Desperate OPEC Cuts Oil Output for First Time in 8 Years
Sensing its growing irrelevancy and need for money, the Organization of the Petroleum Exporting Countries (OPEC), at the behest of Saudi Arabia, has buckled and agreed to cut its oil output for the first time since 2008.
Starting in January, the cartel will cut 1.2 million barrels from its daily production in an effort to boost oil prices, which have halved since 2014. (Source: “Oil Surges on OPEC Deal to Cut Production,” The Wall Street Journal, November 30, 2016.)
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The reduction of 1.2 million barrels per day leaves its output at 32.5 million barrels. Other non-OPEC nations are expected to cut an additional 600,000 per day off of their production. The cut in production effectively puts an end to Saudi Arabia’s efforts to crush the U.S. fracking industry.
In fact, the strategy entirely backfired. Saudi Arabia was hoping that flooding the world with unwanted oil would plunge prices so low that high-cost endeavors like U.S. fracking would dry up. That didn’t happen. The ever-industrious U.S. fracking industry just became more efficient. What did low oil prices do? Drained the cartel of much-needed money.
Oil prices took a major hit back in November 2014 after Saudi Arabia refused to cut OPEC oil production. Despite weak global demand, Saudi Arabia was going to pump out oil at a breakneck pace and saturate the market. By January 2015, oil prices had crashed to around $43.00 per barrel; a year later, oil prices had fallen to $26.00 per barrel.
The only reason Saudi Arabia could afford to keep giving away something no one wanted was that it thought it could afford to. And Saudi Arabia doesn’t like competition. Naturally, this did not sit well with less well-heeled members of OPEC like Iran, Iraq, Nigeria, and Venezuela. But who was going to stand up to the House of Saud? And really, how long could the U.S. fracking industry hold out?
What Did 2 Years of Low Oil Accomplish?
OPEC’s decision to pump oil at a record pace didn’t have the intended consequences. Instead of hurting the U.S. fracking and oil industry, it had a major impact on the global oil sector, and the global economy. OPEC’s decision to pump, pump, pump also cobbled its fellow member states.
OPEC’s experiment led to a $745.0-billion (22%) drop in upstream oil and gas development between 2015 and 2020. This led to a 56% collapse in worldwide drilling activity. In October 2014, just before OPEC’s fateful decision, the number of active worldwide rigs was 3,657. In October 2016, it was just 1,620. (Source: “Thousands of layoffs and half a trillion in revenue losses: OPEC’s two-year price war has added up,” Financial Post, November 29, 2016.)
Halving oil prices chopped $410.0 billion in revenue from OPEC coffers. In 2014, OPEC countries earned $745.0 billion, by 2015, that number had tumbled to just $350.0 billion. In 2016, that number is expected to fall to just $338.0 billion, which is 55% less than what the cartel brought in in 2014.
Saudi Arabia’s bet didn’t just hurt countries like Venezuela. Over those two years, Saudi Arabia burned through $209.0 billion in reserves. The country still has over $520.0 billion in reserves, but that figure is projected to fall to $460.0 billion by the end of next year.
That’s a risky gamble for a country that gets three quarters of its revenue from oil. In fact, the slump in oil prices created a $98.0-billion budget deficit for Saudi Arabia in 2015. To combat the deficit, the Saudi government was forced to introduce austerity measures. But not even that was enough. Further efforts to reduce the deficit could have a serious impact on the country’s non-oil economy.
Today, Saudi Arabia’s finance minister said that it owes billions of dollars to private construction firms and foreign workers, many of whom have not been paid in months. The kingdom has also cancelled $266.0 billion in new contracts. (Source: “Saudi Arabia admits owing billions of dollars to contractors over oil slump,” RT, November 11, 2016.)
Where Is Oil Headed in 2017?
A reduction in oil output may not have the desired effect for OPEC members. While oil prices have climbed around nine percent to roughly $50.00 per barrel since the announcement, the good old days of crude at $100.00 a barrel is a pipe dream.
For starters, Donald Trump has promised to free up more drilling in the U.S., which will increase global supply. Lest we forget, the global economy is not exactly running at full steam; there are still fears about the eurozone and Japan economies.
Again, oil prices rebounded after the announcement, but futures contracts for crude are holding steady at around $54.00 per barrel from July 2017 to November 2019. That could change quickly in the event of unforeseen geopolitical events but, as it stands, the future of oil does not look all that different from where it stands today.
Saudi Arabia’s oil gambit didn’t really pan out. What it did do though, was create a greater urgency to develop U.S. oil supplies and the need to wean us off crude oil from politically unstable nations like Saudi Arabia.
