OPEC Is Cannibalizing Itself

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Includes: OIL, USO
by: Daniel Jones

Summary

Although many investors blame fracking on the current energy market imbalance, this is anything but the truth.

In recent months, the problem has come not from the U.S. but from OPEC as it tries to stave off competition from shale frackers.

However, not every OPEC member is being treated the same way, as we see when we look at the group's production data.

Whether due to political pressure or cost issues, some members of OPEC are being cannibalized by others, a move that will create dissent and cause a push for higher prices.

Ultimately, this will likely be a net positive for investors in the oil space.

Late last year, OPEC (the Oil Producing Exporting Countries) announced that they were raising their target amount of oil being produced within their borders by 1.5 million barrels per day from 30 million to 31.5 million, sending the price of crude sharply lower. While this may seem disastrous for a market that has already seen overproduction, the fact remains that the group has been producing around those levels for months now, so an announcement such as that was largely priced in already. Given these facts, combined with the continued drop in crude prices, I figured it would be interesting to dig in a bit to OPEC's data and see who is taking advantage of OPEC's higher output and who has been left out to dry.

Who is to blame for high output?

Issues relating to the oversupply of crude oil starting rearing their ugly head toward the middle of 2014 and worsened throughout the year and into this year. For the most part, the U.S. has been blamed as a major contributor to high production levels across the world, combined with the prospect of slightly slower demand growth being projected into the future. There is no denying that the U.S. has been to blame for some of the increase in production, especially if you look at the picture over a period of a few years, but is the country really the most guilty party?

The answer to this is a resounding no. During 2014, the U.S. produced an average of 8.71 million barrels of oil per day. If the EIA (Energy Information Administration) is correct, output for 2015 will have averaged about 9.33 million barrels per day. This represents an increase of about 0.62 million barrels daily or about 226.3 million barrels annually. OPEC, on the other hand, has had a larger role to play between 2014 and today. While output for the group fell by about 158 thousand barrels daily between 2013 and 2014, it quickly soared by 1.49 million barrels daily from 30.08 million barrels in 2014 to 31.57 million by the third quarter of this year. If estimates are correct that we've been oversupplied by 2 million barrels (the EIA implies about 1.6 million, which is what I think is more likely), then OPEC has been responsible for about 72% of the issue.

But not everyone in OPEC has been so fortunate

Except for a few exceptions like Saudi Arabia, which has a significant cash horde on hand, most of the OPEC members have seen their economies hit hard by the downturn in crude, none, perhaps, harder than Venezuela. Even though OPEC has increased output in an attempt to not only kill shale producers in the U.S. but also to help squeeze out any extra money that they can from selling oil abroad, not every player has benefited from the rising output provided by the group. In the graph below, you can see what the production situation looks like for each OPEC member for 2013, 2014, and the first three quarters of 2015.

Click to enlarge

What's interesting to note from all of this is that there's some consistency between how the big players have benefited and how the small players in OPEC have been hurt. Based on the data provided, since 2013, every single member of OPEC that, today, produces fewer than 2.75 million barrels of crude per day, has seen output fall. The two exceptions to this have been Angola, which has seen its production rise by 21 thousand barrels per day, in aggregate, after falling earlier this year, and Kuwait, which has seen its output rise by 25 thousand barrels per day. If you take all the other small players in this space, they've actually reported a decrease in output totaling 851 thousand barrels per day during this timeframe. In some cases, like Libya, this is due to political turmoil but the case is not clear for everyone involved.

On the other side of the 2.75 million barrel daily level, we have Iran, Iraq, the UAE, and Saudi Arabia. As you can see in the graph, each of these players has seen output rise during this period. We do not know why this increase has taken place but it's likely due to these larger groups being able to pressure their weaker members to cut output and/or it could be driven by a lack of ability to invest (at profitable levels) to maintain or increase production in those smaller producers. Either way, what is certain is that it has been these four nations that have enjoyed some offset for the fall in prices that has shaken the industry over the past year.

What this means for investors

Looking at all the data provided by OPEC, we understand who the important players are in causing this downturn in oil prices. Everybody has always known that Saudi Arabia is the big fish out there but it's important to understand they aren't alone in the privileged category. Ultimately, this means that investors should keep a close eye out on each country but in different ways. Should OPEC cut, this cut will likely have a disproportionate share coming from the smaller members, not the larger ones, since it's evident that the big boys like Saudi Arabia and the UAE aren't afraid to take production from the weaker links in the chain to help themselves out.

This also means, however, that the smaller players are the most likely to push for some sort of move from OPEC as a whole since it looks as though they are being hurt enough that they cannot even maintain high production. As I've said, some of this is also, undeniably, political in nature (especially with Libya) but not all of it, which means that a willingness to be hurt more than their larger neighbors will still likely result in more profit in the long run for everybody involved. My own suspicion here is that, with smaller players in OPEC being harmed by low energy prices, especially Venezuela, it's only a matter of time before they collectively cut, no matter how unfair the distribution of the cut is.

Takeaway

Based on all this data, the conclusion I'm arriving at is that there is likely a great deal of discontent among the small players of OPEC but some level of content among the larger players who've been able to increase output to help offset lower prices. Ultimately, however, with the economies of some of these smaller players struggling, I think it's only a matter of time before an arrangement is made to cut output as a whole (absent rising demand or a drop in production outside of the group that offsets the supply and demand imbalance that exists today), which should prove bullish for long-oriented oil investors down the road.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.