On October 17, 1973, the Organization of Petroleum Exporting Countries agreed to a 5 percent production cut from the previous month’s levels. They intended this strategy not solely for increasing their oil revenue but to punish the United States for its support of Israel in the Yom Kippur War. This production cut increased the price of oil dramatically and led to oil discoveries around the world including massive plays in Alaska, Mexico, and the North Sea. Those three regions alone added approximately 6 million bbls/day to the world oil supply in the next seven years following the embargo. 43 years later, OPEC meets on November 30th to discuss a production cut to support depressed oil prices. While the geopolitical sphere has changed dramatically, economic laws remain the same.
Cutting production ultimately decreases your own market share and subsidizes your competitors. A natural result of the production cuts in the ‘70s were the depressed oil prices in the ‘80s. OPEC claims that it brings stability to oil prices, but it is a cartel designed to raise prices at the expense of the consumer. Calls for OPEC to begin were in response to a Standard Oil New Jersey executive lowering his prices from Middle Eastern concessions in order to compete with cheaper Soviet crude that was gaining market share. Good businesses in a market economy will compete on price to guard their long term market share. Former CEO of Aramco and longtime oil minister in Saudi Arabia, Ali Al-Naimi saw this, and he was the leading voice of the Thanksgiving Day 2014 decision to veto any production cuts so that Saudi Arabia’s competitors, particularly US unconventional oil production, didn’t gain ground on market share.
But Al-Naimi is gone. New leadership has come about in Saudi Arabia and a return to becoming the swing producer is a possibility. At the OPEC technical meeting in Vienna this past weekend, Iran and Iraq both expressed that they should be exempt from production cuts. As the number two and three largest producers of crude oil in OPEC, this is a blow to the hopes of a production cut, but Saudi Arabia has taken the major burden of cuts before and could potentially do it again. President Maduro of Venezuela, perhaps the most outspoken advocate of a production cut, even expressed that he wants the United States in attendance since it is the leading producer of combined oil and natural gas:
“they proposed inviting the government of the U.S. to the next OPEC meeting, and I agreed with that, because they are a big producer and they can’t be isolated from this and be lured by analysts, warmongers, or anti-Russia sectors,”
Unlike the countries in attendance at the meeting in Vienna this month, the United States government has no authority to cap production, at least in the current market. United States production is so dividend among independent producers that without radical government edicts a production cut in the United States would never happen unless the market directed it.
Cutting production in 2016 is much more dangerous to OPEC ‘s market share than the Arab Embargo of 1973. In those days, peak oil theory was widely accepted and oil shortage fears were commonplace. OPEC was taking a gamble that Western companies wouldn’t discover massive oil plays, or as they are called in the industry, “elephants.” Today, the United States has massive reserves of oil and gas that will be, not might be, produced at the right price point. Resource plays of tight oil require great amounts of wells to be drilled and have higher development costs than a conventional field, but the reserves are there. At low oil prices most investments in domestic exploration are going into two regions, the Permian basin in West Texas and the SCOOP/STACK plays in Oklahoma. With an increase in oil prices, not only will these plays see more activity but Bakken and Eagleford Shale activity becomes much more attractive. This degree of agility in American shale companies have to adjust to changes in oil prices has never been seen before. The abundance of service providers and independent oil producers generated by a market system has given American companies this unprecedented power.
OPEC may agree to a production cut even with this guaranteed loss of market share. Politics often favors near term public opinion over long term returns, but what will happen when the competitors they subsidize increase production enough to depress the oil prices down the road? Further production cuts would be needed by Arab countries in a cycle that will eventually hurt their oil revenues.
Richard Sigman is a petroleum engineer from Texas A&M with hydraulic fracturing experience in Texas and Oklahoma. He has completed a Master’s degree in Energy Economics from the University of French Petroleum in Rueil-Malmaison, France, and is currently a graduate student at the University of Oklahoma in Norman.