Oh Heck, OPEC!

OPEC, the Organization of the Petroleum Exporting Countries, along with Russia, met earlier this month to discuss primarily a cap on oil production. Prices have been languishing of late, and the simple reason for this is there is far too much of the stuff. Oil production is severely outweighing oil demand; stockpiles are rising and prices are falling.

OPEC (et al) met in Doha, and tried to outline the production limit and the terms that this would need in order to be put into practice. Iran simply refused to stick to any such production limit, and if one country fails to agree, well, the whole idea is off the table.

One of the major reasons that Iran didn’t want to take part in the production limit is down to nuclear sanctions that were place on the country. Although these were lifted at the beginning of the year, their enforcement has severely damaged Iran’s oil market share. By refusing the production limit, Iran hopes to regain some of this share, although it is a risky strategy, which could see prices continue to stay low.

Iran simply refused to stick to any such production limit, and if one country fails to agree, well, the whole idea is off the table.

But Low Prices Are Better Than No Prices, Right?

Production costs, that is to say how much it actually costs to remove a barrel of oil from the ground, vary wildly from country to country. A lot of factors are at play here, everything from local wages to age of extraction equipment to, even, the pressure that the oil is at in the ground. But what is simple to understand is this; it is considerably cheaper for the Middle East to extract oil from the ground, and that is why they are able to make a profit even when prices are languishing.

At the moment, oil is back around the $45 a barrel mark and although that seems low, it is actually the highest level its been since November. At that price, oil remains a viable profit margin for most OPEC producers. It costs Saudi Arabia around $9.90 to produce a barrel of oil. Iran pay slightly more at $12.60. Russia, it’s around $17.20, and Venezuela pay some of the highest prices in OPEC at over $23.

But let’s put that in perspective. The breakeven point for the US is around $36.20, which means that they are making less and less with every barrel sold. Obviously, this isn’t a strict black and white issue about money invested production versus profit made from selling, because there are options with what to do with the stock and how to recoup the investment, but for now, you cannot escape the fact that the US is at risk of making very little profit (if any) if prices hold or drop from this level in the long-term.

For OPEC a production limit would help to boost their profits margins, but at the moment they are still rather healthy. Arguably America would be the main beneficiary of this production cap, and so the decision is as much about profit as it is politics.

So Why Are The Producers Still Selling Oil?

It would seem like a bad time for Iran to get back into the oil market, right? You know, with demand at an historic low, and production peaking at historic highs for many countries. But, sometimes is isn’t about money, moreover it is about market share.

Iran have reentered the market, having had their share drop to zero during the years of sanctions. But now they are halting the OPEC production cap with the simply intention of regaining market share. Although they will be, if prices continue to drop, taking a hit on their oil now, capturing a percentage of the market share also means that when the prices eventually recover, Iran can capitalize on them and make a tidy profit.

At the moment, the US is struggling to keep its market share, with the number of producers in decline. Iran (and most of OPEC) are able to hold out and maintain their share, simply down to a lower breakeven point which ensures they can hold their position in times of austere prices for longer.

Going forward, we will see a recovery in oil prices at some point, but it will be of interest to see which countries have been able to ride out the period low prices.

But Why Don’t We Need So Much Oil Anymore?

The glut of oil that we are experiencing now is both a combination of economic slowdown in global powerhouses like China, and the increased production levels. Despite the lower prices, the US hit a 43-year production high earlier in the year (whist they try to maintain market share). Saudi Arabia is also pumping record amounts, so whilst the number one importer of oil (China) sees its economy slowly grind to a halt, the world seems to be having a boom year with oil production.

It doesn’t take an expert to see that is simply unsustainable, but many are pointing that out.

Normally, low prices would help boost the global economies, but this isn’t happening at the moment. In fact, production in the US is falling.

So What Does The Future Hold?

If you are looking at news, and reacting accordingly, like the majority of the investment world, you’ll know that OPEC are set to meet again in June. No doubt a production cap will still be on the agenda, but something significant will have had to happen for Iran to suddenly decide that this is something they are happy to consider.

Expect that volatility will return to the markets the closer we get to June’s meeting. And expect that investors and traders will try to second guess what influence the talks will have on the markets.

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