As the OPEC oil cartel prepares for its informal meeting in Algeria this week, media speculation and oil price fluctuations are rife in response to the possibility of an oil production freeze agreement between OPEC and non-OPEC countries. But these permutations beg one important question: haven’t we heard it all before?
Venezuelan President Nicolas Maduro gave oil traders a glimmer of hope after talks two weeks ago Sunday with Iranian President Hassan Rohani, when he stated that oil-producing nations were “close to a deal.” But while these words might have been enough to cause oil markets to rally for a few hours, it would be a mistake to think of them as being prophetic. In fact, it is possible that a supply deal is not close to being agreed as Mr Maduro might have us believe, and the President is simply crying wolf in a strategic bid to dupe traders into optimism and buoy the oil market. Cash-stricken Venezuela has said many times in the past that producers were close to agreeing a production freeze, while the actual outcome has been markedly different.
The elephant in the room is that in the current economic environment, it is not in the interests of major oil nations to significantly cut production. The emergence of US shale as a major rival to traditional oil production methods has presented a structural challenge to OPEC’s ability to stabilise the oil market. The US shale revolution and its exponential productivity gains over the last two years have flooded the market with cheap oil and driven down prices.
Whilst an attempt by OPEC to cut production in response to US shale might raise the oil price in the short term, it would also inevitably result in OPEC countries ceding more market share to US shale producers. In a world increasingly moving towards decarbonisation and reduced oil consumption, large oil-producing countries with poorly diversified economies will be looking to retain as much market share as possible to safeguard revenues and continue subsidising costly government programmes.
Therefore, when Saudi Arabia and Russia announce that they see merit in limiting or cutting production, observers should think twice about the sincerity of their commitment to such a goal. As the officials of major oil-producing nations quietly concede, OPEC’s greatest value in an evolving energy landscape is its ability to inspire hope, though usually false, in the market, which is one explanation for why they haven’t managed to agree anything despite so many meetings in recent months.
As such, the idea that OPEC will suddenly agree a supply freeze this week appears unlikely, and companies and traders can expect more of the same. But regardless of any decision, oil companies have to learn how to operate with the mindset that oil will stay low for longer, and implement how to transform the business models so that with lower costs, profits can be increased in a tougher economic environment. A wise move would be a strategic pivot towards innovative contracting and financing, which could include consortium building or new forms of economic modelling. It would also mean taking a fresh look at how projects are approached, and being able to identify all the key variables in successful project development from the outset. A low oil price need not mean that oil companies cannot succeed or thrive, and the strongest will see this as an opportunity for increasing efficiency and emerging stronger in the longer term. But it is meticulous forward planning, rather than desperate hoping, which will be the key to the puzzle.
Chris Freeman is a partner and director of field development for io oil & gas consulting.