Why OPEC may simply fade away

14 Jun 2011

Nothing lasts forever. So it’s worth asking whether the Organization of Petroleum Exporting Countries (OPEC) has had its day—and whether that matters.

The recent meeting of the Organization of Petroleum Exporting Countries, or OPEC, “was one of the worst meetings we’ve ever had,” according to Saudi Arabia’s oil minister, Ali al-Naimi, because of a rancorous split between the “haves” and “have-nots”—in terms of spare production capacity, or the ability to “open the taps” and produce much more oil quickly.

By most estimates, Saudi Arabia is the only OPEC member with significant spare capacity—that is, more than 1 million barrels per day. Other members in the Gulf, such as Kuwait, have some spare capacity, but not much.

The source of the disagreement was that the Saudis wanted OPEC to vote to raise the overall quotas for oil production from the whole cartel. “Oil prices are hurting the economy,” said Fatih Birol, the International Energy Agency’s chief economist, in a New York Times article. “I hope to see more oil in the markets soon.”

At least one Saudi prince agrees that oil prices are too high—albeit for another reason. Prince Al-Waleed bin Talal told CNN he would like to see prices around $70 to $80 a barrel. “We don’t want the West to go and find alternatives,” he said, “because, clearly, the higher the price of oil goes, the more they have incentives to go and find alternatives.”

But the “have-nots”—those that can’t easily boost their production any higher—had nothing to gain by voting to raise quotas, it seems. If OPEC is able to put more oil the market, prices will only come down. That means the “have-nots,” already pumping flat-out, would simply make less money. So not too surprisingly, the have-nots—the majority—banded together and voted against the Saudi proposal to raise the quotas.

Former Shell CEO John Hofmeister said on Fox News that it was no surprise, and portrayed the OPEC spat as a battle between “the truly anti-, anti-American crowd, the Venezuelans, the Iranians, and others, against the more statesmanlike group, like the Saudis and the UAE”. Whether he actually believes that or not, the fact that he brought it up suggests this kind of view resonates with a lot of people in government and industry—that it’s about whether, to use Bush’s formulation, they’re for us or against us.

I’d say it’s no surprise that the Saudi proposal failed to win the day—but for a completely different reason. It’s simply that we’re in a new era when it comes to oil. Most members of OPEC had nothing to gain by raising quotas—and that means that OPEC may have served its purpose. It could go the way of the Railroad Commission of Texas.

Most people, I imagine, have never heard of that body. But in the 1930s the Railroad Commission was big news across the U.S., because of the enormous power it wielded over the oil industry. Wildcatters were finding too much oil in Texas, more than the market could handle, and prices crashed. To try to rein in production and keep prices reasonable, Texas put its Railroad Commission in charge of setting production quotas, to try to keep prices up. By the 1960s, the quotas were being eased, and by 1971, the quotas were completely ended.

Why? Some say it’s because cheap Middle East oil left Texas oil unable to compete. But I think the real reason is that the U.S. had reached its all-time peak of oil production in 1970.

The production was on a plateau from 1970 to 1972, and—in retrospect—began a clear decline from 1973 onward. It wasn’t obvious at the time that 1970 would be the all-time peak—even though a well-known geologist, M. King Hubbert of Shell Oil, had predicted it—but producers knew they were having a hard time keeping up with demand. The U.S. had been self-sufficient in oil up through the end of World War II, but by 1970, a large and increasing share of its oil came from imports.

At that point, the Texas oil quotas were obsolete: When oil was too plentiful, they kept production down, to keep prices up and avoid waste. But when oil production could no longer keep up with demand, then they no longer had need for the quotas.

The Railroad Commission of Texas was the inspiration for OPEC, and it served much the same purpose. Although OPEC did not put quotas into place from day one, much of their power over the past four decades has come from their ability—and willingness—to ramp production up and down as needed, based on what’s happening in the rest of the oil market. When production elsewhere was high, OPEC scaled back to keep prices from crashing. When production elsewhere was low, then OPEC pumped more to keep prices from skyrocketing.

That era seems to have ended. If most OPEC members don’t have any spare capacity to speak of, then it’s really up to the Saudis to decide what they want to do with their spare capacity. The Saudis don’t really need OPEC anymore, it seems, and neither do the other members.

Media reports have often made it sound as if the fact that OPEC is losing control over oil prices is something scary, which we should be worried about. It is a sign of something scary—but not simply because OPEC is losing control. It’s because that’s a sign, it seems to me, that the era of cheap and plentiful oil is over.

It’s not clear how much more the Saudis can actually give, however. Here’s what the Saudi oil minister told Platts:

Saudi Arabia, Kuwait, the UAE and Qatar are “able and willing” to supply whatever the market needs, he told reporters. “The market is not going to see a shortage because we did not reach agreement at this meeting,” he said, adding: “We have the capacity to deliver and we will deliver it.”

… Asked how much the four countries could increase production by, Naimi said: “Whatever the market needs.”

As for Saudi Arabia, “let the buyers come and we will supply them with what they want, whatever they need,” Naimi said.

This sounds to me like swagger and bluster. There’s no way that they can supply any amount; by most estimates, these countries have at most 4 million barrels per day of spare capacity.

Over at The Oil Drum, Rembrandt Koppelaar has an interesting post: “The OPEC meeting – How much will production really increase?” (The graph I linked to above about spare capacity is from his article.)

His answer for how much OPEC exports will rise is, to sum up, is “not much.” For one thing, the summer is heating up and Saudis own demand for running air conditioners will increase, drawing on the country’s oil-fueled power plants.

And his answer for how much it might bring down oil prices, the answer is also “not much.” If the world knows that boosting production means there’s not much spare capacity left as a buffer in case of problems—say, more turmoil in another oil exporting country—then the price could remain high.

A similar kind of tightness in the U.S. oil market made America vulnerable to the 1973 OPEC embargo and contributed to the energy crises and economic woes that lasted until the early 1980s. I think we’re seeing a replay of this on a global scale—and it will be much worse this time.

OPEC still has a lot of power, in theory; if some of their countries decided to stop oil production, it would cause major problems. But they seem unlikely to do this by choice, because they’re spending a lot of their oil revenues to keep their countries running—and the Saudis, for one, have boosted spending recently to try to quell dissent.

Middle East oil will remain crucial for decades to come, even if they can’t raise production much further. But OPEC, as a powerful organization, may soon fade away. The sooner we erase the mystique around OPEC, and realize they can’t be the world’s saviors, then the better placed we’ll be to cope with the situation that we’re in.


books I've read on failure & grace

The World Without Us
The Last Oil Shock: A Survival Guide to the Imminent Extinction of Petroleum Man
A Paradise Built in Hell: The Extraordinary Communities That Arise in Disaster
Hell and High Water: Global Warming--the Solution and the Politics--and What We Should Do
The Worst Hard Time: The Untold Story of Those Who Survived the Great American Dust Bowl
The Tipping Point
Three Cups of Tea: One Man's Mission to Promote Peace... One School at a Time
The Upside of Down: Catastrophe, Creativity and the Renewal of Civilization
Out of Poverty: What Works When Traditional Approaches Fail
The Little Ice Age: How Climate Made History, 1300-1850
Confessions of an Eco-Sinner: Tracking Down the Sources of My Stuff
Deep Economy: The Wealth of Communities and the Durable Future
The Geography of Bliss: One Grump's Search for the Happiest Places in the World

Mason's favorite books »