A New Oil Price War

Last year’s deal between the member states of OPEC and a number of leading non-OPEC oil producing countries resulted in an immediate 25% increase in the price of oil just before the end of 2016, easing the pressures on oil-producing countries that had suffered from 30 months of low oil prices.  In the months since the sharp increase in the price of oil, these gains were held and the price of oil remained remarkably steady.  However, reports that a number of countries were not meeting their oil output reduction targets led to Saudi Arabia announcing that it had increased its own oil output, a development that led to a 9% drop in the price of oil in recent days.  Furthermore, there are a number of signs that suggest that the deal on cutting oil output could be on the verge of collapsing.  Should this happen, there will be major implications, not just for oil-producing countries, but also for the entire global economy.

From the time it led efforts to cut global oil output until its recent decision to announce that it had raised its own oil output in response to other countries cheating on the oil production cut deal, Saudi Arabia has clearly been attempting to reassert its authority over the global oil industry.  For decades, Saudi Arabia had more influence over the industry than any other country thanks to its abundant oil supplies and the extremely low cost of extracting oil in Saudi Arabia.  However, the expansion of non-traditional oil centers such as the shale oil industry in the United States or the oil sands industry in Canada has significantly weakened Saudi Arabia’s influence over the industry.  This led to Saudi Arabia leading efforts to convince OPEC and many non-OPEC oil producers to cut oil output late last year.  However, Saudi officials feel as though many of the countries that signed on to this deal have failed to cut their oil production levels as much as they promised to when they signed on to this deal.  As a result, Saudi Arabia announced recently that it had raised its own oil output by 2.7% last month, thus failing to meet its pledge to further reduce the country’s oil output as part of the global deal.  However, it should be noted that, this announced production hike may not have actually occurred and may have been nothing more than a warning to its deal partners to hold up their end of the bargain.

Saudi Arabia’s chief concerns in recent weeks have been reports that many of the countries that are part of the deal to reduce oil output have not kept their promise to reduce production.  For example, OPEC member states such as Venezuela and Angola, two countries in the midst of severe economic turmoil, were reported to have failed to comply with their agreements to reduce oil output in early 2017.  Likewise, countries such as Kazakhstan and Azerbaijan that are outside of OPEC but were part of this latest deal were also reported to have not complied with the terms of the oil production cut deal.  Furthermore, Russia, the country that led efforts to bring non-OPEC oil producers into this deal, was reported to have only made one-third of its promised output reductions in early 2017.  Meanwhile, the 25% increase in the price of oil that followed last year’s deal led to a massive increase in the number of oil drilling rigs in use in the United States, highlighting that country’s new role as a key determiner of the global price of oil.  Altogether, the developments of recent weeks have shown how Saudi Arabia’s influence over the global oil industry has waned as the industry has diversified greatly in recent years.

As was the case before last year’s deal, supply and demand factors are both leading to increasing downwards pressure on the price of oil.  On the demand side, sluggish economic growth and a greater use of other sources of energy have prevented global demand for oil from rising as fast as oil-producing countries had hoped.  While demand growth remains weak, supplies of oil remain high, as evidenced by the fact that oil inventory levels rose in most of the world’s leading economies in early 2017, despite the production cuts that were made in the wake of last year’s deal.  Moreover, while the 25% increase in the price of oil at the end of last year was welcome news for the world’s leading oil producing countries, it was not enough to repair the damage done to the economies of many of these countries.  With economic struggles continuing in oil-producing countries such as Russia, Nigeria, Venezuela and elsewhere, the temptation to further increase oil output will remain great.  Furthermore, any future increase in the price of oil will prompt a surge in production in places such as the United States, Canada and elsewhere.  As a result, the downward pressure on the price of oil is forecast to remain in place and the likelihood of a collapse of this deal to cut oil production will continue to rise in the coming months.