The Tin Lesson for Oil

Copyright © 2021 Energy Intelligence Group
July 2021 Philip Verleger

The world oil market may have reached an important transition point. A wealthy oil-exporting country with large reserves and low costs has expanded its capacity and plans further additions. Also, the nation's leaders have expressed concern that the push to limit future oil use may leave billions of barrels of global reserves in the ground, and have started down a path to ensure that as little as possible of their own reserves are stranded. If not forestalled by Opec-plus consessions, this strategy may send prices down and ring the death knell for the oil cartel. This is not a new story. Similar forces collapsed the tin market 36 years ago. In that episode, a new tin producer refused to join an established Opec-like agreement that managed global production, choosing instead to take advantage of lower-than-average production costs. This destroyed the International Tin Agreement (ITA). The resulting 1985 tin price collapse offers a cautionary lesson to the members of Opec-plus.

The July Opec-plus meeting ended in disarray when the United Arab Emirates (UAE) balked at an extension of their current agreement through 2022 that was recommended by Saudi Arabia and Russia, the group's largest producers. The Saudi and Russian recommendation omitted any adjustment in the UAE's quota to reflect its increased productive capacity, or "baseline."

The UAE has complained that its current quota, based on its November 2019 production level, is well below its current capacity of 3.8 million barrels per day. In addition, the UAE is spending over $100 billion to expand its capacity to 5 million b/d, a target it expects to meet by 2030.

The other Opec-plus members initially resisted the UAE's call to revise their agreement, apparently thinking that renegotiating quotas would be complicated and could collapse the agreement altogether.

In taking that stance, the organization risked pushing the UAE to veto any extension of the agreement past April 2022 -- or just walk away from the pact -- leaving all countries to produce at will starting in May 2022. Another price war could result. Should that be the case, the UAE is better prepared than any other producer to survive.

It now appears that Saudi Arabia, at least, may be willing to accept some increase in the UAE baseline, allowing Opec-plus to muddle through if other members are willing to go along (IOD Jul.14'21 ). But a full Opec-plus deal is by no means a certainty.

The Tin Experience

The tin experience warns of another possible outcome. Beginning in the 1950s, world tin production was subject to a UN-sanctioned international commodity agreement: the ITA.

Such commodity agreements were created to stabilize prices. Producing and consuming countries alike joined in order to benefit from that stabilization, in many cases agreeing to build buffer stocks and employ managers to keep prices within a specific range. The member producing countries would also agree to limit output and exports when instructed to by the commodity managers during times of surplus. The managers, in turn, would order a release from the buffer stocks whenever prices exceeded the target range.

Of these agreements, the ITA was one of the longer lasting ones. Created in 1953, the ITA was then reviewed, and revised if needed, in 1955, 1960, 1965, 1970, 1975 and 1980.

The ITA became endangered in the 1970s as, among other developments, aluminum replaced tin in beverage cans, a primary use for tin. Consumption dropped from 170,000 tons in 1970 to 153,000 tons the year before the 1985 collapse.

Still, the managers of the International Tin Council (ITC) were able to maintain high prices despite the reduced use. Those prices enabled high-cost mines in England and Malaysia to keep operating. In 1985, Malaysia was the world's leading producer despite its high costs, accounting for almost 20% of world supply.

The ITC's propping up of tin prices also prompted non-ITA producers to enter the market. By 1984, those producers accounted for 40% of world supply. Brazil was one of the new entrants, producing 14% of global supply by 1985, with production costs roughly half those of Malaysia's.

Eventually, the ITC managers had to reduce production quotas for members in order to offset the increase in unregulated output from non-member countries. They also tried to rein in "wildcat" producers. In September 1985, a Malaysian delegation visited Brazil to persuade the young but prolific tin producer to get in step and join the council. One Malaysian minister presciently warned that the ITC might fail if Brazil did not cut output. Brazil maintained its production. In November 1985, the ITC collapsed.

Oil Lessons

I would not be surprised to see a similar collapse in the oil market within a year. The UAE could become Opec-plus' Brazil unless the group makes a quick adjustment to production quotas. The UAE can do this because it is in the unique position of being financially indifferent regarding producing at its current output level or at capacity.

Some key figures capture the UAE's powerful status: The annual revenue it would lose if the Opec-plus agreement collapsed and it produced at full capacity with a price of $40 per barrel, as compared to producing at the July target level for 12 months at an assumed price of $65/bbl, is just $14 billion. That compares to a loss of $21.4 billion for Saudi Arabia and $32.3 billion for Russia.

Of the Opec-plus members, the UAE suffers the smallest hurt. The UAE also has the largest financial reserves to tide it through a price war and the best marketing system to compete, with its development of Murban futures (WEO Mar.17'21 ).

Data on GDP growth, population and population growth further clarify the UAE's financial strength. Its GDP per capita in 2019 was $43,000. Saudi Arabia's was half that at $23,000. Further, the Saudi population is increasing by almost 2% per year, while the UAE's is rising at 1.4% annually.

The other Opec-plus members -- as well as the industry executives, politicians, analysts and economists -- who want high oil prices and market stability should be concerned that the oil price stabilization program will fail for the same reason the tin program failed. They should be further concerned by the fact that commodity agreements for coffee, sugar and rubber also fell apart.

Indeed, Opec-plus' efforts to manage oil may have reached the end of the line unless it accedes to the UAE's demands. If Saudi Arabia has, indeed, accepted the UAE's demand, the reason may be be that its leaders see this risk.

Philip Verleger is an economist who has written about energy markets for over 40 years. A graduate of MIT, he has served two presidents, taught at Yale and helped develop energy commodity markets since 1980.

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