It was 2016’s most ambitious economic move.
The Organization of the Petroleum Exporting Countries, the oil-producers’ cartel that last century haunted the industrialized powers, has harnessed Russia to help restore and multiply the organization’s pressure on the energy markets.
One month on, the move seems a success, as crude prices CLG7, +0.22% climbed from $46 to $54 per barrel, underscoring a year in which oil’s 60%-plunge since 2014 finally bottomed out at $35.
Don’t hold your breath.
Yes, the decline of recent years has bottomed out. But prices aren’t about to soar because the economic conditions aren’t there. On the contrary, 2017 will expose the new-and-improved producers’ cartel as the same failed idea it has been even in its best times.
This decade’s oil glut has been fed by two trends, on the supply side, fracking has multiplied U.S. production. On the demand side, the Great Recession that followed the 2008 financial crisis slowed industrial activity in the developed world and shrank the middle classes’ available income, all of which cut energy consumption.
The common denominator between these two developments is that they represent organic economic realities. That cannot be said of what OPEC and Russia did, which is a bureaucratic plot to disrupt market dynamics.
The markets have repeatedly displayed their impatience with such administrative intrusions, which defy economic gravity by trying to obstruct the reality of supply and demand.
The world was afforded a good reminder of this axiom during Fidel Castro’s recent eulogies, when all recalled how Cuba fell on its knees once the U.S.S.R. realized the oil it was shipping Castro should be sold elsewhere for more than double that artificial price.
The OPEC-Russia deal’s vulnerabilities were evident before it was signed. A simple roll call of its parties showed that the agreement lacked four of the world’s 10 leading oil producers: China, Canada, Brazil, and the U.S.
Between them, these four produce one-third of the 10 leading producers’ output. That is besides the deal failing to recruit smaller, but still sizable, oil-producers Norway and Britain. Even more tellingly, when the deal was done, it turned out that OPEC member Indonesia had opted out.
Added up, the deal’s non-signatories represent a critical mass whose increased production as prices rise will compensate for a good portion of the quantities that OPEC and its partners have promised to remove from the markets.
This is besides that experience shows the deal’s signatories are likely to cheat each other.
As data compiled by Goldman Sachs and Commerzbank show, OPEC members have historically violated their own production caps steadily and systematically. Such a scenario is even more realistic now, because there are 11 non-OPEC parties to the deal besides Russia, from Bolivia to Brunei.
The lack of a tool for efficient supervision and disciplining punctured OPEC’s previous production caps, and there is no reason to believe that things will play out differently in the much larger and looser configuration that was unveiled last month.
The signatories will have good reason to cheat each other for the same reason they arrived at the deal in the first place, which is that most of their economies are ill.
The Saudi case is glaring, as the kingdom that over the years allowed oil to account for 80% of internal revenue and 90% of exports suddenly faced a $98-billion budget deficit for fiscal 2015. This year it slashed gas subsidies, nearly doubling its retail price, and cut senior officials’ wages by 20%, the first time ever Riyadh cut public-sector pay.
The Russian economy is different, as it has some serious industry and now also a thriving agricultural sector. However, much like its new partner, Moscow has also made oil, by design, its dominant export.
Not only the Russians and Saudis, but most of their unholy alliance’s other partners, from Iraq to Equatorial Guinea, have economies that rely excessively on oil revenue (notable exceptions are Mexico and Malaysia.)
Petrodollars in such countries finance the ruling elites’ good life and also keep the masses at bay, through bloated public sectors and elaborate subsidy systems. That is why they won’t be able to sustain production cuts for more than a brief period; their fiscal needs will be urgent and the temptation to lie about outputs will be difficult to resist.
Indeed, this deal pits productive economies, from China to Germany, against industrial reactionaries, from Venezuela to Kuwait. Last century, this clash resulted in the industrialized economies’ redoubled efforts to find new oil fields, to cultivate conservation, and to develop alternative energy.
The result for the cartel was devastating. Oil plunged from $35 per barrel in 1980 to $10 in 1986. OPEC was supposed to learn from this that bullying ultimately backfires, but OPEC members remained addicted to their easy money, mostly with catastrophic results, like Venezuela’s current social collapse.
This year’s move will unravel much faster than in the last century, because China, OPEC’s biggest client, has the world’s largest shale deposits. China has only begun to frack, but it plans to multiply production more than twentyfold by the end of the decade, making shale 15% of its gas production.
In 2017, while their mutual cheating begins to show, OPEC and its fellow riders will learn that China is intensifying its fracking. This is besides Donald Trump likely expanding drilling and fracking across the U.S. while telling his friend Vladimir Putin that lifting American sanctions means lifting Russian production caps.
Oil supply, it follows, will be ample, its prices will return to decline sooner rather than later, and those who own it will have little choice but to peddle it back to the marketplace, where it belongs.
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Source: MarketWatch
