Oil prices opened significantly down this week in the wake of an utter failure of an OPEC agreement. Falling to 37.61 in the wake of the failed Doha meeting, only an act of divine providence saved the tumbling commodity from hitting the recent low at 35.54. Specifically, a well-timed strike in Kuwait slashed oil production in the country by more than 60% which gave some faint hope to the oil bulls. However, the fact anyone is surprised by the failure of OPEC to reach an agreement remains more interesting. Ultimately, the politicising of oil prices and some shrewd manoeuvring by the house of Saudi doomed the chances of a successful agreement before the meetings even began. The failure to reach an agreement now casts serious doubts about the future viability of the OPEC model of price manipulation.
Firstly, any game theorist will tell you that anti-competitive agreements only function if all the colluders can cooperate or coerce one another. In the instance of the OPEC cartel, fundamental and ever-growing animosity between certain members will ultimately prevent any agreement from surviving for long. As was seen in the Doha talks, the Saudis refuse to cooperate with a production freeze so long as their nemesis Iran is not held to the same restrictive agreement. Additionally, OPEC clearly lacks the coercive power to bring either Iran or Saudi Arabia into line. Furthermore, anti-competitive agreements are prone to failure unless there are severe penalties to dissuade cheating. Even if Iran had been involved, eventually the freeze would have collapsed as the incentive to undermine the agreement would eventually outweigh the penalty of doing so.
Furthermore, the OPEC meeting was never really going to bear fruit because oil and Saudi foreign policy are no longer decoupled. As Iran is using oil to fuel its newly open economy, suppressing oil prices remains one of the best ways for Prince Mohammed bin Salman to counteract Iran’s growing influence. As a result, the move to block the Doha agreement or any future production freezes appears to be part of the Prince’s comprehensive strategy to increase national security. Already it has been seen that the Saudi defence minister has worked to insulate his country from lower oil prices. At the same time, he uses oil prices to impede rival gulf nations the ability to challenge Saudi Arabia in the region. Consequently, targeting Iran’s economy could skew the proxy wars in both Yemen and Syria in favour of Sunni-led Saudi Arabia.
The politicising of oil prices by the deputy crown prince casts serious doubts over the ability for OPEC to function as a cartel in the future. As a result of the Saudis conflict with Iran, two of the cartels major players are effectively preventing the formation of a monopoly. Without this monopoly, any future talk of production freezes is unlikely to be able to push oil higher as the credibility of OPEC is eroded. Furthermore, OPEC already faces questions over its ability to artificially inflate prices as developments in US shale provide an extremely strong zone of resistance around the $50 mark. As a result, the cartel may finally be showing signs that it can no longer hike oil prices as and when its members wish.
Going forward, Prince Mohammed bin Salman will be an interesting force in the oil markets. As a result, his departure from the long-standing separation of commercial and political considerations could be another step in freeing oil from OPEC price manipulation. Ultimately, the market will be watching patiently to see if Saudi Arabia can reduce its dependence on oil in the next few years. If the transition is successful, we could see oil being low for a very long time yet as the Prince strong arms the rest of OPEC’s members.