OPEC isn't dead, it's shifting strategies

Carlos Garcia Rawlins/Reuters

OPEC is the ultimate cartel, it was formed to get its members a better price for their product than the free market would allow, and the members did that by working together to restrict supply.

There is a reason that governments outlaw cartels, they prevent prices finding their true level and they transfer wealth from consumers to producers.

But when the cartel is made up of governments, well there is no-one to outlaw them, so instead they become revered bodies charged with bringing stability to markets and protecting the interests of producers and consumers. That's OPEC.

But there is only one reason for OPEC's existence and that is to make the oil price higher than it would be otherwise; everything else is window dressing.

In Vienna OPEC wrong footed everyone by abandoning the quota limit for OPEC production. Of course everyone knows that the quotas were widely ignored anyway but if you look back over the past few years, as Javier Blas has done (see his tweet below), there is at least a correlation between OPEC's actual production and the declared limit.

Tweet Embed:
https://twitter.com/mims/statuses/673052459007389696
#OPEC doesn't look like the #oil cartel Kissinger once said was able to "blackmail" the U.S. https://t.co/as1GiVaAGu pic.twitter.com/XLSmSfIk3U

 Now the limit has gone missing, so does that mean the cartel is finished and that OPEC is a dead duck? It is probably not dead; it's just resting, or perhaps the better phrase is regrouping.

One massive problem that OPEC has had for years has been the allocation of the overall quota amongst its members.

Some countries claim this capacity or that capacity, or this reserve base or that reserve base, and when Iraq is rebuilding its productive capacity and Iran is claiming it will increase production by 500,000 bbls/day as soon as sanctions are lifted, the whole problem gets more and more intractable.

You might wonder why they argue about the numbers but the great bonus of having OPEC recognize a productive capacity larger than one's actual capacity is that then a cut to that limit might not actually require a reduction in production at all, and all without the appearance of cheating – which is a tad harder now that satellites can track tanker movements at will.

So what I suspect may be going on is a recognition that, for good or ill, the Saudi strategy has become OPEC's strategy and that OPEC will pump (or is pumping) all it can; and given that, the organization has no better opportunity for calibrating each member's potential oil production capacity than by measuring what everyone can actually produce when everyone is flat out.

Most OPEC production cuts in the past were really Saudi production cuts. To bring the market into balance a cut of 1.5 million barrels per day would do the trick.

If every member were honest and really did cut production that would only require a 5 percent reduction in production, and that could easily generate a 30 percent uplift in the oil price. But if the past is a guide to the future that would really be a 15 percent cut for Saudi Arabia and no cut at all for anyone else.

Whilst everyone thinks OPEC is in disarray and that it can no longer function as an effective cartel, the abandonment of the quota level for the organization could end up being a pre-cursor to the establishment of a new reality based set of quotas for everyone.

Another six months of low prices may just be enough to convince the serial cheaters (I'm looking at you Venezuela and Nigeria) and the less disciplined members of the group that when Saudi relents and says, "it's time for a new set of quotas," all members may play fair for a while.

So I suspect that rather than giving up being a cartel, OPEC is actually preparing itself for a new and perhaps more effective phase of its existence.

NOW WATCH: This 3-minute animation will change your perception of time