Oil Prices Are Low

So why is OPEC+ opening the oil taps?

Drill Baby Drill

As a general rule, the Saudis don’t like the Emiratis for all the usual “hate-thy-neighbor” reasons: Saudi Arabia wants to be the Big Man on the block, the UAE doesn’t want to be the sidekick. OPEC+ is the Saudi’s baby and the Emeratis have made an art of openly flouting OPEC+s production quotas. Which only partly explains why an organization that only exists to elevate oil prices is doing its best to suppress them: jacking up production quotas to 411,000 b/d in June - the third quota rise in as many months. If you’re piling the kids into the family truckster this summer, the cost of a tankful will be nice - until it isn’t.

One theory is that opening the spigots punishes OPEC+’s quota cheats by driving the price down. Which it will, but it also makes the honest members less willing to stay to stick to the numbers.

Another theory is that the ramped up production was a way to curry favor ahead of President Trump’s visit to the Gulf. He needs low energy prices in the headlines until the tariff whiplash subsides. The president, and the economy, is going to be disappointed: the world is a lot more energy efficient than it was 30 years ago, so low oil prices aren’t going to be the economic stimulus it once was. That’s probably it, or at least part of it.

From the Saudi point of view, it’s a sneaky concession as it comes right as the “Drill, Baby, Drill” policy is starting to run up against the law of diminishing returns. First, the shale projects largely responsible for the US energy boom have a much shorter production life than traditional oil extractions. Many have already peaked. The second brake is that the cost of new projects, as well as maintaining the old ones, is increasing with onerous steel and aluminum tariffs; adding 50% to new project build outs. With prices at $60-65 p/b energy producers are operating on very thin margins and most green alternatives are getting priced entirely out of the market.

Which leads us to a more Machiavellian theory: the production boost is an attempt by Saudi Arabia to increase OPEC+s market share by keeping prices and profits low enough to discourage investment in alternatives and exploration. Call it the Walmart effect where a large producer keeps prices low enough to drive out competition in order to increase market share and pricing dominance.

Will this work? It’s hard to say. For one thing, it requires discipline within the cartel, which brings us back to the UAE. No, the Saudis and the Emeratis don’t like each other, but it's one of those marriages where the costs of divorce are tricky. Complicating the math is that the costs aren’t equal. The Saudis need a price of $90 p/b to balance the books. They’re sitting on a heap of cash, so they can take the hit in the short run, but not forever. For their part, the UAE only need a price of $50 p/b to stay in the black.

So the Saudi Arabia tolerates the cheating, because if the UAE quit the cartel – like it has threatened to do – that would be the end of OPEC+. That is unlikely, but it would cause a long term drop in energy prices along with wild market volatility.

Assuming that demand stayed somewhat level. Which it won’t. For one thing, even with a weakening global economy, that energy sucking juggernaut that is AI isn’t going anywhere. All those cryptos suck up a lot of juice as well. All of which will keep fossil fuels in the driver’s seat over the medium term. In the way back is nuclear power for the moment, even though it’s probably the ultimate endgame - say 75 years.

The great unknown is the if and when of one major power taking a shot at another. The army has retired its horses and the navy doesn’t use sailing ships anymore. A big war will suck up a lot of oil why it wrecks the sea-lanes.

The QED being that prices are going to stay in this narrow $60-65 window for the time being, but expect swings. A green transition was always going to be a long process, now it’s going to be longer. Europe, which was driving the charge adoption has shifted to nearer existential threats. Provided we can avoid Armageddon, none of this should affect your summer vacation.