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Currently in the final stage of my doctoral work on the political economy of national oil companies. Here you'll find some of my findings--as well as other musings on oil-related topics. All comments -- civil, civilized or barbarian -- are welcome

Trump orders OPEC to pump more—and lower prices. He’s barking up the wrong tree

Trump orders OPEC to pump more—and lower prices. He’s barking up the wrong tree

President Trump wants lower pump prices—and he’s looking to OPEC, the club of oil producers, to make it happen. Not only is it rare for a US president to do this openly, but it’s misguided: OPEC members are deeply divided on the production-price question, and OPEC’s share of global production—even if their members did agree—would have only a marginal effect on prices anyway.

July 2018 – SC McKnight

All modern US presidents worry about pump prices. So, we shouldn’t be surprised when Donald J Trump ordered OPEC (the Organization of Petroleum-Exporting Countries), in the form of tweet (below) and interview, to stop manipulating the market. But OPEC is a shadow of its former self, more political club whose members are deeply divided than disciplined cartel united to manipulate prices through production.

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This article first argues that OPEC, the main organization of oil exporters, is neither the decisive force of its 1970s embargo fame nor a monopoly (it accounts for way less than half of global oil production) nor even a cartel—that is, a group that limits production in order to push up prices. OPEC’s 16 members are deeply divided on the price-production question, among countless others. Finally, many of its members couldn’t push to maximum production even if they wanted to, constrained by a lack of capital, knowhow, violent conflict—or mix of all three. So Mr Trump wants lower oil prices? He’s asking the wrong group—one that is neither unified nor monopolistic—to make that happen.

OPEC: One of many

OPEC, the main organization of oil exporters, doesn’t drive oil markets—not anymore anyway. Saudi Arabia, as OPEC’s highest-producing member, has influential but often thankless of job of acting as ‘swing producer’, able to loosen or tighten production and so impacting consumers in faraway gas stations. Pumping nearly 10m barrels per day and accounting for about a tenth global oil production, Saudi Arabia is still a major force in the global oil market. But today it’s one of many (Figure 1).

Figure 1: Top 12 Oil Producers (2017 production in million barrels per day)

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Source: IEA, February 2018

With the ‘frackers’ leading the so-called ‘shale revolution’ of the late 2000s, the United States has reemerged as a major oil producer. In fact, the International Energy Agency (IEA) estimates that the United States in 2019 will (again) become the world’s largest oil producer. Along with Russia’s roughly 11m barrels per day of production—a country with whom Saudi Arabia reached a tentative entente on production and the Syrian civil war in late 2017—that’s about a quarter of global production that is outside of OPEC’s direct control. This means OPEC, once reigning force over global oil prices by sheer virtue of grouping well over half of the world’s oil production, now needs to make room for other players over which it has only marginal indirect influence.

OPEC, and the Saudis in particular, saw the dangers of rival production (Figure 2) in the United States. In 2014, fearing the long-term impacts of rival production in the United States, OPEC tried to squash the shale revolution: OPEC members stopped trying to agree on production quotas—never an easy task and practically useless anyway (see below). The hope was that OPEC—and especially its most influential member, Saudi Arabia—could flood the market, push down prices and force profit-driven shale producers to either dramatically cut investment or shudder projects altogether.

Prices did crash (hitting a low of around $44/b in March 2015). But shale producers hung around—in part buoyed by Wall St who wasn’t ready to let their shale producers die off just yet. When prices recovered to $60/b in mid-May 2015, shale producers had not only weathered the storm, but had stronger than before, their techniques honed, their operations more efficient, and their workforces more productive. And they’d even found a price ecosystem in which they could survive—what Petromatrix calls the ‘shale band’—a realistic price range between $45-65/b. The frackers were here to stay.

Figure 2: US oil production from tight shale formations

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Figure 3: Oil production in the United States (both conventional and fracked)

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Source: Fractracker

Figure 3: Oil production in the United States (both conventional and hydraulically fractured)

OPEC’s nightmare was now real. Not only had OPEC failed to suffocate the shale producers in their grave, but OPEC’s efforts actually made shale producers stronger—and capable of surviving in a price range that most OPEC members see as too low. To make matters worse for OPEC, a self-reinforcing tendency has gone to work here, too: the more shale production that comes online, the more world oil prices will live in this ‘shale band’ price range. And the more oil prices push above this range, the more projects from the so-called ‘fracklog’—the list of ready-to-go but higher-cost projects—will be profitable. All of this means that the mantle of ‘swing producer’—the ability to pour on or hold back oil production—has shifted from Saudi Arabia to these nimble, flexible shale producers in states like North Dakota, Texas and Pennsylvania, ready to go at realistic price-points.

OPEC members: Divided we stand

There’s just too much history—little of it peaceful, almost none of it collaborative—between OPEC members. The organization emerged in the 1960s, the result of the egregious exploitation of the so-called ‘majors’, predominantly American and British oil companies, at a time of when decolonization and the existence of Israel made newly sovereign states particularly sensitive—and angry—about anti-imperialism.

But OPEC really came into its own with the oil embargo of 1973, this time the coordinated effort of mostly Arab oil producers who wanted to punish the major consuming nations of the West for their support of Israel. So, politics were part of OPEC’s DNA from the start with decision-making on prices and production as means, not an end in itself.

And it’s politics—mostly between its members—that’s getting in the way again. Today, their divisions extend well beyond more traditional matters—such as how to deal with the United States or Israel—to dozens of relatively new and sometimes intractable issues: civil wars in Syria and Yemen, the geopolitical rivalry between Saudi Arabi and Iran, the Qatari blockade, Iran’s nuclear question, Venezuela’s crisis, Iraq’s reconstruction, and on and on.

