Comments by Jean Francois Seznec, Stimson trustee, on current Gulf issues

April 02, 2013

OPEC is not dead, nor about to die, but that its influence on prices today is minimal.

The quota system never really worked well, except perhaps in 1999 when the Saudis convinced, or actually bullied, all the producers to cut production to increase prices. Saudi Arabia was then, and still is, the only country with substantial excess capacity. In 1998/1999, Ali al Naimi probably decided that most producers, which were flooding the markets to gain market share, needed to be taught a lesson through unbearable low prices. Saudi Arabia increased production by a mere 500,000 b/d in a market glut bringing prices down below $12/b. Most producers quickly agreed to cut.

However, the first cuts did not come from OPEC as an organization but because of an informal arrangement between the Saudis, the Norwegians, the Mexicans and the Russians. These four countries decided to cut production by a mere 1 million b/d prices, which resulted very rapidly in a doubling of prices from $20 to $40. At that point, all producers, including those of OPEC, remembered that oil is an inelastic commodity and joined the bandwagon to instigate further cuts, which brought prices closer to $80/b.

In 2013, there is no real quota system. The cuts initiated in 1999 have been forgotten as demand picked up. In 2013 all OPEC members [except Saudi Arabia] still produce at capacity, with the Saudis making up for the shortfalls of Iran [1.5 million b/d] or of others as needed. The promised large increases from Iraq have been small in real terms and production has remained steady at 3.0million b/d for about a year.

Today prices hover around $110 Brent. They have been stable for the past three years and are likely to stay that way for some time. I would disagree with those who say that demand is declining because of the recession and because of increase production in the US. Of course, production in the US is increasing rapidly, but demand in the US has picked up as well. According to the Oil and Gas Journal, overall US demand is still at 18.3 million b/d, up a bit from last year. In February 2013, US demand is met by 7 million b/d of local production of crude up 21% year on year while imports have declined for crude and products by only 1 million b/d from 10.9 million b/d to 9.9 million b/d.

At the same time demand in other parts of the world, has increased, and is expected to continue increasing. The overall world demand, as extrapolated from MEES is now at about 90 million b/d, increasing at about 1 million b/d each year. Supplies from outside OPEC have been steady for the past two years at about 58 million b/d. The new suppliers of East Africa are barely meeting the decline of the old producers. Chinese and Indian demand is expected to keep increasing along with their still substantial economic growth, Furthermore, the OPEC members themselves are using increasingly larger volume of their own crude to produce electricity, desalinated water, petrochemicals, and for transportation taking a few million b/d off the market. In other words supply barely meets demand. Hence prices are stable.

This stability of supply and demand means that OPEC can continue on its merry way without great conflicts between members as they are all making as much money as they can, except for Iran. Should Iran ever rejoin the rest of the world, they will be able to raise production, but that does not bother most OPEC members today, as it will take some time for the Iranian to increase production back to its old days of 3 million b/d of export. By then the end of the economic crisis in the West and the increases in demand from Asia and from the producers themselves may easily absorb their extra barrels, as well as those new ones from the US.

Hence, OPEC has not been much of a cartel for the past thirty years. In my view, with price remaining stable, it will continue as a comfortable club in which members exchange information and try to understand market trends and new technologies.

Dr. Jean-Francois Seznec is a Stimson Trustee. He is a founding member and Managing Partner of the Lafayette Group, LLC, a US based private investment company. Previously, Dr. Seznec served as a Visiting Associate Professor at Georgetown University's Center for Contemporary Arab Studies. His research centered on the influence of the Arab-Persian Gulf political and social variables on the financial and oil markets in the region. Dr. Seznec has 25 years experience in international banking and finance of which ten years were spent in the Middle East, including two years in Riyadh at SIDF and six years in Bahrain covering Saudi Arabia. He uses his knowledge of business in the Middle East and the United States to further his analysis of the Arab-Persian Gulf.