OPEC is changing fundamentally as power in the oil market shifts towards Saudi Arabia, acting in concert with Russia, while the other members of the organisation are increasingly marginalised.
In theory, all members of the Organization of the Petroleum Countries are equal, and the group has always taken decisions by consensus (“Statute of the Organization of the Petroleum Exporting Countries”, 1961 and 2012).
OPEC’s founding statute stipulates that it “shall be guided by the principle of sovereign equality of its member countries” (Article 3).
In practice, some members of OPEC have always been more powerful than others, but that imbalance has been widening, with Saudi Arabia becoming the dominant decision-maker.
Saudi Arabia’s oil production overtook Iran’s in the 1970s, and the gap has grown steadily wider as a result of the Iranian revolution, the Iran-Iraq war and multiple rounds of sanctions.
Saudi Arabia is the only member of the organisation with a large enough share of output to have a measurable influence prices and the budgetary flexibility to adjust its production significantly.
In reality, Saudi Arabia decides how much to produce given market conditions, playing the role of swing producer, while the other members of the organisation essentially produce as much as they are technically able.
Since the late 1990s, Saudi Arabia has increasingly coordinated production policy with neighbouring Kuwait and the United Arab Emirates, largely ending their former rivalry and accusations of cheating.
These three Gulf countries have become the core of OPEC, with the other members playing a peripheral role in output policy (tmsnrt.rs/2IwJMbP).
The balance of power within OPEC has been shifting towards Saudi Arabia and its allies for the last 20 years, but production problems in other member countries have accelerated the trend in recent years.
Venezuela’s output has fallen sharply as a result of mismanagement and internal unrest. Libya’s production has been cut by the country’s civil war.
Nigeria and Angola are suffering from chronic production problems. Iran’s output has been hampered by repeated rounds of sanctions.
Iraq is the only OPEC member which has experienced a significant increase in output since the country has recovered from the 2003 U.S.-led invasion and ensuing internal security problems.
But Iraq has always attempted to maximise output because of its enormous need for revenues to meet heavy budget commitments and it plays little practical role in OPEC’s production policy.
Since 2011, Saudi Arabia and its key allies have consistently accounted for around 48-49 percent of total OPEC output (“Statistical Review of World Energy”, BP, 2018).
More importantly, Saudi Arabia and its allies account for almost all the organisation’s spare production capacity and therefore almost all its production flexibility.
Saudi Arabia and its allies accounted for most of the voluntary production cuts implemented during 2017/18 and now hold most of the spare capacity that could be made available to the market in 2018/19.
Saudi Arabia has around 2 million barrels per day (bpd) of unused output capacity, while the UAE has around 330,000 bpd and Kuwait around 220,000, according to the International Energy Agency.
Most other members of the organisation have only negligible amounts of unused capacity that could be readily and reliably available to the market (“Oil Market Report”, IEA, June 2018).
And among the three Gulf allies, Saudi Arabia has by far the largest production and unused capacity, cementing its role as the de facto leader of OPEC.
OPEC’s biggest problem in attempting to manage the oil market has always been its inability to control production from countries which remain outside the organisation.
OPEC’s efforts to stabilise and raise prices have frequently been undermined by the growth of alternative sources of supply (Alaska, China, the Soviet Union, the North Sea and now the shale fields of North America).
Saudi Arabia, as OPEC leader, has made repeated overtures to non-OPEC countries since the mid-1980s to restrain their production, with uneven success.
Since 2016, however, Saudi Arabia has forged an effective working relationship with Russia and a group of other, smaller non-OPEC producers to limit output.
Just as Saudi Arabia has dominated OPEC, Russia dominates the group of non-OPEC allies, contributing most of the output, production cuts and spare capacity.
In effect, Saudi Arabia and Russia have emerged as joint market managers, with other OPEC and non-OPEC countries relegated to a marginal role.
OPEC is no longer the primary decision-making forum for producing countries trying to coordinate policy on output and prices.
Real decision-making power has passed from OPEC and its group of allies into the hands of Saudi Arabia and Russia.
Saudi Arabia and Russia have been careful to maintain the formal involvement of OPEC and the wider group of countries, known as OPEC+.
But the real decisions on production policy are now being made bilaterally and outside the OPEC and OPEC+ structures.
The marginalisation of OPEC as a formal decision-making group was evident during the organisation’s meetings in Vienna between June 20 and June 23.
Despite four days of discussions, OPEC and OPEC+ failed to reach a detailed agreement on production policy in the second half of 2018.
The final communiques issued after the OPEC and OPEC+ meetings did not specify either a formal output ceiling or country allocations.
Instead, it was left to Saudi and Russian officials to brief the media afterwards that collective output would increase by around 1 million bpd.
Saudi Arabia and Russia will contribute almost all the increase in output, with smaller contributions from Kuwait and the UAE.
In theory, this decision was taken by consensus among OPEC and non-OPEC members, with Iran and other members persuaded to give their assent to a vague joint statement.
In practice, Saudi Arabia and Russia are likely to have increased their production by 1 million bpd, whether other OPEC and non-OPEC countries agreed or not.
If Iran or any other country had walked out of the discussions, it would not have made any practical difference to the amount of oil supplied to the market in the second half of 2018.
Saudi Arabia is keen to maintain the formal structure of OPEC and non-OPEC cooperation; the consensus outcome of the meetings was an important step towards that objective.
But the preservation of the OPEC+ group masks the fact real power in the oil market has shifted decisively to Saudi Arabia and Russia, with some political input from the United States.
Saudi and Russian market power will become even more evident in the second half of 2018, if the two countries proceed with the agreed increase in production.
Assuming Saudi Arabia and its two Gulf allies increase their combined production by 700,000-800,000 bpd, their share of total OPEC output will climb above 50 percent for the first time since the mid-1990s.
And if Venezuela’s output continues to fall, which seems likely, and Iran’s production is curbed by U.S. sanctions, the three Gulf allies will see their share of OPEC output climb to the highest level since 1981.
By 2019, the oil market will have less than 1 million bpd of spare production capacity, essentially all of it located in Saudi Arabia.