Who is Really Responsible for the Increase?
Anwar Altaqi – Esam Aziz
The U.S. Senate Judiciary Subcommittee on Antitrust, Competition Policy, and Consumer Rights is set to hear testimonies regarding a bill that would change antitrust laws and allow the United States to sue the Organization of the Petroleum Exporting Countries (OPEC). The likelihood of passing the bill, called the “No Oil Producing and Exporting Cartels Act,” or NOPEC, was once thought to be a long shot.
But due to President Trump’s frequent criticism of OPEC in recent months, the bill could pass. It is true that higher oil prices hurt emerging and developed economies alike. The damage in the case of poor countries is even deeper. But is it really OPEC that causes prices to rise?
For countries that import large quantities of oil, like India or Indonesia, lower oil prices were a blessing. For those that export oil, like Russia and Brazil, lower prices were obviously a curse. This is reflected in the exchange rate of the currencies of each country in the two categories. For example, and because the dollar exchange rate is reversely correlated with oil prices, the Russian ruble has risen 12 percent against the dollar during this year.
Thus, the ruble is one of the top performing emerging market currencies this year so far. Moreover, the ruble benefitted from the increase in oil prices and is one of the highest-yielding Emerging Markets (EM) currencies right now with a key interest rate of 10.5 percent.
On the other hand, a country like the Philippines, dependent on imported oil, is suffering due to the increase in crude prices. Every dollar movement in the world oil price will have an impact on the local pump price, coupled with the devaluation of the Philippine peso to the U.S. dollar.
Yet, blaming OPEC is, to say the least, unfair. Due to the financial crisis and recession that followed, oil prices crashed as demand was drastically down. This led to an oversupply, and hence, market imbalance. Investments in oil and gas were severely cut with prices repelling investors. Records show that new oil and gas discoveries were at their lowest since the early 1950s. To put this into perspective, the new discoveries in 2017 were only enough to meet 10 percent of the demand.
The reasons are simple: The return on investment allocated for exploration was not encouraging due to lower prices. Moreover, it is getting harder to find large discoveries, known as “elephants,” and most of the prospective areas have already been explored. The cost of maintenance is critical in areas where asset infrastructure is aging. Current production from existing oil fields is declining, and the rate of decline is accelerating by four percent annually. In addition, in some countries like Venezuela, Libya, and Iran, geopolitical issues continue to disrupt supply.
Workforce reductions made during the recession resulted in the loss of technical skills, and damaged the industry’s ability to attract new talent. Operators acknowledge the gap between the expanded capabilities needed, on the one hand, and their diminished capabilities, on the other. There is also the expected demographic shift as a large portion of the sector’s aging workforce retires.
But where is the responsibility of OPEC in all this?
Emerging economies have to find ways to encourage exploration, drilling, and producing. For instance, in the case of the Philippines, the average annual drilling is five wells in the past 10 years, which is way behind ASEAN neighbors of Myanmar (29), Malaysia (81), Indonesia (903), Thailand (594), and Vietnam (43). Incentives to private capital helps along these lines once drawn together with investors in the field of energy in the country or its region.
As for developed economies, they know already what drives prices upward. The International Energy Agency (IEA), the Paris-based energy watchdog, said: “It is too soon to say what will happen this time but we should examine whether other producers could step in to ensure an orderly flow of oil to the market and offset a disruption to Iranian exports.” Geostrategic factors play an important role as we have seen after the U.S. decision to re-impose sanctions on Iran and Russia, and from internal troubles in Libya and Venezuela.
Still, no sign of OPEC.
When oil went as low as $30 per barrel, OPEC did not point its finger towards the United States with accusations that it caused the fall. Moreover, OPEC and Russia decided to increase output when the United States decided to shut out Iran exports. The two players were reversing their previous step to curb production in order to prevent the sale of oil at prices cheaper than bottled water. If they left the spiral in its downward direction, we would later see oil selling at $200 a barrel, as investors would abandon the sector altogether.
Saudi Arabia, the leading producer in OPEC, gained a new reliable partner during this episode of fighting to regain balance in the market: Russia.
We do not understand why President Trump has the impression that OPEC alone is responsible for higher prices of oil.
Furthermore, the political and economic crisis affecting Venezuela has resulted in its crude production going into free-fall. The collapse has tightened oil markets much more quickly than anticipated, experts say. Output is down so much that Venezuela has cut production (though by force) even more than Saudi Arabia, OPEC’s biggest producer. The ongoing escalation of tensions between Saudi Arabia and Iran, as well as continuing conflicts in Iraq, Libya, Syria, and Yemen, have taken their toll on the region.
These are all either geostrategic or political and economic troubles. Nowhere in the picture of today’s market do we see OPEC playing a questionable role to artificially raise prices. President Trump should pay more attention to the supply-demand balance and to the various ongoing crises throughout the world. They are playing a larger role than the justified action by OPEC to bring balance to a market that was increasingly collapsing.