OPEC’s Oil Undulations

Story Highlights:

• OPEC left oil production quotas unchanged Wednesday as member countries were unable to reach a consensus on whether to increase them.
• Both camps cited market fundamentals in support of their positions, but politics are undoubtedly playing a role as well.
• Either way, the impact on markets is likely fairly short term in nature, especially if Saudi Arabia increases production anyway.

OPEC announced Wednesday they were unable to agree on whether to increase production quotas—resulting in unchanged output and likely contributing to oil’s 2% gain Wednesday. Saudi Arabia and the three other Gulf Cooperative Council (GCC) members (Kuwait, Qatar and the United Arab Emirates) had proposed an increase of 1.5 million barrels a day (bb/d) to 30.3 million bb/d total. However, opposition (primarily from Iran and Venezuela) prevented the cartel—which makes decisions by consensus—from reaching a decision.

Publicly, the quota disagreement reflects different assessments of market fundamentals. Saudi Arabia and the GCC argue inventories are already declining (true, though they’re still higher than average) and are likely to decline at an accelerating rate later this year—which, without an OPEC production increase, seems quite likely since demand growth looks set to outpace non-OPEC supply growth this year. Moreover, they believe current prices may weigh on demand—something Saudi Arabia in particular as the largest supplier wants to avoid.

In contrast, Iran, Venezuela and others (including Algeria, Angola, Libya and Iraq—a non-quota country) claim the market’s oversupplied. Further, they argue current prices reflect speculation rather than fundamentals, which is only partly true—some speculation is built into the market and may still be there, but current prices don’t appear to be wildly divergent from fundamentals. (What’s more, speculation isn’t necessarily bad. Speculators have always been a normal part of oil markets and play a role in increasing liquidity, price discovery, etc.) Based on this assessment, Iran argues the cartel should wait to raise quotas until the market actually tightens further, not solely based on the expectation it will tighten.

Beyond the public façade, this disagreement over quotas likely has far more to do with political considerations than market fundamentals. Iran and Venezuela likely don’t have much spare capacity—though officially, on paper, they do. So simply speaking, if quotas were increased, Iran and Venezuela could face falling crude prices but wouldn’t benefit from increased volumes. In contrast, Saudi Arabia and the GCC control almost all of OPEC’s estimated spare capacity and would consequently account for nearly all the incremental production increase. Second, Saudi Arabia and the GCC are politically motivated to appease their oil-consuming allies, who have increasingly called for higher production, whereas Iran and Venezuela are happy to cause whatever political discomfort they can for consumers like the US and its allies.

But in the immediate term, gridlock over production quotas likely has limited implications. Saudi Arabia doesn’t need Iran’s permission to raise quotas and has indicated it will unilaterally raise production as it sees fit. Further, while higher OPEC production could increase spot market supply and put downward pressure on spot prices, it would also reduce spare capacity—a potential upward price pressure longer term.

At the end of the day, history shows OPEC members may agree to multilateral decisions but ultimately are more likely to act in their own best interest, regardless of political wrangling's to the contrary. And if there are profits to be made by increasing production, it’s likely Saudi Arabia moves forward, regardless of protestations from the likes of Iran and Venezuela.