Opec+ and the US are fighting a silent price war

Alamy via Reuters Connect

A silent oil price war is under way between the US and Opec+ – and there is little by way of reprieve in sight. 

Opec+, the powerful oil collective led by Saudi Arabia and Russia, appears to have elected thus far to keep its oil price within a band of $80-$90 per barrel. To that end, the 12-member body has repeatedly voted to maintain cuts in oil production over the last year.

Now investors await this weekend’s Opec+ meeting. Most traders expect the body to maintain restraint into the third quarter.

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However, North America’s vast shale oil reserves have given the US its own clout. Some experts call the US the global “swing producer” – an honour formerly bestowed on Saudi Arabia.

Now, whenever Saudi Arabia-led Opec+ orchestrates production cuts, the US ramps up production and the oil price neutralises.

Furthermore, modern shale technology facilitates the opening and closing of oil taps with ease, unlike conventional production methods that can take months to bring oil on stream.

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Back in September 2022 the US produced 12.33 million barrels per day (bpd), while Saudi Arabia produced 11 million bpd. However, fast forward to April 2024 and US production stands at 13.13 million bpd and Saudi Arabia at just 9.25 million bpd.

US production is mainly orientated towards internal consumption, while Saudi Arabia is a major oil exporter.

The idea behind Opec+ production cuts is to stabilise the oil price, or generate higher prices as most of the cartel countries require a certain oil price threshold (breakeven oil price) to balance their books.

Saudi Arabia’s fiscal balance dipped into the red by more than 15 percent in 2015 when the average oil price crashed to $53.6 per barrel.

However, the kingdom’s fiscal balance turned positive by 2.5 percent when oil prices increased to $99 per barrel.

There is thus a clear incentive for Opec+ to keep oil prices above $90 per barrel to maintain balanced budgets.

To understand this price war fully, the larger context of energy markets must be considered. The world is still heavily reliant on fossil fuels, despite rapid strides in renewables.

While governments contend with intense pressures to transition to clean energy due to climate change, the ambition is at odds with the on-the-ground reality.

For example, against the need to add 500GW of additional renewable annual capacity to enable the transition, the current rate of annual capacity addition globally is just 150GW.

To put it another way, capital expenditure on renewables is running at a global rate of $300 billion annually. However, a sum closer to $1 trillion per year is needed to close the energy gap sustainably.

While governments contend with intense pressures to transition to clean energy due to climate change, the ambition is at odds with reality

In contrast, the global oil and gas sector invests about $500 billion annually in maintenance and development.

This steady flow of funds to conventional energy players, paired with under-investment in renewables, will only lengthen the time to transition. Some reports estimate that it will take another 50 years for the world to wean itself off fossil fuels.

In the past, whenever Opec+ initiated supply actions – whether increasing or decreasing – it saw instant results in the form of price. At that point, Saudi Arabia enjoyed the coveted status of being a swing producer. Opec+ held sway over oil prices.

Saudi Arabia tended to treat this swing producer status with responsibility, mindful that the bulk of its clients were emerging markets with extreme sensitivity to high oil prices.

Since 2014 however, Saudi Arabia has run fiscal deficits (except for one year in 2022). The IMF is also forecasting deficits for the period 2024-2029, averaging about 2.5 percent of GDP as the kingdom spends like never before on development projects. The country therefore badly needs the support of a buoyant oil price.

Given this context, Saudi Arabia, along with Russia and other Opec+ members, will do its best to keep production under check and not let the price drop below a floor of around $80 per barrel. 

At the same time, the US will continue to play the role of swing producer to prevent oil prices from spiking above $100 per barrel, which can be understood as the ceiling. 

Thus far, this oil price war has taken place calmly and quietly within this band. Barring any major geopolitical developments, both parties will continue to hold their respective positions.

But it should be noted that the US has benefitted more than Saudi Arabia. North America enjoys higher production and higher prices, while Saudi Arabia pays dearly in the form of lower production and weaker prices. 

Looking forward, Opec+ must contend with two thorny challenges – the ability of the US to fill supply gaps, and the rapid growth of renewables. The latter trend is especially important as it will greatly reduce the global need for fossil fuels.

However, the triumph of renewables and the demise of fossil fuels is likely to be a long time coming.

M R Raghu is CEO of Marmore Mena Intelligence, a research subsidiary of Kuwait Financial Centre (Markaz)