Here's Why Oil Producers Are Driving Prices Lower
10:59 Share

You're listening to an iHeart Podcast. Hiscox Small Business Insurance knows there is no business like your business. Across America, over 600,000 small businesses, from accountants and architects to photographers and yoga instructors, look to Hiscox Insurance for protection. Find flexible coverage that adapts to the needs of your small business with a fast, easy online quote at Hiscox.com. That's H-I-S-C-O-X dot com.

There's no business like small business. Hiscox Small Business Insurance.

When you're with Amex Business Platinum, you have the card that helps businesses dream bigger. Get a flexible spending limit that adapts with your business and earn 1.5 times membership rewards points on select business purchases so you can stock up on what you need to take your business further and get rewarded for growing bigger. That's the powerful backing of American Express. Not all purchases will be approved. Terms apply. Learn more at AmericanExpress.com slash AmexBusiness.

I'm Stephen Carroll and this is Here's Why, where we take one news story and explain it in just a few minutes with our experts here at Bloomberg.

Take a look at the price of energy this morning. Brent has slipped through $60. $59 is where we're trading. We are basically back to a four-year low again. When US President Donald Trump was inaugurated to his second term in January, oil prices on the international benchmark Brent crude were around $80 a barrel, the highest since last summer. But in early May, they dipped to around $60, the lowest, in four years.

One side of the story is fears over how big oil consumers like China might be hit by US trade tariffs. But there's also been a change from the countries that produce oil.

At its latest meeting, the OPEC Plus group of oil-producing nations decided to increase production for a second month in a row. OPEC has been trying to balance the supply and demand and find that continuously problem with the oil producers. You're a Saudis, you're like, why am I going to keep subsidizing their output at the expense of mine?

So here's why oil producers are driving prices lower.

Bloomberg Opinion columnist Javier Blas joins me now for more. Javier, first of all, a bit of context. How much influence does OPEC Plus have over global oil prices?

OPEC Plus has a lot of influence over global oil prices because it produces, when you count all the barrels, more than 50% of global oil production. So what it does can push prices up and down. And we have seen in the past that the cartel has been quite effective in cutting production, in restricting the supply to push prices much higher. At times, Saudi Arabia...

Semi-official policy has been to keep prices as close as it was possible to $100 a barrel. So they are very influential, perhaps not as influential as in the 1970s, the time of the true oil crisis, but they still remain probably the most important factor in the oil market.

And who holds the power within the group? Within the group, one country and perhaps another country that really hold the power. Those are Saudi Arabia, first and foremost, and then Russia. They are the number two and number three global producers. The largest oil producer nowadays is the United States, thanks to the shale revolution. But Saudi Arabia and Russia pump

each about 10 million barrels a day, again when you count all the barrels, not just crude but other liquids, and both are very influential. They produce more than double the next member of the OPEC+ alliance. And that is a group that was formed about a decade ago, exactly at the end of 2016. And the group is the traditional members of the OPEC cartel plus a few other countries that's the plus.

on OPEC+, that decided to join forces, but they are not formal members of the oil cartel. It's what we call a club, an alliance, or a cartel and a few friends. The friends are Russia, Kazakhstan, and a number of other non-OPEC producers that in 2016 decided that joining forces with Saudi Arabia and the rest of OPEC made sense, made economic sense. And they have

been, until now, very effective in managing the market. But from time to time, not everyone inside this family gets along well and agrees with the decisions. As you pointed out in your recent column, cartels exist to drive prices higher.

So why then is OPEC Plus increasing supply, which is a move that would drive prices down? Yes, you are absolutely right. I mean, the only reason for having an oil cartel is to push the price of the commodity that that cartel aims to control higher. You do not try to lower prices. That would be like a policy of shooting yourself in the foot. And that's not what rational countries do.

However, from time to time, oil cartels face an economic dilemma. One of the members just refused not to play by the rules. And the rules here are the production quotas. The quotas are the official level that the cartel sets for each of their members, how much oil they need to produce on a given month. For OPEC+, the group sets a

official level for the whole group and then quotas for each of their members. And what happened is from time to time, one of those countries say, well, I want to produce more. They may have a new oil field coming on stream. They may need the money. And at the end of the day, this is a prisoner's dilemma. The cartel

can only do one thing when someone is cheating. It's to apply some diplomatic pressure, perhaps asking politely, nicely, "Please, will you behave?" To start being a bit more forceful on that diplomatic pressure and going publicly, "We are not happy. This member of the cartel is not behaving by the rules. He's cheating on us."

