Producers and economies will feel the pressure

Petrol prices dropped for the 12th successive time this week and even better news appears to lie ahead for holiday motorists. That has been virtually guaranteed by the strategy adopted by the Organisation of Petroleum Exporting Countries late last month. Rather than cut production in response to a falling price caused by a glut of oil, as would normally occur, it elected to allow the price to continue falling. Its aim is to retain market share, and it believes that it will have to suffer only limited short-term pain to do so. By any yardstick, it is a high-risk gambit.

The genesis of this boon for oil-importing countries like New Zealand lies in the extracting of oil from difficult-to-drill places, which became profitable over the past decade as prices rose on strong global demand. The use of techniques such as fracking, especially in the United States, to extract oil from shale formations, introduced a substantial new supply source. For a time, that had little impact on price because production was restrained by geopolitical factors in countries such as Iraq and Libya.

Over the past year or so, however, these countries have become bigger suppliers, just as demand for oil in Europe and Asia has declined. The outcome of all this has been a reduction in Opec's market share. Last year, its share of global production averaged 43.4 per cent, down from 44.6 per cent in 2012. Opec's response is based on the notion that its members are the industry's low-cost producers and have the biggest resource base. They can, therefore, tolerate a lesser return for a period. Shale-oil producers, however, will be losing money and will have to shut down. Investment will also be deferred. A medium-term oil shortage will cause prices to recover, and Opec will maintain or even improve its market share.

This strategy was not supported unanimously by Opec's members. Some, like Venezuela and Iran, are in economic difficulty and saw a production cut as the best course. Iran's Oil Minister, Bijan Namdar Zanganeh, talked of "shock therapy", and said the issue of market share and tumbling prices should have been handled "with caution and gradually". He has good reason for concern.


The major imponderable in the strategy, the brainchild of Saudi Arabia and its Gulf allies, is how low the global price must go to stall the shale bonanza. Some American producers will need a price much higher than that currently to remain profitable, but others may be sustainable. Certainly, the situation will not resolve itself in a few months. In the meantime, economies like that of Venezuela, which depend heavily on oil revenue, will come under increasing pressure, as will domestic stability. That creates potential for the disintegration of Opec.

The cartel's strategy also creates woes for some other major producers, notably Russia. Most will conclude they have little option but to hold back production and hope the financial pain is short-lived. But Russia's economic plight could persuade Vladimir Putin to opt for a face-saving and distracting activity. The purpose would be twofold because a lift in geopolitical tension would also prompt an increase in the price of oil.

Barring that outcome, consumers will continue to be the winners for some time to come. But even for New Zealanders, the five-year low in crude prices is not an unalloyed benefit. US giant Chevron has, for the first time, acquired an exploration licence here. But it is now reviewing its capital expenditure programme in line with the new price environment. New Zealand could be a loser in its search for low-cost options.