Friday, October 24, 2014

Opec now just a paper tiger

OCT 24, 2014


FORTY-ONE years ago this month, the Arab oil embargo began. The countries that were part of it belonged, of course, to the Organisation of Petroleum Exporting Countries - Opec - which had banded together 13 years earlier to strengthen their ability to negotiate with international oil companies. The embargo led to widespread shortages in the United States, higher prices at the petrol pump and long lines at petrol stations. By the time it ended, the price of oil had risen to US$12 a barrel, from US$3.

Perhaps more important than the price increases themselves was the new world order the embargo signalled. The embargo "set in motion geopolitical circumstances that eventually allowed (Opec) to wrest control over global oil production and pricing from the giant international oil companies - ushering in an era of significantly higher oil prices", as Ms Amy Myers Jaffe and Mr Ed Morse noted in an article in Foreign Policy magazine that was published last year on the 40th anniversary. Twice a year, Opec's oil ministers would meet in Vienna, where they would set oil policy - deciding to either hold back or increase oil production. There was always cheating among members, but there was usually enough discipline in the ranks to keep prices more or less where Opec wanted them.

As it happens, the title of that Foreign Policy article was The End Of Opec. Ms Jaffe and Mr Morse are both global energy experts - she is the executive director of Energy and Sustainability at the University of California, Davis, and he is the global head of commodities research at Citigroup - who say that if America plays its cards right, Opec's dominance over the oil market could be over. I think that day may have already arrived.

"Opec is not going to survive another 50 years," Mr Morse told me. "It probably won't even survive another 10. It has become extremely difficult for them to forge an agreement."

When Mr Morse and Ms Jaffe wrote their article last year, the price of oil was more than US$100 a barrel. Today, the per-barrel price is in the low- to mid-US$80s. It has dropped more than 25 per cent since June. There was a time when US$80 a barrel would have been more than satisfactory for Opec members, but those days are long gone. Venezuela's budgetary needs require that it sell its oil at well above US$100 a barrel. The Arab Spring prompted a number of important Opec members, including Saudi Arabia and the United Arab Emirates (UAE), to increase budgetary spending to keep their own populations quiescent. According to the International Monetary Fund, the UAE needs a price of more than US$80 to meet its budgetary obligations. That's up from less than US$25 a barrel in 2008.

Not long ago, Venezuela asked for an emergency Opec meeting to discuss decreasing production. Iran has said that such a meeting is unnecessary. Meanwhile, Saudi Arabia has made it clear that it is primarily concerned with not losing market share, so it will continue to pump out oil regardless of the needs of other Opec members. This is not exactly cartel-like behaviour. The next Opec meeting is scheduled for late next month, but there is little likelihood of an agreement.

And why does Opec suddenly find itself in such disarray? Simply put, the supply of oil is greater than the demand, and Opec has lost its ability to control the supply. Part of the reason is a slowdown in global demand. China's economy has slowed, and so has its voracious appetite for oil. Japan, meanwhile, is increasingly turning to natural gas and nuclear power.

But an even bigger part of the reason is that the shale revolution in North America is utterly changing the supply-demand dynamic. Since 2008, says Dr Bernard Weinstein, an energy expert at Southern Methodist University, oil production in the US is up 60 per cent. That's an additional three million barrels a day. Within a few years, predicts Mr Morse, America will overtake Russia and Saudi Arabia and become the world's largest oil producer.

What's more, according to another article Mr Morse wrote, this one for Foreign Affairs magazine, "the costs of finding and producing oil and gas in shale and tight rock formations are steadily going down and will drop even more in the years to come". In other words, the American energy industry might well be able to withstand further price drops easier than Opec members.

When I got Ms Jaffe on the phone, I asked her if she thought Opec was a spent force. "You can never say 'never'," she replied, and then laid out a few dire scenarios - mostly revolving around oil fields being bombed or attacked - that might make supply scarce again. But barring that, this is a moment we've long been waiting for. Thanks to the shale revolution, Opec has become a paper tiger.


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