Guest Post: OPEC Has Lost The Power To Lower The Price of Oil

Tyler Durden's picture

Submitted by Chris Martenson contributing editor Gregor Macdonald

OPEC Has Lost The Power To Lower The Price of Oil

There’s been a lot of excitement in the past year over the rise of North American oil production and the promise of increased oil production across the whole of the Americas in the years to come. National security experts and other geo-political observers have waxed poetic at the thought of this emerging, hemispheric strength in energy supply.

What’s less discussed, however, is the negligible effect this supply swing is having on lowering the price of oil, due to the fact that, combined with OPEC production, aggregate global production remains mostly flat. 

But there’s another component to this new belief in the changing global landscape for oil: the dawning awareness that OPEC’s power has finally gone into decline. You can read the celebration of OPEC’s waning in power in practically every publication from Foreign Policy to various political blogs and op-eds. David Ignatius of the Washington Post wrapped up nearly all of the recent claims in a nice bundle in his May 4, 2012 piece, An Economic Boom Ahead?, when he quoted PFC Energy’s David West:

“This is the energy equivalent of the Berlin Wall coming down,” contends West. “Just as the trauma of the Cold War ended in Berlin, so the trauma of the 1973 oil embargo is ending now.” The geopolitical implications of this change are striking: “We will no longer rely on the Middle East, or compete with such nations as China or India for resources.”

(Source)

While it’s true that the Americas hold great promise to convert natural gas resources to higher production levels, that is not the case with oil. The celebration of a geo-political swing in energy power therefore misses a crucial point: No region -- from OPEC to Non-OPEC, from Africa to Russia -- has the single-handed ability to lower the price of oil now, because none can bring on new supply quickly enough for a long-enough sustained period of time.

And there is more to this story than meets the eye.

History of OPEC

For over 30 years, OPEC has produced less than half of the world’s oil. Indeed, as of today, OPEC produces only a little more than 40% of the world’s oil. But most of the world’s spare capacity has been held by Gulf State producers. Thus OPEC, primarily Saudi Arabia, has long been able to control the price of oil in not one, but two, directions. Historically this has meant that the concentration of oil pricing power resided with OPEC and its largest producer, Saudi Arabia.

But starting in 2005, global oil markets sensed that OPEC was only able to influence the price of oil in one direction: higher, by lowering output. OPEC’s ability to lower prices started to crack, break up, and generally fail as the first phase of oil’s repricing headed into 2008. Indeed, OPEC raised production several times in the 2004-2008 period, attempting to restrain oil prices as it moved to protect the global economy from an oil shock. However, the oil market, which was going through a fundamental transition at the time, as it reoriented itself towards insatiable, price-insensitive demand from Asia -- paid little attention.

Instead, supply disruptions at small producers and in small regions had a greater influence on oil price (pushing it higher) than OPEC's influence on attempting to push the price lower.

It’s actually not clear that OPEC has had any measurable influence on restraining oil prices for years. Summer hurricanes in the Gulf of Mexico, unrest and outages in the Niger Delta, and various strikes presented greater upward pressure on oil prices than upward OPEC supply changes.

The Mythology of OPEC

There is a trailing cultural myth, therefore, (which is nothing more than a hangover from 30 years ago), that OPEC can mount swift, price-killing upsurges of production. But as the below chart shows, OPEC production has made no progress in at all in the seven years since 2005, as oil began its price transition.

As oil rose above $50 in 2005, eventually reaching $90 in 2007, and then on to levels above $140 in 2008, OPEC production both rose and fell, but without any reliable correlation to price. In the aftermath of 2008, OPEC production has correlated better with the recovery in oil prices. But again, the rise in OPEC production has only come back towards the previous highs from last decade. Here is a recent news story rather breathlessly discussing the most recent OPEC production levels this year:

Acting to mitigate market nervousness amid Iran supply fears, OPEC on Thursday said it was pumping more oil than the market needs—at levels not seen since summer 2008—and expressed a cautiously optimistic note on demand. The cautious optimism, combined with a production boost sufficient to cover all of Iran's oil exports, is likely to further stabilize oil markets, where volatility by some measures has already smoothed in recent weeks. In its latest monthly market report, the Organization of Petroleum Exporting Countries said its crude production was 32.42 million barrels a day in March, up 317,000 barrels a day from the previous month.

