OPEC’s Venezuela Dilemma and U.S. Energy Policy

As senior officials from the Organization of Petroleum Exporting Countries (OPEC) gather in Houston for the international industry gathering CERA Week, they will be listening carefully to speeches by the CEOs of the largest U.S. independent oil companies about the prospects for the rise in U.S. production in 2018 and 2019. Likely, they won’t like what they hear. U.S. industry leaders are saying U.S. shale production could add another one million barrels per day (b/d) or more on top of already substantial increases, if oil prices remain stable. Best C-suite guesses from Texas are that a sustained $50 to $60 oil price could result in a fifteen million b/d mark for U.S. production in the 2020s, up from ten million b/d currently. U.S. shale’s capacity to surprise to the upside is likely to leave OPEC producers with some soul searching to do as they consider their strategy for the second half of the year and beyond.

OPEC has received some unexpected help to make space for rising Iraqi and U.S. oil exports from the sudden collapse of Venezuela’s oil industry where workers, faint from lack of food, are abandoning their posts to emigrate or worse to sell stolen pipes and wires to make ends meet for their families. Energy Intelligence Group is reporting this week that Venezuela’s oil production has fallen to 1.4 million b/d last month, down from 1.8 million b/d just last autumn. But ironically, a further collapse of Venezuela’s oil industry could make OPEC’s deliberations harder, not easier, if it ruptures the conviction of the current output reduction sharing coalition. If too many Venezuelan oil workers abandon their posts at once out of desperation, the country’s fate could more closely mirror Iran in 1979 when a crippling oil worker’s strike brought Iranian oil exports to zero and rendered the Shah’s rule untenable. The U.S. also continues to mull additional sanctions against Venezuela, including oil trade related restrictions, to pressure Caracas to restore democratic processes inside its borders. Trading with state owned PDVSA is becoming more difficult but Venezuela has been using U.S. tight oil as a diluent for its heavy oil.

Historically, during many past oil disruptions, OPEC’s Arab members like Saudi Arabia and Kuwait have increased exports to prevent oil prices from skyrocketing. Kuwait especially is likely to argue that will be necessary to keep oil prices from going too high since it is keenly aware that the high prices of the early 2010s were exactly what stimulated the very U.S. shale oil investment and energy efficiency technologies that are plaguing the long run outlook for OPEC oil today. Studies on how digitization of mobility can eliminate oil use has led many organizations, including some large oil companies, to speculate that oil demand could peak sometime after 2030. The argument that the OPEC cuts need to be abandoned sooner rather than later could also sit well with Russia’s oil oligarchs who have been unhappy to see continued cooperation with OPEC that has left some one to two million b/d of potential Russian projects on hold.

But Saudi Arabia could worry that a premature relaxing of the “super” OPEC coalition agreement could bring prices lower than the $70 it is targeting to keep its domestic spending on track and to position state oil firm Saudi Aramco for a successful five percent initial public offering (IPO) sale. It has been seeking a long lasting condominium with Russia to prevent a return to destabilizing competition for market share. Expanding U.S. exports have eaten away at Mideast sales to Asia. Russia is also looking to sell more oil and gas eastwards.

All this leaves OPEC (and its partnership with Russia) in a quandary. Traditionally, OPEC’s Gulf cooperation council members, Saudi Arabia, Kuwait and the United Arab Emirates have made extra investments to carry spare capacity to respond to sudden supply shocks and/or to punish usurpers who could challenge OPEC for market share. But in the age of U.S. oil abundance, OPEC’s Gulf members are questioning whether this approach continues to make sense. In a world where peak oil demand is being mooted, will “the shareholder” (eg ruling royal governments) order national oil companies to spend billions of dollars to develop new spare capacity, even if it could not be needed? But if producers fail to make those investments and oil prices ratchet up to extremely lofty levels, can that propel a faster acceleration to low carbon electric cars, shared mobility services, and oil saving devices, hurting those very same oil producers even more harshly in the long run? China is clearly positioning itself to take advantage of such an eventuality with a multi-trillion dollar industrial export policy for renewables and clean tech of its own making.

The overall uncertain situation has led to some incoherent commentary by OPEC leaders. On the one hand, some leaders talk about the global oil field three percent decline rate in near hysterical terms as potentially leading to an epic supply crisis in the coming years. They cite this risk as a reason to keep oil prices high. On the other hand, even as they sound that alarm, they are not willing to bet with their own pocketbooks on making major investments to plug that supposed hole. The alternative option for OPEC to restart the price war seems equally toothless, especially if those flooding the market do not appear to be able to survive the sustained revenue drop to make it an effective threat. Citi projects that even with expected declines in production in certain non-OPEC producing countries, continued increases from Brazil, Canada, Africa, and global natural gas liquids will overwhelm losses elsewhere, even without a higher than expected contribution from U.S. shale, assuming geopolitical events don’t create an unexpected cutoff of a major producer.

It is in this context of confusion that the United States needs to consider the dangers of altering a suite of energy policies that are working. The United States is well positioned to supply individual U.S. refiners with heavy crude from the Strategic Petroleum Reserve (SPR), should it find that new sanctions or internal strife means those refiners have to abandon Venezuelan heavy oil imports. In other words, the SPR is not superfluous. Corporate efficiency standards for U.S. cars help constrain U.S. domestic oil use, freeing up U.S. refined products and crude oil for export and enhancing the role of U.S. energy production to constrain OPEC and Russian market power. Free trade agreements with Canada and Mexico are ensuring a strong nearby pipeline market for rising U.S. surpluses of natural gas. U.S. assistance for its clean tech industry prevents China from monopolizing benefits that can come to an economy when higher oil prices prompt countries to shift more quickly to energy saving technologies and renewable energy. The Trump administration needs to slow down in busting with tradition when it comes to energy. Some of the tried and true policies of the past are contributing to this administration’s mantra of energy dominance. They need to focus on the old saying “If it ain’t broken, don’t fix it.”