The End of OPEC or a New Beginning?

On the Horizon

The COVID-19 pandemic will be a history-altering event. But where will it take us? In “On the Horizon,” a new CSIS series, our scholars offer their insights into the fundamental changes we might anticipate for our future social and economic world.

Many people have heralded the “end of OPEC” throughout its 60-year history. Even when it was alive some analysts regarded it as functionally dead several times. The most recent time was during the oil price crash of 2014 when U.S. oil production so voraciously outpaced demand growth that OPEC walked away from trying to bolster prices in an effort to let market forces tamp down the U.S. tight oil sector. Even then, OPEC members came back together in 2016 with a newly established OPEC+ arrangement—adding Russia and a handful of other non-OPEC producers to their alliance in order to bolster the size of their market share and influence on the market.

Now the OPEC alliance has fallen apart once again in the face of the largest and fastest oil demand decrease to date, caused by the economic downturn related to the coronavirus. Three weeks ago, when the impact of the virus was still not fully appreciated, OPEC+ held a meeting to discuss how they should respond to rapidly slowing demand in China and the prospect for that demand slowdown to damage oil markets into the second quarter of the year. Russia was not inclined to make additional cuts despite the OPEC decision to recommend an additional 1.5 million barrel per day cut on top of the 2.1 million barrels per day already officially being held off the market by the group. Not only did the agreement for new cuts fail but the entire previous supply curtailment arrangement fell apart. Saudi Arabia in turn vowed to raise production from 9.7 million barrels per day to 12 million barrels per day, with an extra 300,000 barrels per day put onto the market from storage. This move, along with Saudi Arabia’s decision to drastically cut the price at which they were selling crude, led to an all-out price war that still defines market conditions today. Oil prices have declined over 50 percent, with one major U.S. benchmark crude hitting below $20 per barrel and crude prices in other specific locations selling at negative prices. With no end in sight to this combination of oil demand collapse and surge of supply, global storage is filling up fast and will bring an abrupt halt to oil production in a few months’ time at most.

So, what does all this mean for OPEC, and how might the oil price war end? Two main theories prevail. The first is that OPEC+ is down for the count with little to no chance of a Russia-Saudi rapprochement and that in today’s market conditions there is very little reason for the original OPEC, without Russia, to come to any sort of supply arrangement. Two main assumptions accompany this theory. The first is that Saudi Arabia has embarked on an entirely new energy strategy where they have decided that oil is a declining market and that now is the time to win as much market share as possible to monetize their oil assets before they are worth less to the global economy. The second is that Russia has dispensed with its potentially productive relationship with Saudi Arabia and the entrée that being part of OPEC bought Russia in the broader Middle East region. Both of these assumptions seem somewhat implausible. The first because Saudi Arabia is still extremely dependent on oil to run its economy and the kind of shock therapy it is going through right now is a high-risk way of testing out their transition plan. The second is that Russia was always an opportunistic player in the OPEC+ arrangement. They never really cut very production much and seemed opportunistic rather than strategic in their relationship development in the Middle East. Other than the very real chance that Russia sees this economic downturn as a chance to harm the U.S. tight oil sector (something Russian oil companies have wanted for some time and were perhaps even more pleased to pursue after several rounds of U.S. sanctions on Russian energy projects and companies), if it was playing an opportunistic game then it will likely join the arrangement again should the right opportunity presents itself.

The second theory is that OPEC may be getting another new member—well, perhaps member in principle—the United States. To be clear, nobody is really suggesting that the United States would become a formal member of OPEC, but one member of the Texas Railroad Commission has suggested that the way to put the OPEC supply arrangement back together would be for the United States (Texas specifically) to put its own production curtailment on the table as a U.S. overture toward oil market stability. To say that the U.S. position on OPEC right now is muddled is an understatement. A week ago, a group of 12 senators signed a letter to Saudi crown prince Mohammed Bin Salman asking Saudi Arabia to live up to their role as guarantor of oil market stability, which one could read as a statement in favor of an OPEC supply arrangement. The next week, many of the same senators wrote a letter to President Trump, suggesting punitive measures be taken against members of the OPEC cartel for their behavior in the market.

The situation is even murkier when a commissioner who regulates production for the state of Texas suggests that an organized supply curtailment may be the best strategic decision for the industry, while many large producers in the Permian Basin (the largest producing basin in the Texas) and elsewhere are adamantly opposed to those measures. Here the Trump administration adds even more confusion. First, the president suggested low oil prices were good for the U.S. economy—unfortunately, this is only true if people can use oil, which is not happening very much in a country locked down for social distancing. Second, after President Trump suggested the administration is willing to use diplomatic means to intervene in the oil price war, and after Secretary Pompeo publicly urged the Saudis to stand for oil market stability as the leader of the G20, a G20 communiqué emerged with absolutely no mention of energy or the oil markets.

So, what happens next? Well, supplier dynamics aside, the next two months will be downright terrible for the oil and gas industry as even stricter coronavirus-related lockdowns take hold in the United States. Oil market analysts are now forecasting oil demand declines of 12-20 million barrels per day out of a 100 million barrel per day market over that timeframe. Even after the lockdowns are lifted, economic recovery will likely be slow and bumpy as resolution of the pandemic looks to be at least 18 months down the road in even the most optimistic scenarios. In this type of world, supply arrangements matter very little until a recovery starts to take hold. At that point, the industry will have weathered so much damage—in the United States, in OPEC countries, and in Russia—that all cards will likely be on the table to make some sort of deal.

The ideal outcome is that an oil market stability agreement comes from the G20 or some combination of the International Energy Agency and International Energy Forum that can bring major producers and consumer to the table to consider the prudent steps to establish some sort of path forward.

As for OPEC, it is likely that the group can come to another supply arrangement down the road when their actions can have some sort of impact on the market. Without Russia or the United States involved, however, it is not clear when that will be. OPEC as an organization, rather, should spend some time thinking not just about the immediate market conditions but the longer-term stability of the oil-producing countries that make up its membership, In reality, many OPEC countries have been suffering at the hand of low oil prices for quite some time, and this particular market downturn will only serve to destabilize them further. Moreover, in a world where oil is forecast to be in structural decline within the next couple of decades, someone should start thinking about how to transition these countries—many of which are relatively poor, less stable, and suffer from poor governance—to a more sustainable economic trajectory. Regardless of what happens to market dynamics over the next couple of years, that could be an important future role for OPEC.

Sarah Ladislaw is senior vice president and director and senior fellow of the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.

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Sarah Ladislaw

Sarah Ladislaw

Former Senior Associate (Non-resident), Energy Security and Climate Change Program