Yes, but there’s a neglected point to make: these production levels are not special. Not meaningful. And are not newsworthy in any sense. Production at/above 32 million barrels a day? That level has been reached at least 4-5 times since 2005, with at best weak correlation to price changes.

Let's take a closer look at the global share of oil supply, divided in two between non-OPEC and OPEC production.

Non-OPEC vs. OPEC Oil Production 

There are several possible conclusions to draw from the above chart, which shows that non-OPEC provided nearly 58% of global crude oil supply in 2011, and OPEC provided 42%.

  1. Non-OPEC is the domain of private oil companies, and has managed to increase its market share over the past 30 years through competition and through the use of technology.
  2. OPEC’s market share has stagnated, possibly due to the predominance of state-run oil companies and the interference of political structures.
  3. Non-OPEC has the pricing power, due to its larger market share.
  4. Or perhaps OPEC still retains the pricing power, due to its greater quantity of spare capacity.

There’s an element of truth in each of these observations. 

Many also believe that both OPEC and non-OPEC could be producing a lot more oil. In the case of OPEC, many harbor the view that state-run producers and governments are sitting on massive, hidden spare capacity and retaining it as a cartel to manipulate oil prices higher. In the case of non-OPEC, many believe that environmentalists, regulations, and other limits placed by democratically-elected governments are suppressing a wall of supply that could come to market easily if only the oil is ‘set free.’

These views, however, are not only extreme but shaky. They are typical of the kind of grand claims that fit people’s worries and suspicions, rather than fitting any empirical data. The fact is that OPEC spare capacity has been under pressure for some time despite persistent belief to the contrary, with estimates running below 3 mbpd, or even below 2 mbpd. (For recent commentary on OPEC spare capacity, see A Model of Oil Prices by Chris Nelder). The case for hidden, held-back oil capacity in OPEC is weak, especially as domestic populations in the Gulf have dramatically increased the consumption of their own oil.

Meanwhile, non-OPEC large producers like Russia have significantly increased production this past decade. And regions like North America have been able to slow declines. Western oil companies -- which dominate non-OPEC production -- have scoured the globe looking to replace their reserves, but largely to no avail. This is why ExxonMobil and ConocoPhilips eventually gave up, capitulated, and bought natural gas assets instead. By doing so, they followed in the steps of Royal Dutch Shell, which had taken the natural gas pathway years earlier.

Therefore, a fact about non-OPEC production that was unknown even to the industry ten years ago is now very plain: There just isn’t a vast quantity of new oil that can come online easily and inexpensively outside of OPEC-controlled regions. Only Russia, the largest non-OPEC producer and now the largest single country producer in the world -- eclipsing even Saudi Arabia -- was able to significantly increase production.

A Window into Non-OPEC Supply: Russia

Two charts will tell us all we need to know about the limits facing non-OPEC crude oil production. First, let’s take a look at total non-OPEC production on an annual basis:

Just as with OPEC production, little if any progress has been made in the past seven years. This has been a complete surprise to most analysts, especially within the industry itself. Who would have thought that with a regime change in oil prices, non-OPEC could not sustainably increase production to much higher levels? Instead, non-OPEC production remains stuck around a ceiling, just like OPEC.

The Big Reveal comes, however, when we take a look at non-OPEC supply without Russia.

Without Russia, non-OPEC supply has actually lost about a million barrels a day of production in the last ten years. This speaks volumes to the quickly-rising costs of bringing on a new barrel of oil in non-OPEC regions, which we will discuss further in Part II of this report.

The Price of Oil When OPEC Is Powerless

Let’s imagine for a moment that OPEC could, if it chose to, pour an extra 3 mbpd of oil on the world market. And that by doing so, it could lower the price of WTIC oil to $90 or less. What would that accomplish? And for how long would such “lower” prices last?

In Part II: The Cruel Math of the Marginal Barrel, we explain that while fluctuations in economic activity can certainly raise and lower the price of oil, there are deeper structural reasons why OPEC -- even with its spare capacity -- can no longer sustainably “lower” the price of oil. Moreover, we will discuss how, paradoxically, any surge of supply from OPEC which did persuasively lower the price of oil could wind up having the opposite effect on price eventually thereafter.

Surprising? Yes, but not strange or unlikely, for reasons we will explain. Finally, we conclude that oil’s floor price -- outside of volatile 30-90 day periods -- is higher than ever before. This will make for a large surprise, should another acute phase of the financial crisis rock oil prices lower over a 2-3 month period.

