True or false: The seven most common ideas

Moisés Naím / World Energy & Oil

The global oil scene has always been a battlefield in which the intensity of the commercial skirmishes is only exceeded by the vigor of the geopolitical clashes over its control. This has not changed in recent years, except for the fact that the fighters, weapons, strategies and tactics on that battlefield have been dramatically altered. New technologies have disrupted exploration and production and created new players that use very different tactics, boosting the oil fortunes of producers like the United States. Hedge funds and new forms of financing operations have added financial players to the list of the new forces that are upending oil markets.

National oil companies are working to adjust to the contradictory pressures of the domestic politics of their countries and the international politics that shape their business environment.

Traditional multinational corporations face surprising competition from smaller but more agile and bold, rivals. Changes in the patterns and volumes of the demand for oil have also created new realities. In the midst of these revolutionary changes stands the 55 year-old Organization of Petroleum Exporting Countries, OPEC. OPEC is caught in the middle of this epic struggle. Surely, today it has less influence on the market than during its halcyon days. While in 1974 it accounted for half of the world’s total supply of oil, today OPEC members account for a third - and their share of total supply is expected to continue to dwindle. But is OPEC an endangered species condemned to disappear? Or will its power to determine global oil prices recover? The turmoil in the structure of the global oil industry has inevitably nurtured a spirited debate about OPEC’s future. In this article I have identified some of the most common assertions made about OPEC and discuss how valid they are. Some are true, some false and some others that used to be true are no longer so.

OPEC determines global oil prices: Never True
While at times it wielded substantial price-fixing power OPEC was never a price fixing cartel. In fact, when measured in terms of effectiveness, rather than intentions or public statements, OPEC has rarely been a strong cartel. It reached the acme of its price-fixing power in 1973, during the Arab oil embargo when decisions taken by OPEC effectively contributed to the sudden quadrupling of oil prices. The energy bill of consuming countries skyrocketed. Since then, OPEC has been essentially unable to exercise significant influence over global oil prices. The diverging interests of its member nations made it very difficult to maintain price discipline while new producing countries entered the market refusing to join OPEC.

Periods of high oil prices have been mostly triggered by geopolitical events outside OPEC’s influence. Even today, as Saudi Arabia’s decision to increase production has been an important contributing factor in keeping down prices, the main player has not been OPEC as a whole, but a small and dominant group of Gulf States within the organization. In fact, the decision to keep production levels unchanged runs contrary to the professed policy of OPEC of defending prices by managing output. This recent behavior is nothing new but one more example of what is a clearly identifiable trend with OPEC, namely that its behavior is fundamentally driven by the interests and decisions of its larger producers.

OPEC is doomed to disappear: False
As is the case of many other international organizations that have lost the relevance they once had, OPEC will more likely enjoy bureaucratic immortality. Although its importance has dwindled, OPEC is not in danger of being shot down by its members. Conceived by third-world visionaries in the 1960’s, the organization was given geopolitical legitimacy by its success in raising prices in the early 1970s and also by the ideas and principles expressed by a doctrine called the New International Economic Order (NIOC). The NIOC included as one of its main bedrock principles the right of nation states to control the extraction and marketing of their domestic natural resources. Another was the establishment and recognition of state-managed resource cartels. Their aim was to stabilize commodity prices and, of course, extract from the richer consuming countries “fair” prices for their exports. Surprisingly, OPEC perceived power was greatly aided by M. King Hubert’s Peak Oil theory, which popularized the belief that oil was becoming scarce in the planet and would eventually become extremely scarce. This perception further boosted OPEC’s geopolitical power given that its members controlled most of the oil reserves. Once the assumption that the world would shortly use up the oil has been replaced by the theory of an overflow of petroleum, the importance of a cartel that controls an abundant commodity inevitably declined.

The survival of any cartel depends on two main factors: that the commodity it controls is in short supply and that the members of the cartel respect their agreed production quotas and refrain from adding to the supply beyond their allocated production, thus, pushing prices down. Today, powerful new forces and actors have weakened these two conditions. New sources of energy are entering the market at increasing speed. In Europe, consumption of renewable energy sources has increased some 80 percent in the last 10 years and some 15 percent of electricity consumption in the U.S. now comes from renewable sources. Technological innovations such as thin film solar cells could become real game changers in the energy sector. The shale oil and gas boom, which will spread from the U.S. into at least half a dozen other countries, and the proliferation of independent oil producers are gradually reducing the significance of OPEC’s role in the global energy sector. However, in contrast to similar organizations such the International Association of Coffee Producers (IACP) or the International Tin Council (ITC), which folded when they could no longer pay their debts, OPEC is relatively inexpensive to maintain by its very wealthy members. Therefore, the outlook for OPEC is for progressive irrelevance rather than death.

OPEC was created to maintain market stability: False
Even though its leaders are loath to recognize it, since its inception OPEC has been guided by what it calls “the defense” of oil prices. This meant getting prices as high as the market would bear, while avoiding setting them so high that rival producers or new technologies (especially renewables) would become economically attractive. Despite the official line and the speeches about OPEC’s goal of seeking the elusive equilibrium between supply and demand, what in practice shaped OPEC’s decisions most of the time was getting the best possible prices without stimulating rivals. In fact, for years, the prevailing strategy of the organization, was limiting its members’ output in order to maintain a market dominated by the sellers. Rather than cooperation between producers and consumers, OPEC emphasized a strategy of gaining price advantages over the large consuming countries of the industrialized world, even if its pricing strategy obviously hurt consuming countries in the developing world. Over time, this strategy of maximizing revenues became ineffective, as individual member countries which desperately needed oil income to fill the government’s coffers blatantly violated their production quotas - which they had promised OPEC that they would respect. Today, this situation prevails and the most financially strapped members openly flaunt their output commitments. In part as a result of its inability to maintain discipline in its ranks, OPEC is now calling for increased global cooperation between consumers and producers - a move more likely driven by necessity than by conviction.