And if that doesn't work, the only other solution is to say, well, then we are all going to do the same. We are all going to produce above the target. We are going to all produce a lot more. The price of oil is going to go down, and you are going to pay the financial price of your actions. Obviously, that is shooting yourself in the foot. To attack that cheating country, you need to share the pain of much lower oil prices.

And the Saudis have faced that situation in the past. They have faced oil producers who have cheated on Saudi Arabia. And the Saudis have launched prize wars against those cheating countries in the past to force them to play by the rules. In the 80s, actually, in 1985 is the first example that they launched effectively a prize war against every other member in OPEC.

They launched a similar prize war in 1998 against Venezuela. And they launched a prize war against Russia in 2020. So there is a lot of historical precedent. Has it worked?

It has worked, but it is a very crude, forgive my pun, it is a very crude way to manage the oil market because the Saudis ultimately got their way, but only after significant pain on themselves. And at times, it's not...

100% clear that the Saudis got what they wanted and they were in real trouble. In 1998 Saudi Arabia was in massive economic pain. Ultimately they got what they wanted but they almost bankrupt themselves in the process. So how much pain can Saudi Arabia take on this front to bring the members of the group into line? Here the problem is that the biggest cheating country is Kazakhstan.

which is not a formal member of OPEC, but only part of this PLUS alliance. And that has a bit of extra trouble because I don't think that the Saudis have nearly as much diplomatic leverage over Kazakhstan as they have had with other members that they are much closer and part of the actual core of OPEC. And second, what we call the break-even price, so typically the price at which the budget balances,

excluding debt, is much higher in Saudi Arabia than Kazakhstan. Of course, the Saudis can take on debt, they can reduce their petrodollar reserves, but ultimately you really aim to try to keep your budget within the price of oil and not taking too much debt. And I think that in this situation, Kazakhstan can take a lot more financial pain than Saudi Arabia.

This could be quite the standoff. It is a standoff. And so far, what we are seeing is Kazakhstan so far is getting the pressure. Clearly, they are noticing it. But they are saying, yeah, we hear you, which almost sounds to me the same thing that a teenager respond to their parents when their parents are asking the teenager to clean the room. Yes, mother, I hear you.

and the room remains untidy for the next three months. That's one side of the untidy room. The other factor in all of this, when we're thinking about prices, is the demand side. What is, just briefly, the current thinking about what sort of effect the trade war and the effects on growth could have on oil demand?

Before the trade war started, the consensus in the oil market was that global oil demand was going to grow about 1%. So that's roughly about a million barrels a day. Or to put it in equal terms to an oil producer, we were going to need an extra Libya in 2025.

At the moment, everyone is reducing those forecasts, and the range goes between the most optimistic that they think that we're going to have an oil demand of around 700,000 barrels a day, so 30% reduction in the forecast, to people that they are beginning to think, well, this is really getting very slow. The trade war remains unresolved. Yes, the Chinese and the Americans are talking, but they are talking about talks.

So probably this is going to be worse. And they are expecting oil demand to slow down to about 300,000 to 500,000 barrels a day. Still, everyone so far is talking about a slowdown in the growth. We are not talking about a

contraction in oil demand, which we saw obviously during the pandemic, but that was an unprecedented situation where everyone was not traveling. But we saw a contraction in oil demand back in 2008, 2009 during the global financial crisis. So if the global economy slows down a lot, we may move from a slowdown in oil demand to an actual contraction,

which together with OPEC fighting internal dissidents, that could be a recipe for much lower oil prices. Okay, Javier Blas, Bloomberg Opinion columnist, thank you very much. And you can read Javier's latest work at Bloomberg.com forward slash opinion. For more explanations like this from our team of 3000 journalists and analysts around the world, go to Bloomberg.com forward slash explainers. I'm Stephen Carroll. This is Here's Why. I'll be back next week with more. Thanks for listening.

Hiscox Small Business Insurance knows there is no business like your business. Across America, over 600,000 small businesses, from accountants and architects to photographers and yoga instructors, look to Hiscox Insurance for protection. Find flexible coverage that adapts to the needs of your small business with a fast, easy online quote at Hiscox.com. That's H-I-S-C-O-X dot com.

There's no business like small business. Hiscox Small Business Insurance. Toyota is the best resale value brand for 2025, according to Kelly Blue Books, KBB.com. And with a wide range of dependable vehicles for any lifestyle, you can get everything you need in a vehicle today while investing in tomorrow. So choose Toyota and choose value. Shop

You're listening to an iHeart Podcast.