The End of OPEC

Churchill’s assessment applies to the current oil situation: this is the beginning of the end of OPEC. That much is obvious; the more interesting question is “why?”

OPEC was founded in 1960 to protect the interest of its members, major oil exporting nations. That interest is to stabilize world oil prices at levels that balance their competing objectives to maximize both long term oil demand and the short term oil price. The idea was to keep enough oil off the market during glut periods to elevate the price and insert enough oil onto markets and lower prices during crises to prevent a global recession and to subvert movements toward substitutions for oil.

The cartel has struggled with both tasks. They have had some successes and some failures in keeping short term prices high. But since prices broke out of the $30 ceiling in 2003, OPEC had had little success in containing the price rise. Now analysts are increasingly questioning whether OPEC is able to contain oil prices. Whether they can or not will soon become evident. Regardless of whether OPEC can lower oil prices in the near term, it is clear that soon enough OPEC will not have that ability.

Let me digress for one moment to address the concept of Peak Oil, because I need to use the term. It is now time to adjust our definition, since the term is increasingly being used in a new way by the popular press. “Peak Oil” no longer carries Hubbert’s geological meaning: roughly, the time when maximum oil flow cannot be increased because decreased reserve levels prevent human efforts from being able to get it out of the ground any faster.

Instead, “Peak Oil” is now becoming known as the time when maximum global oil production has been reached for reasons that include both geological constraints and human behavior. In the latter category we have two things: political events that contain production in countries like Nigeria, Iraq, and Venezuela on the one hand. And on the other hand we have conscious decisions to hoard oil by countries like Russia, Kuwait, and, recently, Saudi Arabia, which have all acted to produce oil at less than the maximum geologically possible level.

So, now that you understand what I’m referring to, let me assert that we are now - or soon will be - at Peak Oil due to both geological and human reasons. Both factors working in tandem have created Peak Oil - if not today, then very soon.

I suspect the new Saudi fields being brought on this year and next will give them some ability to flood the market with oil and lower the price temporarily if they choose to do so. But once that surge is over, probably starting in 2010, there will be no ability of OPEC to influence the price of oil. In a Peak Oil world, OPEC, by definition, will not be able to contain the rise in the price of oil; they simply will not have the reserves to do so. Since we are either at or very near Peak Oil, OPEC is now or soon will be quite powerless.

So why is OPEC still hanging around? Quite simply because the world at large is still hanging on their every word. They still have the psychological ability to influence the oil price. They are the Wizard of Oz Oil. Like the Wizard, as soon as they are discovered to be feckless, they will lose their power once and for all, but for now they still have that power.

This explains why OPEC is currently saying, first, that there is no supply problem in oil, that the high price is all due to speculation. Second, they are saying they will meet in September to re-consider their stance. Why? Because right now they cannot add much oil to the market, but they hope that by September the new Saudi fields will be on line and capable of actually making a difference in the global supply. They could maybe do that for a year to two years before being swamped by new higher levels of demand once and for all.

Why will OPEC end? Well, clearly once they are known to have no power they will have no reason to exist. But even before that, I suspect they may wake up to the fact that OPEC no longer benefits their members. While their powers have diminished to nearly zero, they are increasingly being blamed for the rise in oil prices that is starting to become a serious problem for the global economy and is already a disaster for the world’s poor.

Why would OPEC members want to keep that scorn focused upon themselves? It makes no sense. They no longer benefit economically from OPEC because it is not OPEC that is keeping their oil price high. No economic benefit AND becoming the object of global blame? It is not in their self-interest. I predict that OPEC will soon disband. I define “soon” as within the next three years.

Comments

[JREwing]

Nice job, as always, Jim.

I think OPEC pretty much got annihilated with Ronald Reagan taking power. He sent his CIA Boss 'Wild Bill' to Saudi Arabia, who suggested to the Sauds, that it would be cool if they flood the world with oil in order to make Russian crude worth less. In exchange he promised, that the US would stand behind the House of Saud until Kingdom come, no pun intended. That little deal won the cold war by bankrupting the Sowjets, and demonstrated to the communists of the world, that money has more firepower than all russian tanks together.

That may have won the Cold War, but it pissed off the rest of OPEC. So they didn't give a damn about their quotas and produced as much as they could, because let's face it: Most OPEC members are ruled by horrible people who need every dime of oil revenue in order to stay in power. They are so badly in need of money, that they even neglect the infrastructure, that brings them the revenue; just take a look at Iran or Venezuela.

That's why all the way through the 80s and 90s oil was cheaper than dirt. Come on, Diet Coke is more expensive than oil. And I'm not sure which of the two tastes worse.

artificially low prices over a long period of time + underinvestment in oil infrastructure + additional demand from the emerging world = NORMAL PRICES

[freefall51]

Jim,

I guess you captured aaa if not theee macro theme of our times.
Keep going. You are my hero.

[JREwing]

About the press listening to what the OPEC chief has to say:

This is what must have been going on in Hitlers bunker close to the end.
The Sowjets are on top of the bunker, but we still talk about 'Endsieg'. CRAZY!

Folks just can't believe, that times change. 'Because it cannot be, what we don't want to happen!'

The rules of Evolution apply to everyone, not just flora and fauna but people and societies, too.

