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  1. Home
  2. / Investing
  3. / Energy

Ecuador Is Leaving OPEC, Is It a Sign of Things to Come?

Ecuador had asked OPEC for permission to produce above its quota, but it was never answered. It matters little to OPEC -- but for Ecuador, it no longer serves its interests to be part of this bigger organization.
By MALEEHA BENGALI
Oct 03, 2019 | 06:45 AM EDT

In all the mayhem of global economic growth falling off a cliff, as U.S. ISM Manufacturing printed the lowest since 2009, investors lost sight of an important announcement in the world of oil. Ecuador, which is one of the smallest-producing members of OPEC, said on Tuesday it was going to leave the group as of January 1 2020, due to "fiscal problems." It only produces about 545,000 barrels per day (bpd) ~ 1.8% of total OPEC supply. The 14-member group produced about 28.9 mbpd in September, according to recent surveys.

So why is this important?

OPEC oil output has fallen in September to an eight-year low after attacks on Saudi infrastructure that took about 5.7 mbpd out of the market temporarily. All that production was restored by the end of September. Since 2017, OPEC expanded to informally include Russia and other oil allies, as well. This combined group, known as OPEC+, agreed at the start of this year to take 1.2 mbpd of oil out of the market to help offset the demand slowdown and price weakness as Brent prices got to as low as $55/bbl. Brent. This agreement is in place until March 2020. OPEC's share of the cut is 800,000 bpd to be delivered by 11 members excluding Iran, Libya and Venezuela. Compliance has been at 218% in September up from 131% in August.

The fact of the matter is that the real "swing" producers in the oil market are Saudi Arabia, Russia and U.S. -- so USSauRu should be the real new nickname for the group. These three leaders each produce about 10 mbpd, about 10% of global supply, so what they say and do matters. The other "little" players know it.

In February, Ecuador had asked OPEC for permission to produce above its quota, but it was never answered. The country needs funds and it wants to raise production. In the grander scheme of things, this matters little to OPEC -- but for Ecuador, it no longer serves its interests to be part of this bigger organization and play by its rules, as the big boys call it.

Over the last few years, Saudi Arabia has lost its status as top oil exporter, given the rampant growth of U.S. shale that shocked the world markets in its pace and efficacy. But it is the cost to produce oil that is even more important. U.S. Shale is happy as long as WTI oil prices are $45/bbl or above. Today, WTI is trading closer to $52/bbl. Russia is more than pleased to keep pumping, as they make money with Brent above $55/bbl. Brent is closer to $57/bbl today.

Saudi Arabia, however, needs Brent oil prices closer to $70-75/bbl -- not because that is what it costs them to produce oil. Far from it. They have one of the lowest costs overall, but given their budget deficit and spending plans for the future to diversify away from oil revenues, their breakeven for oil prices is much higher. That is the underlying problem.

The OPEC+ alliance was very quick to get a unanimous decision to cut oil back in 2017 in order to protect oil prices. It worked well for everyone, but when prices went higher, market share was lost as other players ramped up. This is the constant struggle for these big players, protect prices or volumes.

Going back to countries like Ecuador or other smaller players, their interests are much different, as they just want to produce as much as they can and at the highest prices possible, so that they can maximize their revenue. The OPEC alliance worked well during the 1970s and previous shocks to the system, but it may not serve the purpose for everyone.

The group maybe called OPEC+, but in reality, the decisions are being made mostly by Saudi Arabia and Russia, the rest are just told to follow along. U.S. shale is entirely independent and the U.S. has its own agenda of maintaining oil independence to serve its own needs. It cannot afford consumer price inflation -- hence, Trump tweets to OPEC to "keep prices down and pump more" -- but yet its economy is also levered to the oil price as it is a significant part of its revenue and employment.

There is always safety in numbers, and so the union made sense. But OPEC has historically always been known for its cheating of quota compliance. Most deals are made behind closed doors prior to the official OPEC meetings. One wonders the point of it all. Can we really blame Ecuador for wanting to leave? And will any other countries follow suit?

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At the time of publication, Bengali had no positions in the securities mentioned.

TAGS: Investing | Markets | Oil | Trading | World | Energy | Emerging Markets (South America, Asia, Middle East) | Middle East | Russia

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