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An article published in the Infantry Journal (U.S.) many years ago contained the following exotic question:

If you only had an hour in which to turn civilians into soldiers, what would your instruction consist of?

A twist on that question holds relevance for today's environment: If you only had an hour to discuss OPEC’s objectives with an indifferent or unfriendly scholar, how would you begin and end this exercise?

I have touched on just such a question in many classroom and examination situations. The school solution commences with the following: OPEC intends to export (and perhaps produce) as little oil as possible. It ends with: OPEC intends to export (and perhaps produce) as little oil as possible, regardless of what its members say or do.

The logic in play here is an extension of the work of three brilliant economists. Professor Gunnar Myrdal, who was one of my teachers at the University of Stockholm; Professor Howard Chenery, who organized a small conference I attended in Paris in the l980s, and whose book (together with Paul Clark) I used when I taught at a U.N. Institute in Dakar (Senegal); and of course the superb article by Professor A.A. Kubursi, "Industrialisation in the Arab States of the Gulf: A Ruhr without Water" (1984).

The explicit observation by Kubursi – and implicit in the work of Myrdal and Chenery – was that, instead of exporting oil in its crude form, if the development process is taken to an optimal conclusion, oil should be used in OPEC-owned refineries, with a large amount of refinery output used in the production of petrochemicals. More important, simple mathematics leads us to conclude that investing in facilities to produce refinery products and petrochemicals without having enough crude to utilize these facilities for ‘X’ years is a serious mistake.

At this point let's bring in the work of a distinguished oil economist who definitely is not a friend of OPEC, Professor Morris Adelman of MIT, and his colleague Martin Zimmerman (1974):

In the production of petrochemicals, most LDCs (less developed countries) are at a severe and permanent disadvantage for lack of know-how, and the high opportunity cost of capital and feedstocks. Other countries, particularly OPEC members, who do not face these obstacles are expanding their petrochemical capacities. This too will drive prices down, lower the profitability of all plants built today, and force losses on many investors. Few can compete with those that get their feed-stocks at a fraction of world prices, and are willing to earn low or negative rates of return.

Earning “low or negative rates of return” is not (and probably never was) the goal of new OPEC refiners and petrochemical producers, since with the huge amounts of feedstocks at their disposal, acceptable margins should be available for a very long time for these firms, not to mention impressive national incomes for the countries in which they are located. Moreover, even if desired outcomes are not immediately achieved, major oil-producing countries can look forward to returns that result from transforming inexpensive refinery products into high-priced petrochemicals. This was pointed out by the Nobel Prize (in chemistry) winner Sir Harry Kroto many years ago.

It cannot be overemphasized that since energy costs are the key burden for chemical industries, the combination of inexpensive energy and state-of-the-art technology will ensure that the center of gravity of the global petrochemical industry will move toward the "least-cost" Middle East. According to the time-honored theory of competitive advantage, that is where it belongs.

“Center of gravity,” though, does not mean complete domination. At any time this industry is a mixture of small and large, low and not-so-low cost, new and old, etc., and so theoretically the OPEC commitment will be adjusted so that the price will be high enough to keep some of the less favorably-endowed plants in operation in order to supply total demand.

Even so, many firms in this line of work have become unpleasantly aware of the realities brought about by the cheaper methods of production at the disposal of countries that no longer want to be a hostage to unfavorable oil or gas prices. Exactly how traditional firms will react to this challenge is uncertain, particularly in the short run, although in the long run many of them have no choice but to cut-and-run, to use one of President George W. Bush’s favourite expressions.

After reading my above thoughts on this subject, and once again reviewing the paper of Professor Kubursi, I would like to say that while you may not find the observations at the beginning of this essay relative or attractive, it is impossible to deny the bottom line. OPEC strategy is going to turn on producing and exporting as little crude oil as possible, and its business and political acquaintances abroad will simply have to get used to and adjust to this arrangement.

References

  • Adelman, Morris A. and Martin B. Zimmerman (1974). "Prices and profits in Petrochemicals: an appraisal of investment by less developed countries."Journal of Industrial Economics (1974).
  • Banks, Ferdinand E. Banks, (2011). "Energy and Economic Theory" Singapore, London and New York: World Scientific._____. (2008). "The sum of many hopes and fears about the energy resources of the Middle East." Lecture at the Ecole Normale Superieure (Paris), May 20, 2008
  • Chenery, Hollis and Paul Clarke (1962). Interindustry Economics. New York: Wiley.
  • Chevalier, Jean-Marie (2009). The New Energy Crisis: Climate, Economics and Geopolitics.
  • London:Palgrave McMillen (with CGEMP, Paris-Dauphine).
  • Eltony, Mohamed Nagy (2009). "Oil dependence and economic development: the tale of Kuwait."
  • Geopolitics of Energy (May).
  • Kubursi, A.A. (1984). 'Industrialisation in the Arab states of the Gulf: A Ruhr without water," in Prospects for the World Oil Industry, edited by Tim Niblock and Richard Lawless. London and Sydney: Croom Helm.

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Source: OPEC's Strategy: Do as Little as Possible