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OPEC’s pain this year could bring gains next year

THE BIG PICTURE:OPEC members are cutting billions from social spending budgets in a bid to ride out the oil glut, but for weaker members it could result in political unrest

Bloomberg

While OPEC’s fight to snatch market share from rival oil producers might look like a costly failure as prices languish below US$50 a barrel, an entirely different picture could emerge next year.

Supplies outside OPEC are expected to contract next year for the first time since 2008, sliding by 200,000 barrels a day, according to the International Energy Agency.

With consumption set to grow by 1.4 million barrels a day, OPEC and its de facto leader, Saudi Arabia, could seize the chance to broaden their market as competitors damaged by the price slump fall off.

“To declare their policy a failure is a pretty big leap,” said Greg Sharenow, who manages US$15 billion as executive vice president of Pacific Investment Management Co. “I don’t think you could view Saudi and OPEC’s business plan and model as being a six or 12-month view. In the long run, what you’re going to see is lower non-OPEC supply, higher demand and greater market share for them.”

OPEC in November last year diverged from its traditional policy of adjusting supply to manage prices, announcing it would maintain output to defend its position in the market. That decision has been tested by the collapse in crude, which has since dropped more than 40 percent amid a global supply glut.

OPEC’s share of the world oil market dwindled to the lowest in a decade last year as surging output from US shale wells eclipsed gains in fuel demand.

Yet the steep slide in Brent, which traded near US$47 yesterday after recovering to more than US$60 in May, could prove beneficial to the 12-member group as higher-cost competitors struggle.

“The worst thing for the Saudi strategy was when prices rallied to US$60 and looked like they’d stay there, because other producers can learn to live with it,” said Paul Horsnell, head of commodities research at Standard Chartered PLC. “For that strategy to work, it needed a further severe downward correction in prices.”

Many US shale companies are burdened by the borrowings that fueled the industry’s boom. Interest payments on the US$235 billion debt of drillers in the Bloomberg Intelligence North America Independent Explorers & Producers Index may thin out some companies even after others found ways to cut costs and boost efficiency. The longer the crude price flags, the greater the pressure on shale producers to retrench.

Such cuts at competitors may be little consolation to OPEC’s most vulnerable members. The weakest — the “Fragile Five” of Algeria, Iraq, Libya, Nigeria and Venezuela — have had to slash social spending following the drop in prices and face increasing risk of political unrest, according to RBC Capital Markets LLC.

Even OPEC’s biggest member is not immune to the pain. The Saudi government is seeking to cut billions of dollars from next year’s budget after running the biggest deficit since 1987 this year, according to two people familiar with the matter.

Meanwhile Iran, once OPEC’s No. 2 producer, is set to swell global oil supply further by raising output once sanctions against the country are lifted.

“If Iran gets its opening right — which is a big if — then it has the capacity to really ramp up production just when the market would otherwise be tightening,” said Seth Kleinman, head of energy strategy at Citigroup Inc in London.

Yet for all the flaws of OPEC’s plan, the alternative approach of reducing production may have turned out worse.

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