OPEC risks Pyrrhic victory with oil policy: Kemp - RTRS

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(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

production again.


    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

are increasing.


    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

was slowing.


    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

market oversupplied.


    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

oil demand.



    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

another downturn.


    In the meantime, oil-producing countries are burning through

their financial reserves at an unsustainable rate according to

the IMF.


    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.


John Kemp


Senior Market Analyst