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June 12, 2015

Written on the Wall: OPEC’s Obituary?

Not that long ago, it used to be that oil traders and energy giants hung on OPEC's every word. Now we have Citigroup's global head of commodities research asking if it's time to write the group's obituary.

Citi's Ed Morse is out with an opinion piece asking whether OPEC's power is essentially gone. The discussion focuses on the group’s senior member, Saudi Arabia, and its relations with other members.

OPEC’s obituary has been prematurely written several times. But discounting a strong future for the oil producer organization, often incorrectly referred to as a cartel, seems more logical today than at perhaps any other point in the group’s 55-year history.

The note went on to say that all this really began last year, when Saudi Arabia gave up its role as "central banker" to the oil market in favor of protecting its own market share.

Late last summer, when the group’s senior member, Saudi Arabia, announced to the world that it would relinquish the role of “Central Banker” to the world’s oil market, it seemed to be asserting that the institution had lost its purpose. The Kingdom, the group’s largest producer by an order of magnitude, proclaimed that it would no longer provide additional or less liquidity to markets by raising or lowering its production to meet its own, and the producer group’s, price objectives. Rather, by ending its decades-long practice of being a swing producer and leading the rest of the producer group in the implementation of its price goals, the Kingdom was going to maximize its own market share

Market share has been a huge topic in the oil market as the U.S. and other countries have become more prominent. In its annual statistical review released this week, for instance, BP said that the U.S. has taken Russia's crown as the biggest oil and natural gas producer and also overtaken Saudi Arabia in crude production. 

One of the key drivers behind this has been the huge increase in production from U.S. shale, which has increased 90 percent since 2012, according to Citi.

In the case of the US, the loss of market share [for OPEC] was initially gradual but built over time. Between late 2013 and mid-2014 Saudi export volumes fell from 1.6-m b/d to 1.0-m b/d mainly due to the shale revolution in the US, where domestic production rose by more than 1.0-m b/d for the third year in a row and obstacles to US exports were depressing the price of US crude versus the rest of the world’s crude oil. 

Also important is China, where OPEC is losing market share. The note points out that in 2013, Saudi Arabia was selling roughly 1.2 million barrels a day to the country, but that fell to an average of about 800,000 barrels a day in 2014. This drop was based on both demand and supply as Chinese GDP growth has fallen from more than 10 percent per year, to about 7 percent. 

Taking all these factors into account, it appears that Saudi Arabia isn't exactly hoping for prices to rise soon and is actually aiming for the opposite. The note says that Saudi Arabia has essentially concluded that a market-share strategy will keep oil prices lower for a longer period and thereby "shift the burden of adjustment" to the higher-cost producers. That would be U.S. shale, deep-water production across the globe, and the oil sands in Canada. 

So with all the changes going on inside and outside OPEC, the note concludes that some of these trends may be here for quite some time.

It’s hard to predict that any structural change in oil markets is “permanent” or “forever,” but it’s also difficult to understand how the oil market will be able to sustain higher prices or even a return to last year’s prices given the entry of shale oil, deep-water output and oil sands into the production system.

Source: First Enercast Financial

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