Ask any free-market economist’s opinion of cartelisation, and you are likely to receive a frosty and disapproving answer. Cartels exist, so the theory goes, to protect the interests of powerful producers of a commodity, at the expense and detriment of lowly and embattled consumers. It’s a well-known argument, which rests upon assumptions that a cartel manipulates supply in order to support prices for its members, and carves up the market so that end-users are deprived of choice. In short, cartels are bad, bad, bad.
But the recent programme of oil production cuts adopted by the “OPEC+” group of oil producers in response to the COVID-19 crisis, appears to have turned this argument on its head, in much the same way as the pandemic turned the global economy on its head. OPEC+, an amalgamation of OPEC’s 13 standing members, along with Russia, Azerbaijan, Mexico and others, agreed earlier this year to cut oil production in a three-phase programme. The first phase started in May 2020 with an output reduction of 9.7m bpd, while phase two from August is imposing a reduction of 7.7m bpd until December 2020. Phase three will run from January 2021 until April 2022, and will see a cut of up to 6m bpd.
The effort is being spread across OPEC+ states, and so far we are seeing a stabilised oil market in terms of supply and prices.
A Brent crude oil price of around USD 45-per-barrel during a global pandemic, and in the middle of the Summer, is certainly a notable outcome. And, the likelihood now is that seasonality and further OPEC+ cuts, albeit at a reduced rate, will support oil prices over the rest of 2020. Alongside voluntary reductions in UK North Sea and US oil production, the overall effect on oil trading risks has been to lower the level of expected bankruptcies among producers, and to reduce performance risks attached to oil suppliers. Know-your-counterparty credit analysts will breathe a sigh of relief that oil reserves on a trading counterparty’s balance sheet (hopefully actual reserves that exist, rather than madeup, hin leong/GP-style (or words to that effect!) can still legitimately be regarded as assets with a decent market value.
The key to the success of OPEC+ has been the fact that its objectives were quantified, transparent and easy to achieve. Coordination of oil production over the last three months has clearly served the immediate interests of both producers and consumers. Of course, this may not make comfortable reading for our free-market economist friends, but arguably, an element of cartelisation through OPEC+ has vastly reduced oil market risks.
And, the model could even find some appeal in other commodities.
The 2001-established Gas Exporting Countries Forum (GECF) has never acted as a cartel in the way that OPEC has, but it may see more interest in its potential for wholesale gas market management in periods of crisis thanks to the OPEC+ experience. There would be obstacles in the case of gas and LNG, however. While Iran and Russia are GECF members, the US and Australia, as prominent LNG producers, would probably not be able to join a body which might evolve into a cartel, since this would appear to be at odds with US and Australian anti-trust laws.
But, are there risks which could arise from the success of OPEC+?
Political risk in the oil market will be viewed as higher by many market participants, since the success of OPEC+ has passed greater power back to Russia and Middle Eastern states. It also means that while the immediate risk of mass bankruptcies among small, independent oil producers may have passed, these producers now have much less freedom to decide their future output programmes. OPEC+ agreed to huge cuts in oil production at this point in time, but there is little to stop them flooding the market with excess production at a future date, which could destabilise US and UK North Sea producers. The potential for this may add to future counterparty risks in these sectors.
Looking back on the last few months, COVID-19 has posed an enormous threat for all of us. But, the feared meltdown in the wholesale crude oil market, as fuels demand collapsed, simply hasn’t happened. OPEC+ will claim the credit for this, and its main protagonists, Russia and Saudi Arabia, are likely to become more assertive on the back of it. Many of the most severe risks in the oil trading market have certainly been mitigated by OPEC+, but fears will be stoked up about where exactly this trend towards greater cartelisation could lead us.
