OPEC’s first fracture

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NICK EICHER, HOST: Coming up next on The World and Everything in It: oil industry shakeups in the Middle East.

OPEC, the Organization of Petroleum Exporting Countries, oversees oil production in the region. Its stated goal is to ensure stable supply, but OPEC is considered a cartel. It’s made up of 12 member countries which decide on prices for the global market. Then their economists estimate demand and calculate the appropriate level of supply to achieve that target price.

By intentionally taking oil off the market, OPEC uses its leverage to act as the “deciding body” for the global price.

MARY REICHARD, HOST: But OPEC got some surprising news last week when the United Arab Emirates severed ties after six decades.

WORLD’s Emma Eicher on what the move might mean.

EMMA EICHER: The United Arab Emirates is the 3rd largest oil producer in OPEC, and its abrupt exit on May 1st signals a potential new order in the Middle East.

It’s a move that isn’t unprecedented, but Heritage Foundation economist E.J. Antoni says what the UAE started may be hard to stop.

E.J. ANTONI: But it could very well turn out that this is the first snowflake, so to speak, in the snowball effect that will eventually be the unraveling of that cartel.

The unraveling comes down to the interplay of supply and demand. Typically, OPEC acts as a gatekeeper, keeping oil prices artificially high by limiting how much its members can supply to global markets.

It’s a strategy that has worked for decades, made even tighter by the closure of the Strait of Hormuz.

But the UAE is done waiting for the gate to reopen.

ANTONI: The UAE, I think, is positioning themselves to be able to meet that huge surge in demand by coming up with a big increase in production... If they're still part of OPEC, OPEC is going to have their boot on UAE's neck essentially, trying to tell them, 'don't produce more.'

Saudi Arabia has the biggest boot in OPEC, as its top oil producer. And some anticipate the Saudis will retaliate. Even though the UAE produces less than half the output of Saudi Arabia, it can still threaten Saudi revenues by loosening the cartel’s control over supply. Meaning, if the UAE pumps at will, that puts downward pressure on prices. 

The UAE’s longstanding relationship with Saudi Arabia has remained tense.

MICHAEL TAMVAKIS: They don't always see eye to eye with the politics of Saudi Arabia, particularly external policies.

Michael Tamvakis is a professor of commodity economics and finance at Citizen George’s University of London. He says that because oil is a global commodity, these two neighbors are head-to-head competitors in the same markets, and their rivalry could spark price wars.

TAMVAKIS: This is where Saudis may start undercutting UAE cargoes. The oils they export are very close in terms of quality, so they can easily replace each other. They may even compete with other markets like Europe and even the United States, although these are smaller markets.

Prices will stay high with the Strait of Hormuz closed and supplies restricted. But once it reopens and the UAE pumps out more oil, prices are predicted to stabilize.

TAMVAKIS: Hopefully we're going to see a lot more oil in the market, and the prices eventually coming down again.

The UAE is a strategic ally of the West. Israel recently supplied the country with laser systems to counteract drone and missile attacks from Iran. And some have said the UAE’s exit is noteworthy for the U.S.

Jim Krane is an energy research fellow at Rice University’s Baker Institute in Houston.

JIM KRANE: UAE has kind of been seeing itself more of a partner of the U.S. and Israel than the other countries in the Gulf. I think it would like to have a bigger role in Washington, and it sees the cartel kind of holding them back from achieving their geopolitical ambitions.

While the UAE’s move is a win for the consumer, market volatility will hit U.S. oil industries hard.

KRANE: You know, the U.S. might not be producing anything if it weren't for OPEC taking so much oil off the market and under-investing in its own resources. So by doing this, by keeping oil off the market and keeping prices high, that's allowing the U.S. oil industry to stay in business and stay profitable.

Because U.S. fracking is often more expensive than traditional drilling, it requires a higher market price to make economic sense. By propping up prices, OPEC has strengthened American competitors.

But long term, the UAE is betting that independence is worth more than the cartel’s protection.

E.J. Antoni of the Heritage Foundation says that once the market adjusts, those who can produce the most will lead the way.

ANTONI: When everyone's trying to refill reserves, they're going to be the big winner. Obviously, any oil consuming nation, though, is also going to benefit somewhat, and that would include us here in the United States... It should … produce some downward pressure on oil prices in the long run.

Reporting for WORLD, I’m Emma Eicher.

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