The Fall of OPEC

Current low prices for oil will likely prove unsustainable and need to rebound somewhat in the next year or two to keep enough drillers in business.  But it would not be wise for American producers to expect much help from the Organization of Petroleum Exporting Countries and other exporting nations in restraining production to boost prices, as seemed to be the hope last week.

Saudi Arabia’s Oil Minister Ali al-Naimi, speaking in Houston this Tuesday, threw cold water on the idea of production cuts, which should not come as surprise, given the predicament that the Saudi and other exporters find themselves in.

Whatever strategy OPEC adopts, it will face a long slough to regain a dominant position in the global pricing of oil.  Market forces will likely overwhelm efforts to get the cartel back to its position of preeminence for many years, and perhaps decades.

Though many Americans view OPEC as a perpetual petroleum colossus, it’s actual record as a cartel is mixed.  After the founding of the organization in 1960, its international impact for a long time was scarcely detectable.  Beginning in 1970, individual OPEC members enjoyed some success wresting major price concessions from major oil companies, but coordination of production levels across the full membership did not occur until after the Arab Oil Embargo launched in October of 1973.

During the Embargo, Arab exporters did not suffer the drop in revenues expected from their cuts in production, because the increased price per barrel more than offset the lower number of barrels sold.  In December of 1973, OPEC shocked American officials by voting to take advantage of short supplies to jack up its prices to previously unheard of levels.  After the Embargo ended in March of 1974, the cartel restrained production to keep prices from falling.

It’s often forgotten that this period of OPEC dominance lasted for less than a decade.  After the Embargo, the United States, Europe and Japan sharply reduced oil consumption, with America adopting mileage efficiency standards, lower speed limits, and market pricing, while other industrial powers imposed hefty gasoline taxes.  Less directly related to the Embargo, long-term projects were boosting supplies from outside OPEC in places like Alaska, Mexico, and the North Sea.

OPEC refused to recognize changing market conditions and continued to hold out for higher prices, in effect planting the seeds for its (as it turned out temporary) demise.  By the early 1980s, net U.S. imports of oil had been cut in half from 1977 levels, and the price of oil was plummeting.  

Steady cuts in the production of Saudi Arabia in the first half of the 1980s were unable to prevent the turn toward increasingly lower prices.  Finally, Saudi Arabia in the mid-1980s ramped up its output to punish OPEC members not helping to avoid oil surpluses and to drive out competitors whose alternative fuels created long-term threats to Saudi market share.  

Though the Saudi strategy did stymie the development of alternatives to conventional oil, it did not bring a return to the high-price environment of the earlier years or a disciplined cartel that could set and enforce production quotas.  With some members ignoring their caps, OPEC impotence and low prices continued into the late 1990s – an era lasting longer than the period when OPEC ruled the roost.

In March of 1999, Iran and Saudi Arabia overcame their grievances to cooperate on lowering production, and new Venezuelan president Hugo Chavez reversed his country’s position into one of fervent support for OPEC quotas, setting the stage for price increases later in the year and eventual strengthening of the cartel.

Less-than-expected demand and surging American production ended the latest period of OPEC ascendency.  Though it is hard to pin an exact year on this fourth major reversal of OPEC fortunes, it was certainly no later than 2014, when U.S. oil production saw its largest year-to-year gain ever.

Trends in cartel influence have momentum, which is why OPEC – including its most influential member, Saudi Arabia – has no viable options for returning to the good old days.

If OPEC did overcome internal strife to lower production, it would cede market share to others, especially Americans who have been making continuous improvements in oil technology.  This is not a winning strategy, since there is no way to know how low production would have to fall and what the future demand for oil will be if global fears of damage to the atmosphere by fossil fuels intensifies.

If OPEC maintains current production (with the now unembargoed Iran ramping up), prices will stay low for a very long time, and some OPEC governments may fall before hydraulic fracturers throw in the towel. 

OPEC has over the years said it would try to keep global prices within a band – not too high, not too low.  It has generally, refused to act, however, when prices rose above the (admittedly somewhat arbitrary) band.  Having not acted on the high side, it has few cards to play on the low side.

American producers who can cut costs and have patient investors can survive this buyers’ market.  But competition for customers has not been this fierce since the mid-1980s.

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