At an energy conference this past weekend Saudi Arabia's OPEC governor Mohammed al-Madi quashed the idea of a quick return of triple digit oil prices. According to a Reuters report he said that, "$100-$120 I think its difficult to reach $120 another time" suggesting that OPEC won't be cutting its production anytime soon in order to boost the oil price. Instead, it looks like OPEC is planning to stand pat and just wait until demand picks up enough to push the price of oil back up to its highs of last summer.
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A shift in policy
Up until last fall it was a largely held belief that OPEC was more concerned with keeping the oil price elevated than anything else. Most of its members had become accustomed to a triple digit oil price and needed that price to balance fiscal budgets. The Saudi OPEC governor acknowledged as much by saying that, "we understand that all countries need higher incomes ... we want higher income, but we want higher incomes for us and future generations." It's that last part about wanting higher incomes for future generations that's really the key reason why it hasn't cut production this time around. OPEC wants to make sure it stays relevant in the decades ahead.
That idea was reinforced by other statements al-Madi made at the conference. He made it clear that OPEC is looking out for itself by saying, "Was OPEC able to control prices? The answer is, if OPEC could have controlled the prices it would have done so, but it is not in the interest of OPEC to control the prices." In other words OPEC could have kept the price of oil in the triple digits, but that wasn't in its best long-term interests.
It's all about market share
The reason high oil prices aren't as important to OPEC at the moment is because demand for oil has been less robust than expected. So, if it kept the oil price high by cutting its own production it would have funneled profits and market share to higher cost competitors. That's because higher oil prices are necessary to fuel the investments needed to grow higher cost production like shale, deepwater and the Canadian oil sands. Basically, if the oil price remained well over $100 because OPEC cut production these competing sources of oil would have taken market share from OPEC, which would have diminished its ability to control the market in the future.
In order to discourage these investments OPEC let the oil price fall when demand for oil was less than expected. The Saudis also made it clear that this stance to stand firm on production isn't being made for political motives, such as putting pressure on diplomatic rival Iran. Instead, this is purely an economic move that is all about maintaining its share of the oil market. He made this point by saying,
There isn't any political dimension in what we do at the oil ministry-our vision is commercial and economic ... We didn't mean to hurt anybody, our vision is simply the following: the producers which have low costs have to have the priority to produce, but those who have high costs have to wait for their turn to produce.
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Further, he insisted that OPEC isn't trying to wage a price war with U.S. shale producers. He said that, "We are not against anybody or against the (production of U.S. shale oil) ... On the contrary we welcome it, as it balances the market in the long run." That being said, while OPEC might not be against shale it certainly won't keep the price of oil artificially high so that U.S. shale producers can take profits and market share at the expense of OPEC. Therefore, it's going to keep flooding the market with oil until supply and demand balance out.
The comments over the weekend by the Saudi OPEC governor suggest that OPEC isn't planning to cut its production any time soon to boost the price of oil. That's not exactly encouraging news for the beleaguered oil industry as it suggests that it could be a while before the price of oil recovers to its previous high. However, low oil prices do tend to spark new demand for oil so the longer prices stay low it could lead to a much more sustainable high for oil prices in the years ahead due the robust demand created by what are now artificially lower oil prices.
The article OPEC Says You Can Forget a Quick Return of $100 Oil originally appeared on Fool.com.
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