Is Crude Oil Facing a 1990's style slump?

Crude oil faced significant falls as OPEC announced that the cartel is to abandon production target setting and will instead allow the oil market to effectively find its own equilibrium. Subsequently, crude oil prices fell over 6%, signalling that a return to the price slump of the late 90’s could be just around the corner.

The 1990’s were a tumultuous period for oil as OPEC sought to control global oil supply with an iron fist. However, the latter part of the decade saw the cartel effectively lose control of the market, and prices plunged to around $10.00 a barrel of crude. As any good historian will tell you, history often repeats and there are some striking similarities between the current market forces and those present in the 1990’s.

That decade in oil history saw exponentially increasing production from Venezuela flooding the world and upsetting the supply side of the market. In response, one of OPEC’s largest members, Saudi Arabia, lifted their production to effectively protect their market share in light of the South American upstarts in-roads to their racket.

The increased supply subsequently depressed world crude prices and the latter part of the decade became a wilderness for oil producers as OPEC’s grip over the market was effectively neutralised. However, like all downturns, price support was eventually discovered, and with the oil cartel’s stewardship, crude prices surged until reaching a peak of $150 a barrel by 2008.

Subsequently, it’s easy to draw a parallel between the current state of the market and that of the late 90’s. This is especially evident when you consider the role of US shale oil producers and, in extension OPEC, in the battle for market share. In fact, the cartel’s strategy of attempting to force out high cost producers smacks of their battle with Venezuela in the 1990’s.

Ultimately, it was political change in Venezuela that ushered in a reduction in oil supply, as the Hugo Chavez led Socialist government took action to cut production. Up until that point, markets remained awash in a crude excess that was difficult to clear. Within a relatively short period of time oil prices rebounded and OPEC had largely regained control of the market.

Currently, it would appear that the political component will largely be the deciding determinant in the ongoing supply war. The question remains as to which regime will blink first in the battle over OPEC’s hegemony over crude oil.

However, this time the Middle Eastern nations have their respective backs to the wall as dwindling foreign currency reserves, and export revenues, put their national accounts under pressure. Given their lack of GDP diversity, and strong reliance upon crude oil export revenues, it’s almost certain that cracks will start to appear amongst the OPEC member states. In contrast, the US economy retains a much greater GDP diversity that is likely to allow them to whether the storm, whilst shale producers continue to produce domestically.

Subsequently, the question remains as to which regimes have the political will to continue the battle in the face of mounting domestic funding pressures. In my humble opinion, OPEC producers will need to blink first, and surrender significant market share, to allow the market, and their respective trade revenues, to rebalance. Otherwise a continuation of the cartel’s strategy of over-supply will continue to damage the global crude market and we could very well see oil prices back in the $20.00’s.