Did OPEC Bite Off More Than It Can Chew?

In our previous article (Crisis of Capitalism? Two Missing “Black Swan” Events), we envisioned that the combined weak western and global economies coupled with the Coronavirus COVID-19 pandemic and, then crowned by the Saudi/Russian/UAE flooding of the oil market to crash prices and drive out the US Shale oil producers, could devastate the US and global economies. We didn’t think the US would stand idly watching as one of its major economic and strategic pillars crumbles but expected it to react, in stages and degrees of severity.

While the infirmity of the global economy is too advanced to save the multiple bubbles, deficits, and debts from popping, we may witness a few ‘last-stands’ to divert or delay the looming disaster of collapse or severe recession.

Stage One:

The first reaction would be directed towards mitigating firstly the damages from the Corona Virus and secondly countering the oil price crash and attempt to halt it and/or partially reverse it.

As for the mitigating part, the US Government has already announced its intent to launch financial assistance stimulus packages and promised more for other affected industries and sectors, including Shale oil. So far, the advertised size of this stimulus has reached approx. $ 2 Trillion and could, thereafter, easily rise substantially. So, if this doesn’t jump-start the economy, it will end up atop the rapidly growing $23+ Trillion Govt debt mountain, which could further weaken the economy.

To counter the oil price crash, the US govt has announced its intention to initially buy approx. 30 million barrels of crude oil for its strategic reserve. This sounds positive and may assuage the growing fear and panic in the markets, but in fact, it only amounts to about 2.5 days of US production and would last approx. 7 days, at the mandatory withdrawal limit of 4.4 million barrels per day. Hence, as the US produces approx. 12.8 million barrels per day and consumes closer to 20 million, this action doesn’t really relieve the economy nor the industry.

Stage Two:

This stage has taken the form of diplomatic and political maneuvering to decouple Saudi from Russia and deal with each separately, i.e. halve the problem and turn it into two smaller problems, each with a different method of dealing with.

Here, the style tended towards ‘moral suasion’ plus sweet talk. It kicked off with the media laying it thick in praise of Saudi, reminding it of its long and commendable role as a force of stability in the oil markets and encouraged it to continue being so – however, no mention was made of the 2014/2015 oil flooding attempt or the oil embargo of 1973/74.

This was followed by reports that a senior US energy official will be sent to Saudi for a few months to negotiate an oil stabilization agreement.

In parallel, a member of the Texas Railroads Commission, which regulates Texas oil & gas affairs, got in touch with the OPEC chairman and proposed to cut the US oil production by 10% from its pre-COVID-19 pandemic level, if both Saudi and Russia agreed to do the same; he reckoned this would lift WTI prices to the mid $ ’30s per barrel and make everybody happy.

However, the US State Dept promptly disavowed such a proposal clearly stating that the Federal Govt has no authority on such matters and it is up to each state to individually decide and commit. Additionally, the Chairman of the Texas Railroad Commission, which regulates Texas oil & gas affairs, unequivocally stated that this production cutting proposal was totally impractical. And lastly, the US oil industry representatives ridiculed such a proposal, describing it as conflicting with their free-market and anti-quotas orientation.

So, what was this exercise all about? It suspiciously appears as a ‘click-and-bait’ ploy to dislodge Saudi’s, and possibly Russia’s, resolve by injecting fictitious alternatives to their survival plan.

Stage Three:

The next stage will be more aggressive, and some indications are beginning to surface. Ten US senators began putting pressure on the Saudi ambassador to the US to back down from excessive oil production, and thirteen senators wrote a letter to the Crown prince of Saudi Arabia reminding him of the long and mutually beneficial relationship between Saudi and the US and, finally, one senator sent an outright demand to President Trump to place an embargo/sanctions on Saudi, OPEC, and Russian oil.

It is not as though the US is a major customer of OPEC oil, especially after Shale came into the picture, but the US controls all the strings to production technology, equipment, oil futures’ markets, shipping, banking & money transfers, arms sales, ammunition, etc., which would throw OPEC countries in a vicious eddy if they did not heed the writing on the wall. Russia, already under US sanctions, is a big boy and can take care of itself, but the OPEC members are, comparatively, helpless.

Stage Four:

If all fails, the battle will become much more ferocious and the ‘Ace of Trumps’, no pun intended, could be played. NOPEC could be deployed and used as a Damocles Sword over all OPEC members.

NOPEC is a law that criminalizes OPEC’s production quotas and price-fixing actions and considers them monopolistic according to the US Sherman Act. Its distinction is that it removes the sovereign immunity of the OPEC and OPEC+ countries and makes them subject to the American courts. As far back as 2000, NOPEC has been repeatedly submitted in the US Congress but was always opposed by the sitting US presidents and threatened with a presidential veto. That is until President Trump, who has declared his support for such a law as far back 2011.

Nevertheless, the pre-election opinions of presidents usually change once they are in the driving seat and properly comprehend the facts of the real world and international relations. A prime example is President Obama’s switch from a pro-NOPEC voting senator to a NOPEC veto threatening President. Similarly, Hilary Clinton voted for NOPEC in one of its early iterations and then became Secretary of State.

Despite the above-normal tendency, President Trump has exhibited an entirely different style when dealing with problems, be they local or international. Accordingly, one could imagine that he is more likely to use NOPEC as a tactical tool to achieve his short-term goals, regardless of its impact on others. So, if OPEC+ doesn’t respond to the US demands, NOPEC’s passage in congress could swiftly progress and promptly land on President Trump’s desk.

OPEC Countries’ Options:

The implementation of NOPEC would be devastating to OPEC members, especially the Gulf Arab oil producers. Their oil revenues not only don’t cover their budget expenditures, but most of their multi-trillion Dollar wealth is in the form of investments, deposits and sovereign wealth funds in the US and other pro-NOPEC countries. In short, the OPEC countries could easily find themselves illiquid, if not bankrupt and, hence, perfect candidates for a failed state scenario and/or a regime change target. Such an act would certainly bag-in more than the seven originally Middle Eastern countries targeted to be destroyed (as stated, a few years back, by General Wesley Clark).

In the face of such extreme nefarious actions, the OPEC countries would have three options. They could toe-the-line the US demands, or they could migrate en-masse to Russia and/or China. However, either of these two moves would be temporary as the resulting internal strife and disruption of such a law would be too huge and devastating to allow them to maintain a constant strategic course.

The third and best option for OPEC may be to preempt NOPEC and immediately dissolve the cartel, especially as it has long lost its effectiveness and its present risks far outweigh its benefits. Of course, this would increase volatility in oil prices and markets, and no oil company would be able to properly plan their CAPEX planning. Eventually, this would become a seesaw of higher price spikes that would be windfalls for the ex-OPEC members, as well as gluts which will worsen their deficits. Nor will the large independent international oil companies be spared this seesaw effect and their inability to forecast the future will only lead to gradual shrinking production and loss of market share, which they more-or-less already foresee and are accordingly adjusting and slowly diversifying away from oil.

The final question is: Was the oil flooding and price crashing justified? The answer is too long, but very briefly, yes it was, despite the risks involved. It was the only option available in the short term and its timing was very propitious. Waiting to act in the longer term, would have guaranteed failure.

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