Click here to access Part II of this report (free executive summary; paid enrollment required for full access).

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ACP's picture

That could probably be used as a fuel too.

CrazyCooter's picture

The peak oil meme is nothing new ... I think most ZH regulars are familiar with the the poster ...

http://www.afterpeakoil.com/poster.htm

I have one of these in my office. Great conversation starter (the sheep don't ask).

Personally, I am closing in on 40. I got 30 years of this shit to survive. If you wonder how, make sure your community (1) produces food and (2) has hydro-power or an equivalent. This is thinking 10+ years down the road, but still ...

Oh, and common law and gun rights. Need those too.

Regards,

Cooter

jayman21's picture

I had to drop the www to see the poster.  Thanks for the link.

 

http://afterpeakoil.com/

Rahm's picture

Almost time to go long oil.  Going to soar soon!

I am a Man I am Forty's picture

btw, my latest stock pick is OAS, it will be $35 to $40 in a year for those that still invest, below 25 is a screaming buy and if it gets down to 22 back up the truck

Marginal Call's picture

Bakken is fools gold.  The depletion rates are killers.

I am a Man I am Forty's picture

there is depletion, but more than made up for in additional holes in the ground, i owned BEXP, and statoil disagrees with you, so does continental resources

CrashisOptimistic's picture

Terminology issues.  Depletion is not the right word.

Flow rate is the right term.  And yes, you drill frantically to undo the loss of flow rate from wells about 18 months old that have begun to reduce output.

And . . . clearly . . . a point is reached when the cumulative decline from all those frantically drilled wells that are 18 mos old overwhelms your ability to drill new holes.  Every well drilled begins its death at 18 months of age.  That contrasts with Ghawar that has wells producing for decades.

It won't be long.

CrazyCooter's picture

Your point, and the point up thread, is very important for people to understand.

Fracking has MUCH less "area under the curve" than traditional wells, and at additional capital costs. In other words, you frack, rates shoot up, and fall back down pretty quick. In traditional wells, you drill, and the oil flows for a long time, then you pump, then you inject ... all at much lower capital cost over a much longer period of time.

Fracking in NatGas is broke dick; it won't work. It will simply burn down the forrest and what survives is still around (some will die, some will live).

Fracking in oil is different because oil prices are SO DAMN HIGH. Fracking for oil, as best I can tell, is a profitable business model. Lots more capital, but if prices stay up, the business model works.

Which is why oil prices are not going down any time soon. **

Regards,

Cooter

** Disclaimer: price projection assumes a stable money supply. In the event of a rapidly expanding money supply, you are fucked.

Canadian Dirtlump's picture

as a bridge to alternative sources and a legit source of easy to get domestic oil it certainly has its place. certainly more than say... nothing..

 

every oil company i deal with here is pleased with their results and has a robust drilling program.

Marginal Call's picture

I can't argue with anything you say, it is a fine bridge.  I also get email teasers about the next Saudi Arabia from every asshole pump and dump operation in the country wanting to charge me $500 for a tip about a Bakken player. 

 

I just want people to have a realistic idea about what it is before they pin their hopes or their savings to it.

Spastica Rex's picture

Realism is for pussies and poor people.

Taint Boil's picture

 

 

May be of interest to some

Bakken Oil Field Myth:
Link 1
Link 2
Link 3
Link 4
Link 5 Wikipedia

Edit: Older articles but still beware of the snake oil BS.... just trying to stir things up a bit .... where is Trav when ya need him

jekyll island's picture

East West Petroleum.  Just signed contracts to frac oil wells in middle east, exporting the technology to Saudi Arabia.  Will do quite well in the next 18-24 months.  

Hulk's picture

I have only one question: Who is making all those fucking barrels ???

Yes_Questions's picture

 

 

Gulf Barrel Fitters

Local 911

JackT's picture

BINGO! No one knows.

sunaJ's picture

Oil makes the world go 'round until it doesn't.

Caviar Emptor's picture

But but I thought it was cool to drive a Hummer!

I ordered a mining truck with 18 foot wheels just to drive to Taco Bell 

Surly Bear's picture

I ordered a mining truck with 18 foot wheels just to drive to Taco Bell 

That's...awesome.

