington probably won’t shed too many tears over the Venezuelan government’s economic problems. After all, the United States declared Venezuela a national security threat in March.

Then there is Russia.

With US-Russia differences over events in Ukraine, and indeed with Saudi Arabia resentful of Russian backing for Syria’s President Bashar al-Assad, both Washington and Riyadh might feel a low oil price could help concentrate minds in Moscow given the dominant position in Russia’s overseas earnings held by oil and gas exports.

On the subject of Syria too, Saudi Arabia has significant differences with Iran and likely sees a lower oil price as an economic advantage over Tehran.

But OPEC also no doubt realises the world is hardly champing at the bit to buy oil at the current low price let alone at a higher level. There is a demand issue just as there is a supply glut.

Notably, both imports and exports declined in October in China, Germany and the United States indicating that, even with the subdued price of crude, international trade flows remain in the doldrums.

With that demand issue in mind, it is logical for low cost oil producers, like Saudi Arabia, to pump as much as possible to maximise their market share and disadvantage competitors but also in the hope of discovering the price point that reignites stronger global economic activity.

There is also the simple fact that many OPEC producers cannot afford to cut back on production as they need the revenues.

The Syrian conflict aside, Bahrain, Kuwait, Qatar, Saudi Arabia and the United Arab Emirates are all embroiled in Yemen’s internal conflict.

Gulf states also have a much higher welfare budget as part of the social contract with their citizenry following the Arab Spring in 2011, and those commitments cannot be reneged upon.

Maximising oil market share, selling down foreign reserves, and increasing borrowing all come together as Arab governments seek to manage their budgets in the current global environment.

All this could, ultimately, prove good news for major oil importers in Asia such as China, India and Japan.

Already, with the oil price so low, some expect China to double its strategic crude oil purchases in 2016, while India is said to have commenced buying oil for its own strategic petroleum reserve back in March.

OPEC’s strategy may yet play out to the advantage of Asia’s and the world’s oil importers but if it does it will not be because the petroleum exporters suddenly embraced altruism.