But back to the all-important price-production question: OPEC’s 16 members are split on whether to release or hold back on production, what others have called the divide between price ‘hawks’ and ‘doves’. For the hawks (countries like Algeria, Iran, Iraq and Venezuela), who live a particularly Hobbesian existence, they want OPEC to be and act like a cartel. That means doing what cartels do: hold back supplies to raise prices. These countries’ reserves are limited—relative to their (often rapidly growing) populations anyway. Their government budgets are dangerously dependent on oil revenues, their governments are unstable and facing domestic unrest. All of this means that low prices—the inevitable result of unrestrained production—could set off a chain of events that ultimately ends their rule.

On the other side, the so-called ‘price doves’ (Saudi Arabia and mainly the Gulf monarchies) have the luxury of seeing a bit more of Locke in their lives. Their reserves are abundant, often both in absolute terms and relative to the size of their populations, and so their regimes—authoritarian, but ruling with a bit more of a velvet glove—can afford to take a long-term approach to the price-production question. The ‘doves’ can live through low prices—living off savings and investments, while hoping low prices eliminate non-OPEC competition—which in the long term, brings up prices again.

Jeff Coghlan, political scientist at Brown University and OPEC expert, rightly sees the dividing line as one between high- and low-cost producers. Any cuts would need to be led by and shouldered (again) largely by Saudi Arabia, OPEC’s de facto decision-maker. And those higher prices, if they did come, would benefit other producers—including those outside OPEC.

The Saudis know that a goldilocks solution of sorts is needed: if prices are too high, it’ll crush oil demand and stimulate (even more) non-OPEC production. That means more shale oil, but also higher-cost producers in Canada’s oil sands, the deep offshore of Mexico and Brazil, and perhaps investing in some new oil ‘frontiers’. In many ways, this was the story of the global oil industry from the mid-1970s to mid-1980s, and later in the mid- to late 2000s. But if prices are too low, like we’ve seen in the late 1980s-early 2000s, higher-cost producers—inside and outside of OPEC alike—would feel the pain. But more importantly for OPEC, lower prices would put their own economies through a fiscal vice with who-knows the political outcomes for members who are overwhelmingly run by authoritarians and dictators.

Lie, cheat, and over-produce

The question isn’t which OPEC members cheat on their quotas; the question is which members cheat more than others. In his study, Coghlan found that between 1982-2009, OPEC members cheated on their aggregate quotas 96% of the time. In other words, OPEC members cheating on quotas is the rule, not the exception. And OPEC as an organization can do little about it. I identify three main reasons for this: OPEC members as states are profoundly weak, if not dysfunctional; secondly, that’s not the real raison d'être for OPEC anyway: this is a political club, one more concerned about intangibles such as status and prestige than actual production quotas.

First, if OPEC is worried that its cuts would benefit non-members, then the same Machiavellian logic applies to other members: if other members sacrifice their production in pursuit of higher prices, another member can cheat on its quota, benefit from both producing above-quota and from the rise in prices that the other members collectively caused. Simply, the incentive to cheat is always there. Since OPEC introduced a quota system in 1982 to try to limit global supply, we should have expected that actual production levels would have influenced OPEC members’ quotas. In reality, it’s been the other way around.

That brings us to the second point: OPEC isn’t a cartel in any meaningful sense. And only in rare moments during in its fifty-plus year-history has it tried to be one. Rather, OPEC members have opted for the prestige of being part of largely developing countries which geographically span the globe, some of whom are extremely wealthy, others very big and influential in their regions.

Some of its members—like Angola—produce more today than it did before joining the organization. Others—like Ecuador, that moves in and out of the organization as it sees fit—produces virtually the same, whether inside or outside of OPEC’s umbrella. Most recently, Indonesia reentered—then promptly left—the organization. While Indonesia is still a modest oil producer (about 500,000 barrels per day), its consumption is twice that, meaning it’s not a net oil-exporting countries (in other words, what the ‘e’ in OPEC stands for). But if seen through the lens of the-more-members-the-better, Indonesia’s reentry as well as the inclusion of relatively insignificant oil producers like Ecuador make sense.

Finally, several of its members couldn’t push to maximum production even if they wanted to, constrained by a lack of capital, knowhow, violent conflict—or mix of all three. This is certainly the case in Libya and Venezuela, now teetering on the brink of civil war with barely functioning central governments. Less extreme examples are Nigeria and Iraq: despite their abundant reserves, their production is restricted, not because of any formal government policy, but because of so many political and economic obstacles.

Conclusion

Mr Trump wants lower pump prices ahead of summer driving season—and November’s congressional midterms. But OPEC isn’t the right audience for his criticism. This piece showed how OPEC is no longer the force it once was. It now accounts for far less than half of global oil production, its members are deeply divided on the production-price question: the ‘hawks’ want to limit production for higher prices; the ‘doves’ are careful not to push prices too high for fear of increased production outside of OPEC and permanently destroying demand for oil—all of which equates to a loss of market share for their most precious resource. Finally, OPEC members as states are simply too weak to strategically control production: virtually all of their oil sectors are run by national oil companies, with all but a few suffering from inefficiencies of all kinds, political interference, and chronic underinvestment. A few OPEC members barely have functioning central governments.

OPEC is fundamentally misunderstood: it’s not a cartel, though only in rare times of collective desperation does it mildly resemble one. Instead, and far more common, its members want the prestige of belonging to an organization that periodically impacts markets—often leading up to a meeting or after an announcement—and an organization that stays in the news. On this point, maybe it should be thankful to the US president.

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