Oil traders shout deals on the floor of the International Petroleum Exchange in London.
Ferran Paredes / Reuters

On September 28, the Organization of the Petroleum Exporting Countries (OPEC) came to an agreement to collectively reduce oil production by as much as 740,000 barrels per day in an effort to boost sluggish prices. Although the announcement is the first of its kind in nearly a decade and was initially accompanied by a five percent rise in prices, the deal is, in fact, mostly meaningless. And that’s just fine. 

The buzz around the agreement—some market analysts say it “changes entirely what OPEC is doing”—is premature, to say the least. The 14 member states of OPEC essentially “agreed to agree,” leaving the details of an actual deal for November 30, when hard decisions will be made on how much each country is willing to cut its production. OPEC members also concluded that at least three countries—Nigeria, Iran, and Libya—ought to be able to maintain or possibly even increase their production levels as they recover from sanctions or domestic political turmoil. That means that other OPEC members would have to make larger cuts. 

Reaching a consensus among OPEC’s many members will not be easy. Libya barely has a central government. Iran and Saudi Arabia are geopolitical rivals. And even the relatively close-knit monarchies of the Persian Gulf disagree about conflicts in Yemen, Syria, and elsewhere. These differences in geopolitical interests erode trust and make it harder to enforce norms of collective action that are mutually beneficial.

Supposing OPEC does reach an agreement in November, it is not likely that its member countries will stick to it. In a detailed analysis of OPEC’s behavior since 1982, I found that OPEC cheated on its own aggregate production target a whopping 96 percent of the time—and every member is guilty of taking part. Worse still, changes in production targets had almost no impact on production itself. Maybe 2016 will be different, but this pattern cannot be ignored.

OPEC’s main problem is that it has no real way of enforcing its agreements. Members such as Algeria, Iraq, and Venezuela typically want the organization to do what cartels do: constrain oil supplies and raise world prices. But even though they understand that restraint would benefit the organization as a whole, they are not usually willing to sacrifice their own output. Each of these countries depends heavily on oil revenues to balance their fiscal budgets. And all of them already face significant domestic unrest at home, making fiscal cuts hard.

The decline of the Islamic State (also known as ISIS) in 2016 has made OPEC’s task harder. ISIS was inadvertently doing oil producers around the world a favor. Wherever it operated—in Iraq, Libya, or Syria—the oil industry went into decline. This is partly because ISIS itself is terrible at running oil wells, but also because the United States and others target its energy operations during bombing campaigns. By constricting oil supplies, ISIS was putting upward pressure on world prices. As it retreats in 2016, some areas are beginning to recover, making it harder for OPEC to constrain overall production.

The problems with the recent agreement don’t stop there. Even if a real deal is reached and OPEC does start to cut production after November, that deal may not do much to global oil markets. OPEC’s goal is to trim output by 240,000 to 740,000 barrels per day. The high end of that target is still less than one percent of global oil consumption. It is unlikely that such a cut would move world oil prices up by any significant amount and, to the extent that it does, other oil producers are likely to increase production and negate any initial surge in prices.

Still, oil prices did rise about five percent on the day of the announcement, which may have led some market traders to change their expectations about OPEC’s—or, more specifically, Saudi Arabia’s—future production plans. But it is equally plausible that the price shift was simply driven by a psychological priming effect. Historically, when OPEC makes an announcement, oil prices almost always go up in the short term and tend to slide down later when OPEC is quiet. What we know for sure is that OPEC does not tend to shift the market fundamentals—production.

To really understand meaningful market dynamics, it is important to know that the real dividing line in the world oil market is between high- and low-cost producers, not between OPEC and non-OPEC producers. High-cost producers have no incentive to invest at today’s prices, so only the low-cost producers such as Saudi Arabia have real strategic options about whether to increase or decrease their production rate. Interestingly, the United States’ position has changed dramatically in the last few years, with the marginal cost of production falling significantly. That is why the United States has not suffered as much from the drop in oil prices. Although the long-term consequences of low prices are still playing out in the tight U.S. oil industry, it looks like much of it can stay in business at $50 per barrel. According to the Energy Information Administration, U.S. oil production fell from a peak in June 2015 of 9.6 million barrels per day to a current 8.5 million barrels per day. Low oil prices are painful, but not fatal.

Saudi Arabian Oil Minister Ali al-Naimi, December 4, 2015.
Heinz-Peter Bader / Reuters

Scott Sheffield, CEO of Pioneer Natural Resources, a big shale oil company in the United States, says not to expect new oil exploration projects as long as oil stays around $50 to $55 a barrel. Only if oil goes above $60 a barrel would the U.S. industry take off again in a big way. And that’s exactly the outcome that OPEC, and especially Saudi Arabia, wants to avoid—so it is doubtful that the group would make an agreement that could precipitate such a scenario. 

All of this is basically good news for U.S. and European consumers, who benefit from lower oil prices. And low oil prices are good for industry and commerce in the Organisation for Economic Cooperation and Development as well. Low oil prices thus stimulate the economy as a whole. Many economists use a rule of thumb that says every $10 decrease in the price of oil increases U.S. GDP growth by about 0.2 percent. The fall in oil prices since 2014 might finally be showing up in the good economic data we are seeing in 2016, such as the rise in median household income. 

As for oil producers in the United States and Europe, even if a November OPEC deal falls through or fails to generate anything meaningful, all is not lost. Key members of OPEC might cut their oil production anyway since the lower prices yield lower profits. 

Since oil prices began to fall in 2014, while the United States has cut back, OPEC producers have been increasing oil production. That’s exactly the opposite of what you’d expect a cartel to do: a cartel is supposed to restrain oil production when oil prices are falling, in hopes of pushing prices back up. OPEC kept pumping oil because most members, especially Saudi Arabia, did not want to lose market share. And some members, including Iran, Iraq, and Libya, are ramping up production in the wake of their domestic crises. With this glut of oil on the market, we can eventually expect a modest decline in OPEC production, even for OPEC producers. After all, similar dynamics led OPEC and non-OPEC states to cut production in 1998 when oil prices fell below $10 a barrel.

The deeper question here is that if an OPEC agreement is most likely meaningless, why is Saudi Arabia pursuing one at all? One possibility is that it is planning to make a unilateral production cut, regardless of whether there is a deal in November, and it is trying to get some leverage out of it by encouraging others to make cuts, too. A second possibility is that it helps keep OPEC in the news, which adds to OPEC members’ international prestige and standing. Low oil prices in the last two years have had real geopolitical consequences, and OPEC would like to be seen as a real force again. The truth is, though, that the market would look pretty much the same even if OPEC ceased to exist tomorrow. 

All in all, markets and policy makers alike would be wise to politely ignore the maneuvering by OPEC and welcome the continuation of moderate oil prices.

  • JEFF COLGAN is Richard Holbrooke Associate Professor at the Watson Institute of Brown University.
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