OPEC: The Saudis Have Left the Building

Inquiring minds are considering an article entitled The Death Of OPEC.

Saudi Arabia walked out on OPEC yesterday. It said it would not honor the cartel's production cut. It was tired of rants from Hugo Chavez of Venezuela and the well-dressed oil minister from Iran.

As the world's largest crude exporter, the kingdom in the desert took its ball and went home.

As the Saudis left the building the message was shockingly clear. According to The New York Times, “Saudi Arabia will meet the market’s demand,” a senior OPEC delegate said. “We will see what the market requires and we will not leave a customer without oil."

The downward pressure on oil got a second hand. Brazil has confirmed another huge oil deposit to add to one it discovered off-shore earlier this year. The first field uncovered by Petrobras has the promise of being one of the largest in the world. That breadth of that deposit has now expanded.

OPEC needs the Saudis to have any credibility in terms of pricing, supply, and the ongoing success of its bully pulpit. By failing to keep its most critical member it forfeits its leverage.

OPEC has made no announcement to the effect that it is dissolving, but the process is already over.

Douglas A. McIntyre

The article to which Douglas McIntyre is referring is called Saudis Vow to Ignore OPEC Decision to Cut Production.

I hate to break the news to Douglas McIntyre (and others who think similarly) but the simple fact of the matter is OPEC died decades ago, the very day it was born.

In general terms, cartels always fail. Saudi Arabia and for that matter every country in OPEC will do (and more importantly have done) what is in their own country's best interest. The bottom line is that every nation in the so-called "cartel" has cheated on so-called "quotas".

The reason is simple. If every nation honors the quota except one, the one, whoever it is, can make a boatload of money over market price simply by not honoring the quota. The temptation to cheat is enormous.

In practice, they all want to be the "one", so they all have a tendency to cheat. If by some amazing feat they manage not to cheat (it happened once decades ago) the price soars, demand falls off an prices quickly crash.

There is no cartel now, but there never really was one to begin with! It has been that way for decades. It's all an illusion. This announcement will not affect the price of oil one bit, either way, over the long haul.

By the way, all manipulation schemes fail for similar reasons.

Comments

[Hedged In:]

V. thought provoking article -- thanks.

In other words: It's in their long term interests to collectively hold prices high by restricting demand, but there's always a short term interest for one country to break the agreement.

Has anyone mapped this out in game theory?

2008 Sep 12 01:49 AM

[css1971:]

Well, the Saudis have to keep the Republicans in power, what would you expect?

2008 Sep 12 02:12 AM

[Gilroy:]

Michael: That whole "Saudis Walk out on OPEC" business is a total lie. It would be a good idea to simply have Seeking Alpha remove this whole article so that it doesn't mis-inform people. The guy who wrote that "Death of OPEC" article was simply a blogger. You can look all over the web, and the mainstream media never wrote anything about it. You can bet your sweet bippie that if the Saudis had walked out on an OPEC meeting in a huff that the mainstream media would have been all over it like a cheap suit.

2008 Sep 12 02:57 AM

[dlaw:]

If cooperation never works, how do bubbles form?

The author's observations are often extremely good. He should edit out the tired, old, laissez-faire rhetoric.

2008 Sep 12 03:41 AM

[dlaw:]

Y.I. - Yes, actually, Diamond and Dybvig mapped out such a Nash equillibrium, although that was for bank depositors.

But that's half the story. The other half comes when cooperative members of any group receive trustable assurances from each other which have economic value - and that does happen.

It's just the basis for...well,...society. That's all.

2008 Sep 12 03:43 AM

[DONE_SONZ:]

Good cop bad cop

2008 Sep 12 07:18 AM

[mangolfer:]

Good article. Totally understandable why Saudis want lower oil prices and the ignorant greedy other OPEC members don't care about world economy.

