Over the past year and a half, a steady decline in world oil prices has led to the largest international oil market slump in more than a decade.
At market close this past week, Brent Crude, a global benchmark, traded at about $33 per barrel, down 45 percent from last year. The crude oil price per barrel of a U.S. benchmark company was $29.64, nearly half the $50 per barrel price tag that both exporters and consumers find acceptable in the long run.
The underlying cause of the oil slump is an imbalance of market forces, which resulted from a boom in U.S. shale production. The U.S. shale boom drastically increased world oil supplies in a short period of time, driving prices down to twelve-year lows.
Despite this, many of the top oil producing nations have refused to curb their own oil production. Some countries, including Iraq and Iran, have even increased production, further driving down the price.
As a result of these low oil prices, consumers now pay an average of $1.70 per gallon at the pumps, down from $3.44 in August 2014. Similarly, the decrease in oil prices has made it less expensive for people to heat their homes.
These consumer benefits, however, could be erased by threats to the stability of the oil sector if the low prices persist. Since the oil slump began, several large oil producing firms, particularly those in the United States, have been forced to suspend operations. If prices continue to fall, more firms will be forced out of the market, allowing larger, more successful firms to garner larger market shares and indulge in monopolistic behaviors.
According to their mission statement, OPEC, or the Organization of Petroleum Exporting Countries, is an international body that works to “coordinate and unify the petroleum policies of its member countries to ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry.”
At a recent meeting in Doha, the largest OPEC producer, Saudi Arabia, came to an agreement with Russia, the largest non-OPEC producer, to freeze petroleum production at January levels. In theory, capping production would most likely not have much of an effect on either of the top two producers, and it could help stabilize prices.
There are, however, several caveats and potential pitfalls pertaining to this agreement. First, Saudi Arabia and Russia refuse to freeze their output unless other OPEC countries join them. These two large producers fear losing their market shares to countries that are not willing to sign the agreement.
The OPEC countries that are most opposed to a production freeze are Iraq and Iran. Iraq needs money from oil exports to fight ISIS while Iran has vowed to raise production by one million barrels a day in an effort to regain the market share they lost after being slammed by heavy sanctions.
Tensions between Saudi Arabia and Russia, the main proponents of this contract, are rising, as the two nations are on opposite sides of the Syrian conflict. Tension between longtime rivals Saudi Arabia, a predominantly Sunni nation, and Iran, a predominantly Shiite nation, may also make implementing such an agreement difficult.
Finally, using a production freeze as the basis of cooperation means that none of the parties involved have to make any effort to comply. This agreement is a classic example of a prisoner’s dilemma in which it is in the collective interest to cooperate by limiting oil production, but each country also has a strong incentive to deviate from the agreement to turn a larger profit and increase its market share.
While there are some signs of agreement, OPEC has a long way to go before it will be able to stabilize oil prices, if it still can. Russian Energy Minister Alexander Novak remains optimistic about the oil cartel, saying it “would be a positive signal” for the market if an agreement is indeed reached. Negotiations are to be completed by March 1.