The Failure at Doha Has Long-Term Bearish Implications for Oil

The Failure at Doha Has Long-Term Bearish Implications for Oil

The Failure at Doha Has Long‑Term Bearish Implications for Oil

Aside from a short-lived selloff, the failure of oil producers to coordinate so much as a statement following their 17 April meeting in Doha, Qatar, will have little near-term impact on prices. However, it could pose a long-term, downside risk.

Oil producers, including Russia and members of the Organization of the Petroleum Exporting Countries (OPEC), were supposed to establish a “freeze” on output, mostly to send a signal to the market that they would not increase production like they did in 2015, removing a downside market risk. Despite comments from Saudi Arabia Deputy Crown Prince Mohammed bin Salman to Bloomberg a few weeks back, statements from various other sources leading into the meeting suggested a deal was likely, and these meetings are usually a rubber stamp as most details are worked out ahead of time.

The lack of agreement, with Iran’s non-involvement reportedly a sticking point for Saudi Arabia, thus came as a surprise and led to the short-lived selloff.

This meeting was always about signaling and never about materially altering the supply and demand balance because the largest producers (Saudi Arabia and Russia) would find it physically difficult to increase production. As such, investors stepped in to buy the weakness as it is becoming more evident that the market is closer to rebalancing than at any point in the last few years. We address this rebalancing in previous posts, including one last month. In addition, rising production outages, most recently in Kuwait due to labor strikes, have in part done what OPEC could not do, namely cut output.

The failure in Doha has renewed comments about OPEC’s demise. Lost in the debate is a lack of understanding about how OPEC affects prices, which we see in two principal ways: 1) oil production policy and 2) controlling access to large low-cost reserve basins.

On the former, OPEC’s role has been broadly mischaracterized. Specifically, a cartel can have meaningful impact when production needs to be adjusted to address short-term or transient market imbalances, such as a war, hurricane or economic recession. By adjusting production for a relatively short period of time, OPEC can reduce market volatility by bridging imbalances and supporting/reducing prices.

However, if the imbalance is structural in nature, cutting production would only be self-defeating. By supporting prices through production cuts, OPEC would be subsidizing investment in supplies and discouraging consumption. This was the lesson learned from trying, but failing, to support prices in the early 1980s, which led to low prices for a long time as excess supply capacity took more than a decade to work off.

The most interesting implication signaled from the failed meeting and growing disagreement is whether OPEC members do the next rational thing: actually try to increase output by creating an investment climate that enables this. By doing so, OPEC members would increase investment dollars to replace lost revenue from oil sales and create a future income stream once investment comes to fruition.

Venezuela successfully opened up to foreign oil investment in the late 1980s and in turn substantially increased production during the 1990s despite low prices. (Venezuela’s output nowadays hasn’t collapsed, but it is at risk.)

It is worth noting Mexico is opening its oil industry, even though it is facing headwinds because of low prices. Other producers like Algeria are talking about increasing foreign investment.

Not all countries will have the political flexibility to effectuate an opening (and these countries should be on a watch list for instability), but those that receive meaningful investments pose long-term, bearish implications for oil prices. Still, this is not a risk, in our view, for the next year or two.


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