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OPEC: Fall of the Gods

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We are all too aware of the anectode involving Isaac Newton and the falling apple, which it is said to have inspired the great scientist to later on devise and formulate his famous Law of Universal Gravitation, succintly stated in the principle that 'everything that goes up must come down'. Certainly true, this principle, for most of the world we live in - including economics as it relates to OPEC, the oil cartel. To be sure OPEC in years past more often than not seemed to be working on a principle running exactly opposit Newton's famous Law and which could be enunciated with the dictum: 'everything that comes down must go up'. With respect to the price fluctuations at the pump we have all been subjected to for the most part of the year, I thought I'd take a brief trip into OPEC's past fortunes and explore projections into the future. Readers are cautioned that due to the nature of the subject, any consideration must necessarily carry a political weight. As we live in times of democracy everyone is of course free to agree, agree to disagree, disagree to agree and disagree to disagree as the case may be.

The Organization of Petroleum Exporting Countries (OPEC) is comprised of eleven member nations, each with its own individual agenda: Algeria (1969), Indonesia (1962), the Islamic Republic of Iran (1960), Iraq (1960), Kuwait (1960), the Socialist People’s Libyan Arab Jamahiriya (1962), Nigeria (1971), Qatar (1961), Saudi Arabia (1960), United Arab Emirates (1967) and Venezuela (1960). These countries account for 78.3 percent of the world proven crude oil reserves by region. In the past, member states almost never showed identical or even similar interests and often found it difficult to reach consensus on strategy. Countries with relatively small oil reserves or others like Iran and Nigeria with large populations and few other resources often played the part of the "hawks" typically pushing for higher prices. Producers like Saudi Arabia and Kuwait with massive reserves and small populations feared instead that high prices would accelerate technological change and the development of new deposits, thus reducing the value of their oil in the ground. They played often times the part of the "doves" and, on a closer scrutiny, it would appear that the 'doves' are right since their fears are now in the process of being materialized.

OPEC, with headquarters in Vienna, Austria, says it has lost control of crude prices despite a pledge by its ministers to increase oil production to meet an ever increasing demand. The cartel adopted similar strategies before, notably during times of social unrest involving its own member states. This was the strategy adopted after the British blunder in Iran that led to the fall of Shah Reza Pahlavi in the mid '60's, when Saudi Arabia announced it would 'cover' Iran's oil production by exceeding its own quota and then didn't. Or during the First Gulf War, when again OPEC 'guaranteed' the West with increases in supply to balance off prices - and did so but only for a month, right to the end of the hostilities - which also lasted one month. Or, most recently, during America's second armed intervention in Iraq.

This tendency of individual producers to cheat on the cartel agreement is a long-standing feature of OPEC behavior, so that official prices have been unstable - with a few exceptions - practically all the times. But now it seems that the cartel is facing a brand new problem never before anticipated: it is fast reaching maximum production. Put differently, OPEC is no longer able to quench the world's thirst for oil, especially since this thirst is no longer the domain of the West. With its ever rapid modernization, China is poised to become a major consumer of crude - and its effects are beginning already to be felt the world over. And yet, despite the high cost of a barrel of crude, world demand shows no signs of slowing. Consumption is now believed by many analysts to be pressing up against the limits of what the world can produce.

Saudi Arabia is the only country believed to have any surplus production left, and even then the Saudis are pumping close to 90 percent of capacity, according to the U.S. Department of Energy. With worldwide demand this year rising by roughly 2 million barrels per day, whatever excess capacity is out there will be gone soon, with the end result that maybe not this year, but certainly in ‘06 there won’t be any excess capacity left.

That’s little solace to energy consumers, who have been watching rising crude oil prices push pump prices to record levels. And the U.S. economy is already beginning to show signs of slowing down and inflation is starting to creep up. It is out of the question that a continued rise in oil prices will eventually slow growth.

Inevitably Western societies and Japan have started already to explore alternatives. Just like two American Administrations have made perfectly clear that oil will not be used as a bargaining chip against the West, Western governments are already steadfastly at work to reduce their dependence on the very volatile Middle East. Initiatives are mushrooming to find new supplies of natural gas, to exctract fuel from plant material or building solar, wind or nuclear plants to make hydrogen for fuel-cell vehicles. But all this takes time to develop, and the general consensus among analysts is that things will become worse before they become better. And yet, OPEC seems to have begun to lose its grip as the single biggest source of energy - the Fall of the Gods.

OPEC maintains a rosy and somewhat philantropic website at http://www.opec.org that readers interested in this particular subject (and we all should be) are invited to view.

Luigi Frascati

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