OPEC is running out of options.
The price of crude has plummeted 13% in recent weeks to below $46, suggesting that the cartel’s efforts to vanquish cheap oil are falling short.
OPEC and other major producers had been enjoying higher prices since agreeing in November to slash production, a strategy designed to rid global markets of excess supply.
Now, the magic appears to be wearing off.
The cartel has responded to the sharp decline in prices by suggesting that cuts could be extended far beyond their original mid-year deadline.
“I am confident the agreement will be extended into the second half of the year and possibly beyond,” Saudi energy minister Khalid Al-Falih said Monday, according to Reuters.
But with American producers increasing production, extending the freeze may not be enough to stabilize prices or send them higher.
Energy ministers from OPEC members are set to meet on May 25. Here’s a look at their options:
Extend the cuts
OPEC and other major producers agreed to production cuts only after prices dropped as low as $26 in 2016. Getting all the major players on the same page took months of negotiation.
For a while, the strategy appeared to be working, with prices drifted north of $54 earlier this year. That’s right in the cartel’s sweet spot of $50 to $60 per barrel — just high enough for OPEC countries to budget comfortably, but low enough to keep other key producers on the sidelines.
The cartel has a new problem, however — and one that it cannot easily control: American shale producers.
U.S. oil producers have returned to the market with force, doubling the number of rigs in operation over the past year. Years of low prices have forced them to become much more efficient.
Analysts at UBS estimate that U.S. producers can now make money as long as prices remain above $40 per barrel. That’s down from $65 in early 2014.
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The upshot is this: OPEC and other major producers can agree to extend their production cuts, but if prices remain above $40, American producers will keep pumping.
And that means excess supply is likely to remain a problem for the foreseeable future.
Squeeze the Americans
OPEC could reverse course and increase production in an effort to squeeze U.S. producers out of the market.
“If they decide not to extend cuts and ramp production back up we would probably see prices fall,” said Tom Pugh, commodities economist at Capital Economics.
Pugh said that such a strategy would surprise investors, and send prices below $40.
The strategy, however, failed miserably the last time it was tried by the Saudi-led cartel. The group pumped without concern for price starting in 2014, and U.S. producers did idle operations.
But it also had a disastrous effect on the government budgets of OPEC members, forcing them to implement austerity measures.
While many Gulf countries have since implemented reforms to reduce their reliance on oil, other major producers including Russia and Nigeria won’t want to risk another price war.
Investors are now expecting OPEC and its allies to extend their production cuts.
“They have got themselves between a rock and a hard place, because they have now talked about extending the agreement so much,” said Pugh. “If they don’t do it, we could see prices drop to the low forties again.”
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If no deal materializes, the cartel could decide to muddle through in hopes that stronger demand in the second half of the year will reduce some of the supply glut.
Doing nothing would amount to a major policy shift, but perhaps one that’s worth trying.
“I think [OPEC] are now acutely aware that they don’t have the kind of influence they used to have 10 years ago, and that shale is now the swing producer in the market,” Pugh said.
OPEC is running out of options.