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OPEC's Swan Song?

Sam Vaknin, Ph.D. - 3/20/2005

As oil prices shot past the $57 mark in the crude futures markets on both sides of the Atlantic, OPEC, in a meeting in March 2005, raised its combined output by 500,000 barrels per day (bpd), reversing a December 2004 decision to cut production by 1 million bpd. How times change! It is instructive to re-visit the incredibly very recent past. Just two years ago, OPEC was preoccupied with production cuts. Indonesia's then Energy Minister, Purnomo Yusgiantoro, was unhappy with the modest production cut of 2 million barrels per day, adopted by the Organization of Petroleum Exporting Countries in April 2003, to be implemented from June 1, 2003. At the June 11, 2003 get-together in Qatar, he demanded further reductions.

The deal ultimately struck was so convoluted and loopholed that actual output declined by no more than 600,000 bpd, even with miraculously full compliance. Quotas were first raised before the Iraq war to 27.4 million bpd - a theoretical level, not met by actual supply. Crude prices, entering a period of seasonal weakening, dropped further on the June 2003 OPEC news.

Despite Nigerian and Venezuelan crude recovering from months of strife, this downtrend proved to be temporary. Demand soared in both West and East (China). Global excess capacity is at mere 1 million bpd - one fifth its prewar level and one fifth the amount needed to effectively regulate prices, according to the International Monetary Fund's next "World Economic Outlook" (published in April 2005).

So, is OPEC dead in the water?

Far from it. As North American and North Sea production decline, the importance of Gulf producers soars. OPEC's eleven countries - Algeria, Indonesia, Iran, Iraq (suspended in 1990, following its invasion of Kuwait), Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela - control one third to two fifths of global oil output and three quarters of the far more important residual demand - traded between net consumers and net exporters. Residual demand is set to double by 2010.

And OPEC counts among its ranks some of its most astute players in the oil markets. Example: Ali al-Naimi, the Saudi oil minister. Al-Naimi is widely credited with engineering the tripling of oil prices to more than $30 a barrel between 1998 and 1999. As the informal boss of the state-owned Saudi oil behemoth, Aramco, he had introduced postwar output cuts. The oil market is so volatile that even marginal production shifts affect prices disproportionately. Al-Naimi is a master of such fine tuning.

Yet, OPEC - led by Saudi Arabia, now off the US buddy list - faces fundamental problems that no tweaking can resolve. Iraq, in the throes of reconstruction and under America's thumb, may opt to exit the club it has founded in 1960 and, thus unfettered, flood the market with its 2.3 to 2.8 million bpd of oil. Insurgency permitting, Iraqi production can reach 7-8 million bpd in six years, completely upsetting the carefully balanced market sharing agreements among OPEC members.

This nightmare may be years away, what with Iraq's dilapidated and much-looted infrastructure and vehement international wrangling over past and future contracts. All the same, it looms menacing over the organization's future.

Far more ominous perils lurk in Russia, the second largest oil producer and growing. Though the cheapest and most abundant reserves are still to be found in the Persian Gulf, Central Asia and Russia are catching up fast.

Saudi Arabia regards itself as the market regulator. It keeps expensive, fully-developed wells idle as a 1.9 million bpd buffer against supply disruptions. It is this "self-sacrificial" policy that endows it with tremendous clout in the energy markets. Only the United States can afford to emulate it - and even then, the Saudi Kingdom still possesses the largest known reserves and sports the lowest extraction costs worldwide.

OPEC is, therefore, not without muscle. Saudi Arabia had punished uppity producers, such as Nigeria, by flooding the markets and pulverizing prices. Yet, the organization is riven by internecine squabbles about market shares and production ceilings. Giants and dwarves cohabit uneasily and collude to choreograph prices in what has long been a buyers' market. These inherent contradictions are detrimental. If OPEC fails to recruit another massive producer (namely: Russia) soon - it is doomed.

Paradoxically, the Iraq war is exactly what the doctor ordered. OPEC's only long-term hope lies in a geopolitical shift, the harbingers of which are already visible. Russia may join the cartel, disenchanted by an imperious and haughty USA - or the Europeans may "adopt" OPEC as a counterweight to the sole "hyperpower" newfound energy preeminence.

America announced its intention to pull out its troops stationed in Saudi Arabia. As this major producer is thrust into the role of the "bad guy", it acquires incentives to team up with other "pariahs" such as France and, potentially, Russia. Controlling the oil taps is a sure way to render the USA less unilateral and more accommodating.

US interests are diametrically opposed to those of oil producers, whether in OPEC's ranks or without. The United States seeks to secure an uninterrupted supply of cheap oil. Yet, a consistently low price level would go a long way towards reducing Russia back to erstwhile penury. It would also destabilize authoritarian and venal regimes throughout the Middle East.

This unsettling realization is dawning now on minds from Paris to Riyadh and from St. Petersburg to Tehran. As the United States looms large over both producers and consumers, the ironic outcome of the Iraqi war may well be a prolonged oil crunch rather than an oil glut.