This article was published by The McAlvany Intelligence Advisor on Monday, June 25, 2018:  

It’s premature to consider the weekend meeting of OPEC in Vienna as the cartel’s final death rattle. However, it’s clear that its effort to end its production cut agreement amounted to little more than birthing a gnat.

The meeting was supposed to be contentious, with Iran, Libya, and Venezuela promising to scuttle any agreement to raise crude oil production. Oil ministers arrived in Vienna days before the official opening in order to quell that opposition and enlist support. Investors anxiously waited for the final announcement, ready to trade on the news.

Most expected the cartel to end the agreement by promising to raise production by a million barrels of oil a day, reversing the 1.8 million bpd production cut agreement that was installed in January 2017. But after all was said and done, the net “effective” increase is only about 600,000, and that agreement hadn’t been inked by the end of the meeting.

Call it a relief rally: crude oil in the US and in London jumped by $3 a barrel on Friday as word came out that the cartel could manage only a slight increase. The math is complex, but the outcome is nearly certain. OPEC’s initial announcement – tentative only, as all members must sign on to it, along with several critical non-members such as Russia – was to raise production by a million bpd. But not every member of the OPEC cartel is able to increase production significantly. Iran is facing U.S. sanctions and is busy doing “workarounds” to sell its oil under the U.S. radar. Terrorists in Libya have taken about 500,000 barrels of its production off the market, at least until repairs can be completed. And then there’s the unfolding catastrophe in Venezuela that has seen that country’s production drop by nearly a million bpd in just the last year.

The last time the price of crude oil for future delivery jumped this much was when OPEC announced its decision in November 2016 to cut production. The agreement, met at the time with much skepticism that the cartel could enforce it, was to remove about 1.8 million barrels a day from world supplies. Trading at $50 a barrel in early November, crude oil for future delivery jumped to $57 a barrel by January 1, 2016.

Then reality, helped along by U.S. share producers, set in, with new supplies pushing crude oil futures down to $45 a barrel by July.

The same scenario could play out once again: the rise in crude oil prices is likely to be temporary only, as OPEC’s “birthing a gnat” will be perceived as having little or no permanent impact on oil prices. The pressure on oil is inevitably downward.

The fundamentals in world crude oil supplies continue to shift in favor of U.S. oil producers. When OPEC tried to force them out of business by raising production in 2014, weaker producers went bankrupt, costing the U.S. economy some 200,000 oil field jobs. But along the way, the stronger producers kept improving fracking technology, steadily lowering their breakeven costs. Under OPEC’s production cut agreement – allegedly to reduce the crude oil “overhang” in world reserves and “rebalance” the oil market – it made U.S. producers even more profitable.

OPEC’s fatal flaw is that it is a cartel. Ever faced with members seeking their own advantage, its compliance with the January 2017 agreement was remarkable, and unlikely to continue. As oil prices continue to decline in the face of increasing U.S. production, members will see their opportunity to cash in fading away. Other members are just simply unable to increase production even if they want to. Venezuela is in shambles and will take years to recover once Maduro is gone. Libya’s oil fields destroyed by terrorists will not be operational for months. And then there’s Iran.

In the end, OPEC’s death rattle will result from the free market operating in the United States. The contrast between a cartel and a free market is obvious. As Doug Lawler, chief executive of Chesapeake Energy Corporation, said:

We’re not running our business based on what OPEC does regarding supply. We just have to … focus on the technology and the innovation that helps us be efficient regardless of the price.

Ben “Bud” Brigham, founder of Brigham Exploration Company, concluded that “The U.S. has broken OPEC’s capacity to totally control the market. We’re their most significant competitor in terms of production.”

As U.S. fracking technology continues to improve, it steadily relegates OPEC to an ever-shrinking role in the world energy equation. The meeting in Vienna was, in Shakespeare’s words, “much ado about nothing.”


Sources:

Definition of Mojo

The Wall Street Journal: OPEC’s Increased Output Helps U.S. Shale Companies

The Wall Street Journal: Oil Prices Jump After OPEC Deal to Lift Output

The Wall Street Journal: What OPEC’s Solidarity Means for Oil

3-year chart of Crude oil futures

Bio of Ben “Bud” Brigham, founder of Brigham Exploration Company

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