What Next For OPEC+?
UAE Oil Minister and the current OPEC Conference President, Suhail Mohamed al-Mazrouei. (Photo ... [+] credit should read GIUSEPPE CACACE/AFP via Getty Images) AFP via Getty Images  Oil prices are surging after last weeks failed OPEC+ meeting, which is illogical given that the reason for the failure was the UAEs demand to increase its quota. Apparently, traders think that if there is no agreement, then the proposed increase in supply for August to December of 2 mb/d will not happen. That is wishful thinking on the part of the price bulls. Because it is important to remember that OPEC+ or even OPEC2 has no serious enforcement powers. The Texas Railroad Commission sent people with guns into the oil fields to enforce its quotas and the Seven Sisters used interlocking contractual agreements to prevent over-production, but OPEC is more of a gentlemans club without the cigars and whiskey (well, mostly). They rely on persuasion and the nuclear option of a price war/collapse to keep members in line. There have been previous instances when a recalcitrant member exceeded their quotas, notably in the case of Iraq in 1989/90 and Venezuela in the mid-1990s. Saddam Hussein, with the ending of the Iran/Iraq War, revived his plans to raise capacity to 6 mb/d and demanded a quota equal to Irans. When the group hesitated, he simply raised production to match his preferred quota and ultimately they acceded to his demand. It didnt hurt that the market was roughly in balance so that his additional production had minimal impact on prices. When Venezuela announced in the 1990s that it would no longer abide by its quotaswhile officially claiming that its production was adhering to its assigned amount, which no one believedit foolishly thought it could win any price war. As one official told me, the production costs in the Orinoco belt were so low, about $4/barrel, that they could stand up to pressure from Saudi Arabia and others. As the figure below shows, not only was Venezuela far above its quotas, but their example encouraged other members to also ramp up production, and the Saudis demanded an increase in their quota to compensate. That, combined with the Asian recession of 1998, caused the price to collapse to $12/barrel and saw the demise of a number of oil companies (albeit through acquisitions, not bankruptcies). Production above quotas during 1990s. The author from EIG data. Which highlights one of the problems OPEC+ faces with the UAEs demand, namely that the fairly strong adherence to quotas over the past sixteen months could break down if either the UAE succeeds in getting a higher quota or it simply raises production without the groups permission. There is roughly 4 mb/d of spare capacity in OPEC+ outside of Saudi Arabia, but 1.4 mb/d of that is Iranian and not likely to come online soon. Of the rest, nearly all is in Iraq, Kuwait, Russia and the UAE, so that if every one of the smaller members opened their taps, the market would not really notice. Whether or not Iraq and Russia respond to the UAEs demands by either demanding increased allocations or simply cheating will determine whether or not prices crash. Because if either or both of those do so, the Saudis are likely to reduce their voluntary supply reduction, which would signal markets that prices are going to be lower, not higher. Talk of $100 a barrel would evaporate, but whether or not that would discourage U.S. shale producers from continuing to add rigs is not certain. Back in 1976, Paul Eckbo published The Future of World Oil, in which he noted that attempts by commodity producers to stabilize, control and/or raise prices had rarely been successful for more than a few years. Given that, OPEC has been far more effective than its predecessors. However, it has often depended on two factors to keep long-term prices high: disruptions of supply, such as the Iran/Iraq War or the Arab Spring, and resource nationalism, that encouraged oil-rich countries to reduce exploitation of their resources. The end of sanctions on Iran and the move by the UAEand possibly many othersto take advantage of high prices, would reduce both of those factors and thus mean lower prices for longer. The current level will only be a pleasant memory for the industry.