(John Kemp is a Reuters market analyst. The views expressed are his own)
By John Kemp
LONDON, Nov 30 (Reuters) - “If we are victorious in one more
battle with the Romans, we shall be utterly ruined,” King
Pyrrhus of Epirus complained after winning exceptionally bloody
engagements in 280 and 279 BC.
Pyrrhus lost many of his men, most of his generals and had
no reserves left, while “the army of the Romans, as if from a
fountain gushing forth indoors, was easily and speedily filled
up again” according to Plutarch.
The king of Epirus, reported to have been a brilliant
general, has come to symbolise victories that are so expensive
they leave the victor dangerously weakened.
Pyrrhus won the battle but lost the war.
As ministers from the Organization of the Petroleum
Exporting Countries meet in Vienna, some may wonder if the
strategy of maintaining output to defend market share risks
securing a Pyrrhic victory.
OPEC has put shale producers on the defensive and forced the
cancellation of many ambitious oil projects with its strategy of
going for volume over price.
But members are gradually running out of money and the shale
industry is waiting for any upturn in prices to start ramping up
Meanwhile Iran is set to boost its oil exports once
sanctions lifted, which will make the supply glut worse, and the
risks of recession in developed and developing countries alike
Some OPEC members, led by Saudi Arabia, remain hopeful that
they will secure an eventual victory. The question is whether
all the short-term pain will be worth it in the longer run.
In November 2014, OPEC ministers decided to maintain their
production unchanged even though oil prices had already fallen
$40 per barrel, 37 percent, over the previous five months.
In choosing this course, which was led by Saudi Arabia but
endorsed by other members, ministers expressed concern about the
increase in non-OPEC supply and the continued rise in both
developed and developing country stocks.
Twelve months later, oil consumption is growing at some of
the fastest rates in over a decade, U.S. shale production has
peaked for the time being and non-OPEC oil output is forecast to
decline in 2016.
But Russian oil production is the highest on record and oil
inventories in developed countries have risen by 250 million
barrels, almost 6 percent, with millions more extra barrels in
storage in emerging markets.
Oil prices have fallen another $27, and show no signs of
recovering, while many hedge funds are betting they will fall
even further over the next few months.
Lower prices have cut economic growth in half and turned
budget surpluses into big deficits even for the wealthy oil
producers in the Gulf Cooperation Council.
For weaker members of OPEC in Latin America and Africa, as
well as Iran and Iraq, the budgetary and economic impact has
been far worse.
OPEC’s production strategy has been driven by Saudi Arabia,
the cartel’s biggest producer, and its veteran oil minister Ali
Naimi, who has made clear the kingdom felt it had little choice.
Four years with prices averaging at or above $100 per barrel
had left the market on an unsustainable course, with supply
growth accelerating, especially from shale, while demand growth
Oil prices had to fall substantially to curb growth in
high-cost production from shale and other sources while
encouraging faster growth in demand.
If Saudi Arabia had cut its output to prop up prices, it
would simply have encouraged more growth in shale and demands
for even deeper cutbacks later.
Saudi Arabia would have been left with the worst of both
worlds: lower prices and lower production. The strategy had been
tried before in the early 1980s and ended in comprehensive
Commentators close to Saudi Arabia insist policymakers
always understood the rebalancing process would take several
But prices have fallen much further and for much longer than
senior Saudi policymakers believed was likely in 2014.
The gains from the strategy have been modest so far which
has led to mounting questions about whether it is working or
should be changed.
Global oil inventories are still rising by more than 1
million barrels per day.
While shale and non-OPEC output more generally has started
to fall, strong output from Saudi Arabia and Russia has kept the
Consumption has grown by between 1.5 million and 2.0 million
barrels per day in 2015, partly thanks to lower fuel prices, but
there are doubts about whether the pace of growth can be
maintained in 2016.
Iran is poised to add an extra 0.5 million to 1.0 million
barrels per day to the oil market once sanctions are lifted.
In developing countries, which have accounted for all the
increase in fuel demand since 2005, economic growth is slowing
as a result of the collapse in commodity prices and the prospect
of higher U.S. interest rates.
And in the advanced economies, the economic expansion is
relatively mature and there is an increasing risk of another
recession arriving within the next 2-3 years, which would cut
Given continued oversupply in the oil market and the big
build up of inventories, most analysts do not see the market
rebalancing before 2017 or even 2018.
But by the start of 2017, the U.S. expansion will be 90
months old, making it longer than all but three expansions on
record, according to the National Bureau of Economic Research.
By the end of 2018, the U.S. expansion will be 114 months
old, longer than every other expansion except the expansion
which began in March 1991 (http://www.nber.org/cycles.html).
If the strategy is to balance the oil market by 2017 or
2018, it will rebalance just as the U.S. economy is poised for
In the meantime, oil-producing countries are burning through
their financial reserves at an unsustainable rate according to
Saudi Arabia’s external reserves have fallen from a peak of
$737 billion in July 2014 to $654 billion in September 2015.
Other members of OPEC have smaller much financial buffers and
will run out much sooner.
Nearly all members of OPEC will exhaust their reserves in
less than five years, according to the IMF, though in some cases
it may be possible to extend the reserves by issuing foreign
currency debt instead.
Saudi officials have been briefing journalists and analysts
that prices are too low and need to rise to $60-80 per barrel in
the medium term to encourage enough investment to meet demand.
The attempt to guide market expectations higher has not been
backed up by any formal change in output policy (“Saudi counters
lower for longer oil mantra” Financial Times, Nov 26).
For the time being, there appears to be enough political
support in Saudi Arabia and its key allies around the Gulf to
give the strategy more time. But that patience will not last
If the strategy does not show clear signs of working and
prices are not higher by this time next year, the political
pressure to change course will be overwhelming.
For now, the Saudis and OPEC appear committed to their
current course, and a formal policy change appears unlikely.
But there is scope for some flexibility in production at the
margin without formally changing policy, which could limit the
build up of stocks and in turn buy the strategy more time.
Senior Market Analyst