Manthong's picture

What, are you picking up dinner for Michael Moore?

Seer's picture

No, it's for Newt "I can lower oil prices through the 'free market'" Gingrich.

PrinceDraxx's picture

Now if you could park closer than half a mile away you'd be doing it like a boss. lol

CrashisOptimistic's picture

Generally speaking, guys who write about oil scarcity do so for pay, or hope to be paid, and as such they will NOT take extreme positions.

They will not extrapolate what oil scarcity means for 7 billion people.

We do that here, and it doesn't involve price or trading.

spinone's picture

It means war.  Which is why we occupy the land between China and the middle east:  Afganistan.

earleflorida's picture

the ISI control the afghan's

Spastica Rex's picture

I thought we were trying to make life better for women.

ThirdWorldDude's picture

Don't forget the emancipation of poppy fields.

Errol's picture

Crash, you are right: folks who are selling something are just trying to sell advice on profiting from adversity in the short/medium term.

Then again, some of us who have been debating the consequences of "extrapolate what oil scarcity means for 7 billion people" for years now don't really want to discuss it any longer, either.  It is way too late for any meaningful intervention.  As John Michael Greer puts it, "...the word problem implies there is a solution.  What humanity has is not a problem, but a predicament."

I will mention that an engineer-president who has yet to be fully appreciated tried to warn America regarding the consequences of going all-in on fossil fuels.  The voters FLUNG him out of office.  Whatever happened to Americans who actually wanted to hear the truth?  It seems nobody wants a president who "cannot tell a lie".  How many Americans would vote for a guy whose campaign slogan is "Honest Abe"?  It appears that humanity bought and paid for what they're gonna get, good and hard.

Ident 7777 economy's picture

 

 

Errol:

"I will mention that an engineer-president who has yet to be fully appreciated tried to ..."

 

Carter - FAIL. (GENIUS compared to obummer though)

 

'Alternative energy' started during his term has also FAILED.

 

Do you reccall the name of the 'index' started during his term? The "Misery Index"?

 

Begun for a reason ...

 

 

 

malikai's picture

I don't know why anyone would junk this. It's true.

But I do miss the sweater talks.

Flakmeister's picture

Take away the North Sea and Prudhoe from Reagan and you would have had "Mourning in America"....

DaveyJones's picture

Well said Errol. We screwed this one up big time.

AnAnonymous's picture

How many Americans would vote for a guy whose campaign slogan is "Honest Abe"? It appears that humanity bought and paid for what they're gonna get, good and hard.

________________________________________

So true. So true. Made me laugh. See how the jump from 'Americans' to humanity is made easy, even for a blatantly restrictive event like US of A political elections.
Hijacking humanity, so natural to US citizens.
Really.

No, humanity did not buy and pay for what they're going to get.

Humanity will get what US citizens force on them.
That is the point.

Errol's picture

Mr Anonymous, I was conscious of my jump from Americans to humanity when I wrote it.  It appears that most of the rest of the world is very interested in attaining the American "lifestyle".

For example, how is the sale of cars in China trending?  How is Chinese oil consumption trending?

Joe The Plumber's picture

Swing capacity is mostly a myth, but even if saudi could ramp up to 15 million barrels per day within a year it is heavy crude and the bottleneck is heavy crude refining capacity. There is no significant excess capacity that could absorb millions more barrels of heavy crude right now

We better hope that fraking applied to existing wells changes the depletion slope. I am cautiously optimistic we may enter another brief economic spurt from cheap energy over the next twenty years

sangell's picture

Cheap energy has its own costs. If you drive the price of oil down you take out high cost production and new investment in hard to get oil. If it costs $75/barrel to produce Alberta tar sand oil any price below $75 shuts in that oil. Same with deep water oil. No one's going to drill for it if the price doesn't cover the cost of production.

Yes_Questions's picture

 

 

The investment was outsourced, rather, appropriated vis-a-vis rifle, Soldier and drone.

CrashisOptimistic's picture

Price of the failed Repsol well north of Cuba -- $125 million.

Flakmeister's picture

It does not just get shut in... the oil patch is all about cashflow... Selling at below cost does destroy the ability to fund reserve replacement though....

Marginal Call's picture

It most certainly does affect depletion rates.  You turn it into a maximum resevoir contact well, and it's the equivilent of nuking hoover damn as far as flow rates go.