2008 Sep 12 08:30 AM

[whidbey:]

We just simply can not call this one yet. The OPEC group is obviously has internal conflict, and always had for that matter. But what really matters is who ends up with the confidence of the demand side of the market. The Saudis understand that the world is headed into a severe recession, maybe depression, and they want customers and military balance in the middle east. They know what they need, and they will keep their balance through the all the problems.

2008 Sep 12 09:55 AM

[mixter:]

What is, is! I am tired of all of the "know it alls" predicting this and that. If they were so damn smart, they would be billionaires and retired instead of putting out B.S.! If only they could be as smart as Obama thinks he is!

2008 Sep 12 10:31 AM

[notsosmart:]

said it for a long time.if your broker is so smart why is he shilling stocks instead of retired on his 100ft yacht?do your own thinking.believe nobody.all have an agenda.

2008 Sep 12 10:40 AM

[Paul Killinger:]

In truth, OPEC is lucky the Saudis CAN control the price of oil. The others are all idiots in the room, like the D's talking about oil prices in Congress.

What the Saudis know is if the price of oil stays too high for too long, it bodes ill for their long term interests. They've seen oil at anywhere from $10 to $140 in the recent past. In retrospect, they figure $100 is pretty good.

2008 Sep 12 11:51 AM

[mdmrjsds:]

I don't know about the truth of the death of OPEC, but the Saudis recognize their situation, and the situation of other OPEC members. They are marginal countries, accidental beneficiaries of a quirk of nature, parasites on the wealth of the West. If they destroy the West, they open the way for less benign powers to take care of the oil. Given their history in Tibet, the cultural revolution, Tiannenmen Square, how they deal in Africa, does anyone doubt that the Chinese would have a problem with just taking over Saudi Arabia? If the West wasn't standing in the way? I don't doubt it for a minute, and it is clear the Saudis don't either.

I admire what the Chinese dictatorship has accomplished for its people (or more accurately, what it has allowed its people to do for themselves once it got out of the way a little), but that doesn't make me blind to what it is capable of. As China engages with the world that will change, but I don't believe it has changed yet.

2008 Sep 12 01:03 PM

[CaptBob:]

The bottom line is drawn across the bottom of the Earths oil reserve pit.
Is that all there is??? Ans: Yes, and any single country in an attempt to manipulate price cannot add a single barrel!.
Spectacular finds like Brazil's not withstanding , check the stats--each year the Global production goes down, the consumption goes up--and nothing else is needed to increase prices.
To date, Alternatives are a joke and conservation a chuckle. To turn this around someone lacking lobbyists in congress will have to offer the consumer head on competition with fossil fuels.
This was supposed to happen when oil reached $30 a barrel, and made alternatives profitable. So what's afoot???
I don't know, but in the meantime either reach for your wallet or pedal!.

2008 Sep 12 02:10 PM

[Itsonlymoney:]

The Saudi's lost control of the price of oil some time ago ($45)and are just now reasserting themselves. It remains to be seen if they can. Their intentions are the same now as they have always been; to keep the price of oil high enough to make money,stable enough to maintain the current world order, and low enough to discourage alternative energy.

2008 Sep 12 03:25 PM

[Paul Killinger:]

You are EXACTLY right, Money. But it appears $4 gasoline has finally begun to get us off our a--. We'll see.

2008 Sep 12 09:48 PM

[Ferdinand E...:]

Although I am the leading academic energy economist in the world, I notice that my comment was eliminated, probably because I called Milton Friedman ignorant for saying that OPEC would crash and the oil price would descend to $5/b.

Well, since everybody is so wonderfully patriotic these days, maybe they should investigate a discussion between Friedman and General Westmoreland, in which Friedman called those of us in the U.S. who had been drafted for military service "slaves".

2008 Sep 13 06:40 AM

[pockyclips ...:]

The Saudis know which side the camel craps on. If the West gets serious about alternatives, they'll have to pare their harem. So they keep playing Three Card Monte; talking moderating oil price increases the same time they're financing the terrorists. As long as their friends in Washington go along, the Saudis will keep playing the game.

2008 Sep 13 12:32 PM