A lot has been made of OPEC's decision last fall to keep its production steady when the market was oversaturated with oil. At the time the decision was viewed as a direct attack on its oil market rivals including Russia, Iran, and the U.S. Clearly, slowing down these rivals by upending oil prices was one of its goals, however, it wasn't the cartel's only goal. That's because another factor that sent oil prices down in the first place was weaker than expected demand growth for oil, particularly in Asia. OPEC knows that the cure for weak oil demand is a much lower oil price.
Shrinking market shareOPEC's control of the oil market was really being attacked on two fronts. The first battle was being waged on its control of a large portion of the oil market. For years it was able to leverage this control into triple digit oil prices as it kept its production level at the point where it would keep the market just in balance enough that prices wouldn't dip below $100. However, that high price of oil provided an incentive to other non-OPEC producers to invest to grow their own oil production, which as the following chart shows worked to boost oil output over the past few years in the U.S., Russia and Canada.
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Because these nations were boosting their oil output it left OPEC with more competition for oil demand. We see an example of this on the next chart as OPEC's oil was being pushed out of the U.S. oil market as surging production, along with a focus on fuel efficiency, reduced America's need for its oil.
As we can see on that chart over the past decade OPEC's oil production has grown by about 3%. However, U.S. imports from OPEC are down 50%. This left it searching for buyers, with Asia, and China in particular, being a top destination due to its rapidly growing demand for oil as we see below.
The issue OPEC has run into in recent years is the fact that Chinese demand growth for oil has been slowing down. That necessitated a new fight to boost demand.
Priming the pump on demandFrom 2003 to 2012 China's demand for oil was growing at about a half a million barrels a day every year according to the U.S. Energy Information Administration. That equated to nearly two out of every five barrels of demand growth coming straight from China. However, as its economy has matured and slowed so has its voracious demand for oil. Not only that but stubbornly high triple digit oil prices have helped keep a lid on demand growth in the country. Because of this the EIA now sees its demand growth being half of what it was last decade by the end of this decade. Signs that China's demand growth was slowing down appeared last fall, which led to the initial drop in oil prices.
OPEC doesn't want to see Chinese demand weaken because of its importance to the overall growth of the oil market. That's why it decided to pass on lowering its production when oil prices started to tumble. Instead, it saw this as an opportunity to not only provide a blow to its rivals but also jump-start demand growth, not just in China but worldwide. That's because economists estimate that for every $10 decline in the price of oil it will add 0.2% to global GDP, which is expected to fuel additional demand for oil. In fact, economists estimate that 300,000 barrels per day of new demand for oil is created for every $10 drop in the price of oil. What this suggests is OPEC is creating a market for upwards of 1.5 million barrels of oil by simply letting oil prices fall by $50 a barrel. It's a plan that appears to be working as the International Energy Agency recently boosted its demand forecast as it sees demand growth accelerating from 700,000 barrels last year to 1.1 million barrels this year.
Investor takeawayOPEC saw two very big threats to its dominance of the oil market. Not only were its competitors rapidly growing their output, but it was coming at a time that demand growth was slowing. The cartel decided that the best way to solve both problems was to let oil prices collapse. It would fuel increased demand for oil while forcing others out of the market leaving OPEC with an open door to really cash in when the tables turn on supply and demand in the years ahead.
The article OPECs War on Oil Prices Isnt Just about Shale originally appeared on Fool.com.
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