Saudi Arabia will continue to be its most influential member: True
In the foreseeable future there is no rival to Saudi Arabia within OPEC. Its vast proven reserves of good quality, light oil with relatively cheap production costs insure that the Saudi kingdom will continue to be OPEC leader despite the fact that Venezuela - one of OPEC founders - boasts the world’s largest reserves. Venezuela’s lower quality, heavy oil is more expensive to produce. In addition, the Venezuelan government has been unable to create a growth-oriented oil industry and, in fact, its production capacity has been declining. Iran’s conventional oil reserves are the third largest in the world but its oil industry continues to be afflicted by poor operational efficiency and a prolonged period of underinvestment. Things can change and Saudi Arabia’s oil leadership could be affected by political instability or a geopolitical accident that limits its oil export capabilities while Venezuela and, more probably, Iran may recover their competitiveness. Still, most experts agree that the most likely scenario is that Saudi Arabia will continue to retain its leading position within OPEC. The Kingdom leadership is well consolidated, not only thanks to its highly efficient management of its oil industry but also because it wields significant influence over its oil and gas producing allies in the Gulf.

The differences in the national interests of its members can be reconciled: No longer true
As in any other type of association the harmony within OPEC could be easily maintained while results were clearly favorable to the producing countries. The increasing role of independent oil producers in the global market, the boom of oil and gas production in the U.S., China’s increasing reliance on Russia for its energy requirements have greatly contributed to OPEC’s loss of market share and have exacerbated internal frictions within the organization. The attention of member countries has been diverted to individual survival rather than to collective action. Moreover, the international financial crisis and the anemic global economy have hurt the most fiscally vulnerable members of OPEC. The fiscally exposed countries need relatively higher oil prices to balance their public budgets or - absent higher prices - they need to export larger volumes of crude in order to obtain the revenues they badly need. The substantial drop of oil prices that began in the summer of 2014 has added pressures for needy OPEC members to export as much as they can to close their huge fiscal deficits. Naturally, this worsens the misalignments between the OPEC members that enjoy a sounder economic situation and the oil producers who are in dire economic straits. The results of the recent OPEC meeting in which higher production levels were confirmed, show that Saudi Arabia is, more than ever, in the driver’s seat and that the fiscally frail producers will have to fend for themselves.

The boom in oil and shale gas development will become global and will further weaken OPEC in the medium term: True
Most shale oil and gas probable reserves are located in non-OPEC Countries, particularly the U.S., Mexico, Argentina and China. In 2010 these resources were estimated by the International Energy Agency, IEA, to be some 5 trillion barrels of technically recoverable oil, a volume more than four times larger than the proven oil reserves of all OPEC members (about 800 billion barrels of oil). The development of these resources in the U.S. has already had a large impact on the global oil supply and in the softening of prices. As other countries start developing their own resources this impact will become even more significant. Moreover, as a recent Financial Times editorial says: “The shale oil industry of the U.S. is emerging as the world’s swing producer, bringing more crude on to the market when prices rise, and putting a ceiling on its potential price that will probably now be well below $100 per barrel”. U.S. Shale oil production would behave like a thermostat, set at around $70 per barrel, to control oil price in a much more effective way than OPEC ever did. The FT editorial adds: “Rival producers will have to learn how to live with it. Russia needs an oil price of $90 per barrel to balance its budget, Iraq $98, Saudi Arabia $105 and Iran $137, according to Citigroup. Those countries will have to make potentially painful changes if oil prices remain well below those levels for a protracted period. The risk of political instability will rise”. Perhaps the only factor external to the operation that could affect oil prices significantly is the futurization of oil revenues by hedge funds and speculators, the massive buying of oil futures as a hedge against inflation and a weaker U.S. dollar.

OPEC is the main enemy of the environment: False
As producers of fossil fuels, OPEC member countries are certainly responsible for a large share of the carbon emissions which contribute to global warming. However, the main culprits are the consumers, not the producers. Governments are especially responsible for having so far failed to establish carbon pricing policies that create the appropriate incentives to curb emissions. The point is that governments have the main responsibility for adopting and enforcing carbon emission regulations and to stimulate the shift to low carbon energy producing technology. According to the International Energy Agency (IEA) clean-energy levels are still falling short of those needed to limit the global increase in temperatures to 2 degrees centigrade or less. The Agency calls for tripling the public spending in research and development in lowcarbon technologies on the positive side, the IEA notes that “global emissions of climate- warming carbon dioxide did not rise last year (2014), for the first time in 40 years without the presence of an economic crisis”. These good news are credited to shifts in China’s pattern of energy consumption, the world’s biggest carbon polluter and seem to be a sign that efforts to control emissions care starting to be successful.

To add to these good news, President Obama signed in March of this year an Executive order requiring the U.S. federal government to cut greenhouse gas emissions by 40 percent by 2025, from 2008 levels. Companies such as Lockheed Martin and General Electric are announcing voluntary cuts of their own. Such a move would be equivalent to taking about 5.5 million cars off the road for a year. Most important of all, the G7 Countries decided in their June 8th meeting to develop long-term low-carbon strategies and abandon fossil fuels by the end of the century. These are developments that will have dramatic implications for the global energy picture in the medium to long term. They will also add to the pressure that OPEC faces to maintain its relevance.