YOU EITHER ADAPT TO A CHANGING ENVIRONMENT OR YOU GO UNDER!

While we may not die, like an animal in the wilds, we will get a lot poorer, if we don't adapt.

It is fascinating. People, most of all in the business world, try to be so dynamic, they run around with their blackberries beeping and what not, but when it comes to oil they are completely baffled. It's like getting a baby from milk to solid food.

I don't understand, what's so complicated?

If the price of fuel goes up, people demand cars with better fuel economy.

It is already happening. Who would have thought, that Daimler could sell 2500 Smart Cars (here in Germany we call them ELEPHANT-ROLLER SKATES) a month in the US?

The market works. People will stop driving V8s with 25 year old engine technology and drive 6 cylinder turbo diesels instead. It took these oil prices for BMW to invent a device, that automatically stops your engine when you come to a standstill at a red light or in a traffic jam and automatically restarts the engine once you touch the gas pedal, which saves a significant amount of fuel.

The market works. The higher fuel prices get - and they will get higher
(Someone has yet to tell me one logical reason, why the per capita oil consumption in countries like China or India will be a fraction of that in the OECD countries until the end of time)- the more efficient the use of it will become.
Their per capita oil consumption will go up. Ours will come down.

[BrianPursley]

If peak oil ever happens it will be due to human political and technological factors (alternatives, electricity, etc.).

The end of OPEC is wishful thinking. Brazil announced recently that they plan to JOIN OPEC!!!

business.timesonline.c...

money.cnn.com/2008/02/...

[PK deC'ville]

I find it 'interesting' that the new Saudi Oil is scheduled to arrive in September.

Wow! Gas under $3 might help McCain, maybe?

[cal48koho]

We can rely on Jim to give us new ideas which I have not seen elsewhere considered. But how can Jim be right if several recent analysts last week announced that oil will be falling to as low as $80 by the end of the year? Let's hope they are right and Jim, is wrong but my money is with Jim. If OPEC's days are numbered, what would be the point for Brazil to Join OPEC? The track record of oil production from ultra deep water is really unknown and if you read Matt Simmons, the chance of a long production life profile is small. Ithink the best chance of adapting to the Peak Oil future is a sudden drop in production for whatever reason waking up the collective consciousness of the world. Until production falls below demand, little will be done in the way of effective planning for a peak oil world.

[StateofConfusion]

If Opec could lower prices on oil, they would be doing it. The aim is to slow development of alternative energy and transportation such as PHEV. Once Americans are convinced to give up big trucks and SUVs and start using HEV in mass, Opec will have lost control. Very high gas prices will force this change and as for turbo diesels, they have even higher fuel costs.
There are several new engine designs in development that will have numerous advantages in efficiency, mixed fuels and high torque. These are Cyclone Power (CYPW.ob), Axial Vector Engines (AXVC) and Turbine Truck Engines (TTEG).

[bill d]

OPEC members do what the hell they want to do anyway.
They have no incentive to lower prices now.
Even if we develop significant alternate energy sources (which we should) this will not affect the demand from the developing countries.
We still have inefficient machinery that uses oil and unless that can be converted (not likely) to use alternate energy then our use of oil will at least stay the same.
The only reason oil price will come if it is really being driven by speculators (wish it were true) and unless the demand figures are inflated and the supply low balled I can see no reason for a price decline - rather it will continue to increase.
Some say $80, some say $150.
I say bend over and grab your ankles.

[rzc]

Is it possible that the current oil price surge is because both OPEC and non-OPEC countries simply want to hold their oil underground instead of exchanging oil for dollars, as the weak dollar makes the transaction less attractive?

[NormanLepoff, M.D.]

Great article and comments. Thanks.

[Ivar Fylling]

With respect to oil price control, I see no reason for the OPEC not to share the fate of the Texas Railroad commission. Both were assigned with a task of keeping the production down and prices up. No organisation seems to be needed for that anymore, in the US since 1971, globally since ca 2005. Indonesia, the largest OPEC nation, has been a net importer since 2003, and that is not due to quota-problems!

[roller]

OPEC still can (and will be able to) influence the oil price. They can not lower it long-term, for sure, but the whole quota system is not designed to lower the price. Imagine if OPEC comes out tomorrow and says "one million bpd less production"... that would make the news!
So I think OPEC is alive and well, and its power will only grow, as they don't deplete their reserves as fast as the others...

[User 28905]

The problem is not peak oil, but developing large-scale cheaper,sustainable alternatives out there which are many..With the power of the oil interests running this country through its representatives,Pres/V... it's not happening and today,believe it ,the REPUBLICANS senators/Pres,are refusing to extend tax credits for solar and wind power..not to speak of act on global warming prevention..while they get obscenely richer,most of us suffer in ignorance..

[maximax]

I disagree with the conclusion of the article, although the rest is fine although nothing new. Has the IEA been disbanded because it neither can/want to forecast demand accurately, nor is able to stabilise prices in favour of the consume countries? Has the UN Security Council been dissolved because two of its members keep on vetoing the resolutions of the others? The role of OPEC might change, but this cartel is certainly not void in a world where oil is becoming increasingly scarce. Ecuador rejoined, Brazil wants to join, Indonesia is doing hell to stay inside, although it should no more be a member...