Is a secret 'oil war' raging?

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Article Summary
An OPEC production cut would not be effective unless shale oil producers in North America also cut production, which is unlikely.

Oil prices have been falling for the past two months. The OPEC basket price has ranged between $80 and $90 a barrel compared to the $100-$115 range of the past four years. This recent drop happens at a time when oil-producing countries will draft their 2015 budget and try to adopt an average oil price for the upcoming year. The drop in oil prices is expected to adversely affect their budgets. Markets usually expect OPEC countries to cut production when prices fall. This time, however, OPEC is looking to US shale oil to contribute to price stability, because the increase in shale oil production has impacted the markets.

Oil prices have dropped for several reasons. They include increasing supplies while demand is on the decline due to the continuing economic crisis. Asian markets have been affected, especially China, where growth reached 7.31% during the third quarter. Although this rate is relatively high compared with those of other industrialized countries, it is China’s lowest in five years. Asian countries, China in particular, are major importers of crude oil. Most oil from the Gulf and some African countries, especially Nigeria, now goes to Asian countries after some African countries lost their US market as a result of increased production of shale oil, which is of light quality, like Nigerian oil. There is also the competition among oil producers to maintain their share in the Chinese market.

Also, reactions from major oil-producing countries in the Gulf contributed to the rapid price decline. Normally, these countries take the initiative and lower production when demand is low and raise it when demand is high. However, this time, major producing countries have decided to wait and not cut production. Gulf states usually take the first step and then ask the other OPEC countries to also cut production. Nevertheless, there is a clear difficulty in reaching consensus to cut production among OPEC countries. A consensus is required in accordance with OPEC regulations and is essential for the decision to be credible and effective.

Libya, for example, is about to increase production. The country is expected to refuse lowering production after production fell by about 200,000 barrels per day in recent months. Despite the political turmoil, Libya is trying to increase production from its current level of about 900,000 barrels per day.

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Iran is also trying to lift the international embargo imposed on it, which reduced exports to less than 1 million barrels per day from about 2.5 million before the embargo. Iraq is trying to increase production to compensate for many years of low or halted production. It is in urgent need of reconstruction, as the country has to pay its contracts with international oil companies.

These are examples of the expected opposition by some OPEC countries to cut production. There is another challenge, though. To achieve real price stability in light of the drop in demand, private companies producing shale oil should also cut production. Shale oil production in North America continues to rise by about a million barrels a day every year (average production was 18.1 million barrels per day in 2013 and 19.6 million in 2014, and is expected to reach 20.7 million in 2015). Meanwhile, OPEC production has stabilized. (Production was about 30.9 million barrels per day in 2013 and 30.4 million in 2014, and is expected to be 30.5 million in 2015.)

It would be futile for Gulf states to reduce their production rates without the contribution of the remaining OPEC countries and the shale oil producers. It is possible that an OPEC decision could be reached, even if vague, as has occurred in the past. The decision would allow for a reduction that varies from one country to another, with an understanding on a vague production ceiling for OPEC as a whole.

Experience shows that such a settlement is possible. The difficulty lies, however, in reaching an understanding with non-OPEC oil-producing countries. Among that group, the biggest challenge comes from private producers of shale oil in North America. It would be difficult for those companies to agree to OPEC decisions to reduce production, especially in the United States. This would affect their legal status, not to mention the economies where their programs and projects are located. Therein lies the current crisis. How can OPEC and shale oil producers negotiate on production levels in light of the declining demand? What is the minimum that the two parties can afford?

In the past, OPEC countries were able to cut production despite their differences. However, it is very difficult to convince oil shale companies to cooperate, given the nature of their own institutions and the production conditions, which require further drilling and expenses due to the quick depletion of the productive capacity of oil shale. That requires a lot of spending.

The Gulf states can no longer bear this responsibility alone because they would face great difficulties in achieving price stability. If Gulf states cut production alone, they would lose market share in favor of other exporters, without the price changing.

Is the “price war” a plan to strike at the Iranian and Russian economies or an attempt by Gulf states to put an end to the growth of shale oil in North America? Views differ on this matter. Thomas Friedman wrote in the New York Times that Saudi Arabia and the United States are waging an “oil war” against Russia and Iran, and will soon "pump [the countries] to death."

US energy expert Robert McNally, who served in the White House as special assistant to the president on the National Economic Council, believes that the price war is an attempt by Gulf states to put an end to competition from shale oil because low prices will put pressure on shale oil production.

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Found in: shale gas, oil prices, oil, opec, gulf states, china
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