The Influence of OPEC+ on Oil Prices: A Quantitative Assessment.

• Date: 01 September 2023
• Author: Quint, Dominic

1. INTRODUCTION

   The advent of U.S. shale oil has substantially changed the structure of global oil production. The emergence of the U.S. as a dominant market player has had profound implications for the strategic behavior of other oil producers, and in particular for those coalesced in the Organization of Petroleum Exporting Countries (OPEC). Whereas OPEC, which includes large producers like Saudi Arabia, Iraq, Iran and the United Arab Emirates, has gradually lost market shares for the past ten years, U.S. producers have doubled their oil market shares over this period. The U.S. is by now not only the largest oil producer, but also an important oil exporter, after a ban that prevented U.S. firms to sell oil abroad was lifted in December 2015. As a result, the pricing power of OPEC members weakened substantially, oil prices plunged and a supply glut emerged, as testified by a persistent increase in oil inventories. In an attempt to regain some control over crude prices, OPEC and a number of other non-U.S. oil producers forged an alliance in 2016, known as OPEC+. Among non-OPEC members, this coalition includes large producers like Russia, Mexico and Kazakhstan. The strategy adopted by OPEC+ consists of setting explicit production targets for each member with the aim of bringing oil inventories down to their 2010-2014 average.

   In March 2020 the OPEC+ agreement was shaken by the Covid-19 shock. As mobility collapsed due to containment measures adopted on a global scale, demand for oil and the price of crude tumbled. When OPEC, in particular its unofficial leader Saudi Arabia, suggested the implementation of further production cuts to lift oil prices, Russia refused to cooperate, arguing that U.S. producers would gain the most from new efforts to prop up prices. The standoff between Saudi Arabia and Russia lasted more than a month and contributed to exacerbating a supply glut of historical proportions. (1) Eventually a new agreement was reached and a new round of production cuts agreed upon, but this episode showed vividly how the oil market balance is crucially intertwined with the effectiveness of the OPEC+ coalition in influencing prices.

   Against this background, this paper assesses the impact of the OPEC+ coalition on the Brent oil price between January 2017 and January 2020, intentionally excluding the period affected by the Covid-19 shock. Understanding the impact of the OPEC+ agreement is not only relevant for the members of the alliance as even small changes in oil prices will have significant effects on revenues earned on oil exports. This matters also from a global perspective as supply-driven oil price changes affect global economic growth. (2) A glance at raw data indicates that, over the period we are analysing, the price of crude rose substantially, suggesting a significant role for the supply cuts implemented by OPEC+. Yet inventories remained high compared to their historical average, somewhat confuting the idea that OPEC+ achieved their target of substantial market tightening. And oil demand played a key role in keeping oil prices high as economic activity kept growing at a robust pace over these three years, providing an important confounding factor.

   In order to uncover the actual impact of the OPEC+ alliance on the global oil market between January 2017 and January 2020, we recur to counterfactual scenarios based on two structural vector autoregressive (SVAR) models, which allow us to disentangle supply cuts from other disturbances like demand shocks. We compute a counterfactual path of global oil production assuming that OPEC+ would have not implemented its production cuts after December 2016. Our estimated structural models allow us then to recover the implied path of oil production and oil prices that would have cleared the market in absence of the production cuts. Compared to the actual price of oil, this allows us to quantify how much lower oil prices would have been, had the OPEC+ supply agreement not been in place. The first SVAR model that we use for this exercise includes global oil production, global economic activity and the price of Brent and we identify supply shocks alongside with demand and precautionary demand shocks. In our second SVAR specification we split the production of OPEC+ from that of the rest of the world, allowing for strategic interactions between these two large oil producing blocks.

   We find that the impact of OPEC+ on the price of crude oil varied over time, together with the cohesion of the coalition, and that it was overall quantitatively modest. Averaging over the whole period under analysis, our results indicate that the price of oil would have been around 4 USD per barrel lower (6 percent of the average price over the period) had OPEC+ not cut production. It would have taken a much deeper cut in oil production and a much stronger cohesion to achieve the ambitious target that the coalition had set for itself. Although the effect on the price of crude was small, the economic consequences of the OPEC+ agreement for some large oil producers like Russia and Saudi Arabia were not negligible. Given their crude production, the gains in export revenues from the supply cuts are quantifiable in around 10 billion USD per year (0.5 percent of GDP) for Saudi Arabia and around 8 billion USD per year (1.3 percent of GDP) for Russia. (1)

   The remainder of the paper is organized as follows. The next section reviews the related literature. Section 3 discusses recent developments in global oil markets and how OPEC and its allies reacted to them. Section 4 describes the empirical methodology and data and Section 5 presents the main empirical analysis. Finally, Section 6 concludes.

2. RELATIONSHIP WITH THE EXISTING LITERATURE

   This paper relates to a large literature using SVAR models to study global oil market dynamics. Such models have now a long tradition, since the seminal work by Kilian (2009) and Kilian and Murphy (2012, 2014). (4) In our empirical analysis we broadly follow Kilian and Murphy (2014) and use sign restrictions in combination with elasticity bounds to identify structural oil price shocks. Our first SVAR model includes global oil production, a measure of global economic activity and the price of Brent oil. By modeling oil production as a single aggregate, however, this simple specification may neglect some important differences in the behaviour of OPEC and non-OPEC producers (Kolodzeij and Kaufmann, 2014). We account for these differences in a second SVAR model where we treat OPEC+ and non-OPEC+ production as two separate variables. (5) Our methodological approach for the counterfactual analysis is close in spirit to Kilian (2017), who quantifies the effect of shale production on the production of Saudi Arabia and the global oil price between 2008 and 2015. The empirical strategy adopted by Kilian (2017) consists of computing a counterfactual path of global oil production assuming (i) that U.S. production would have remained constant rather than rising after 2008 and (ii) that the observed increase in the output of shale producers was due to exogenous supply shocks, rather than being a reaction to favorable demand conditions. Given these two assumptions, one can easily recover the implied path of oil production and oil prices that would have cleared the market, given an estimated SVAR model. We adopt the same philosophy and assume that all the fall in the production of OPEC+ producers can be attributed to an exogenous shift in their oil supply.

   While SVAR models have become a wide-used tool to analyze oil price dynamics, there are also other approaches to quantify the impact of OPEC decisions on oil prices. A number of papers employ event study methodologies to investigate the impact of OPEC announcement on oil prices (see e.g. Loutia et al. (2016) and the studies mentioned therein). While such event studies allow to analyse the impact of particular production decisions, the methodology would not allow us to construct a counterfactual oil price path. (6) Explicitly modeling the market power of producers when estimating the impact of OPEC producers is another interesting approach. This can either be done by including an industrial organisation model into a DSGE framework (see e.g. Nakov and Nuno, 2013) or by estimating a dominant firm-competitive fringe model (see e.g. Golombek et al., 2018). However, such approaches require explicit assumptions about the bargaining power of producers. Given the growing influence of U.S. producers any such assumption would be too stringent. Focusing on the role of OPEC's spare production capacity for the volatility of oil prices, Pierru et al. (2018) proposes a simple model of global oil supply and demand that can be used to estimate the impact of shifts in supply on oil prices. While such an approach does not depend on identifying assumptions like they are needed in SVAR models, the model would need to be significantly extended in order to allow for any strategic interaction between OPEC+ and non-OPEC+ producers.

   Our paper is close to a stream of papers that analyze the implications of the shale oil boom in the U.S. for...