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Venezuela – The Cost of OPEC’s Price War

Venezuela is having a hard time – the low oil price has disrupted the country’s economy by causing a food price inflation. Their proposed solution? Fixed oil prices! But the idea was not even on the agenda of the latest OPEC meeting. The long term oil market, however, will be discussed on the 4th of December in Vienna, OPEC meeting number 168 – another turning point?

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“Hey Doc, we better back up. We don’t have enough road to get up to 88.” That sadly might be true for the Venezuela as its economy teeters on the brink.

This week as OPEC staff were holding an unusual meeting with five non-member states, calls were once again made by Oil Minister Eulogio del Pino for a change of direction – back to the 1980s policy of fixing oil prices, with a proposed $88 pb as a potential target. “We are concerned about the depletion of reservoirs and about the decline of production,” he said. “We are talking here about an equilibrium price to sustain the production.” Back at home the president Nicolas Maduro told workers he was “doing everything to save the price and the stability of our oil.” Lower oil prices have crippled the economy there with a 22% spike in food price inflation leaving the country with trouble even feeding itself. To tackle this, Maduro recommended a $70 floor.

A price band is a tried and tested method of tackling times of crisis. When oil tanked in the late 1990s to prices of $10 pb OPEC did indeed interfere with the market and set prices at $22 – $28 pb. The policy ended in 2005 only as prices soared with increasing demand. Some analysts said this proposal, supported by former oil minister for Venezuela Rafael Ramirez, might act as a catalyst to effect change in OPEC’s policy. “I think this one might have more substance,” said Paul Horsnell of Standard Chartered who has spent the last twenty years writing about oil markets and OPEC. “Signing up to a $70 – $100 band doesn’t seem too difficult. As long as there is no automatic mechanism linking the band to output it seems a very low cost way of expressing solidarity with the aspirations of other members.”

It seems expressing solidarity was not top of the agenda – the idea was not discussed at OPEC’s meeting.  One delegate said it was “unrealistic”. The Persian Gulf countries and Russia have no apparent interest in cutting production. Another OPEC delegate said, “OPEC made it very clear months ago they will not interfere to control prices and it is the market that should do that.” Instead the group of members and non-members agreed to meet again after the next full OPEC meeting on December 4th. It will then assess the long term oil market.

The group believe any cut would be pointless if the US producers are able to flood the market. However those fears are questionable with signs that output is flatlining as producers run out of ideas to pump more with less return. The EIA suggests there could be a fall greater than 10% in less than a year. There are three key reasons why this is happening: shale oil well output drops by 70% in the first year; cost cutting has led to producers drilling shorter and cheaper vertical wells; and finally firms are reluctant to invest in new rigs while process are so low.

The uneasy relationship between OPEC and Russia is one reason why OPEC is reluctant to cut production with no guarantee of a reciprocal approach. However with Russia being offered illusive OPEC membership this could change. An oil alliance between the world’s two biggest oil producers would dominate the market. So far Russia has not walked into its warm embrace citing technical reasons, however the more likely reason is the fight for control of China’s yuan. Whether this can be agreed in negotiations remains to be seen.

Marty McFly asked in 1955, “What happens to us in the future?” and thought of 2015. Venezuela’s main concern right now isn’t the future 60 years from now, but rather 42 days. That is when OPEC members gather in Vienna for their 168th meeting, one year on from the meeting which changed the world. Will this one?