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The Organization of the Petroleum Exporting Countries [OPEC] includes twelve oil producing nations, mainly in the Middle East and Africa, but also includes Venezuela. It's headquarters, pictured here, is in Vienna, Austria.

OPEC's Dilemma

Calls for energy independence and talk of electric-drive cars is sending a chill through OPEC.

By James L. Williams

The dilemma, whether OPEC members acknowledge it or not, is that OPEC must increase capacity and lower prices or face the permanent loss of a substantial portion of oil's market share in the energy market. In the intermediate term the also risk losing market share within the petroleum segment of the energy market. In the last issue in this series we began the first of several articles addressing "Peak Oil." Today's article qualifies as a peak oil article but its focus is politics and economics rather than the geologic and technical factors that will eventually lead to a peak in production. One might call it a discussion of peak oil consumption.

OPEC's Monthly Bulletin starts with an article titled "Dependence is a two-way street." This is the most prominence OPEC has given to its security concerns. Those living In consuming nations, including your author, have expressed concern about import dependence and the concomitant threats to security. It is not surprising that OPEC views it differently. As Dad used to say, "Don't judge a man until you have walked a few miles in his moccasins."

We will let the OPEC speak for themselves. The following are from OPEC's latest Monthly Report.

"As the DoE states candidly on its website, “oil is the lifeblood of America’s economy”.

"In the US and some other key consuming countries, the fear that supplies of oil might be interrupted is the main reason why governments have decided to support the development of alternatives, such as solar and wind power, nuclear energy and biofuels.

"What the leaders and opinion makers of consuming countries seem to have overlooked in their frenzied search for energy security is that producing countries need security of demand since they too are dependent on oil. Maybe even more than they are. Producers need the revenue that oil exports bring in: in OPEC Member Countries, for example, oil accounted for 73 per cent of total exports in 2005. In some of these countries, the percentage was much higher: 95 per cent in Kuwait, 98 per cent in Nigeria and 99 per cent in Libya. In most of these countries, oil revenues are used to fund educational and health programmes, as well as to build crucial civil and communications infrastructure. Given this dependence, it would hinder, not bolster, their interests to withhold oil from world markets and to drive prices up so high as to hurt the global economy.

"OPEC is committed to supporting oil market stability, a commitment that is built “upon the fundamental recognition that extreme price levels, whether too high or too low, are damaging for both producers and consumers”. As it has done since it was established in 1960, the Organization will continue to work towards ensuring uninterrupted supplies to consumers at reasonable prices. But in the light of recent developments regarding the stated move away from traditional fossil fuels — and oil in particular — OPEC Member Countries feel that they ought to review their future expansion plans. It would, in fact, make no sense for them to spend money unnecessarily on building or improving facilities when their customers are telling them they intend to minimize dependence on OPEC supplies."

OPEC has a valid point. They are more dependent on oil exports than most of the major importing countries are on petroleum imports. However, the not so veiled threat of reducing investment in additional capacity is not a solution to their problem.

In the late 1970s Saudi Oil Minister Yamani warned OPEC that high prices would result in the loss of market for OPEC. They did and the loss came from two directions: lower demand for the high priced oil and greater production from non-OPEC producers.

Between 1979 and 1983 as a result of the price spike of the late 1970s there was an 11.2% (6.5 million b/d) decline in worldwide consumption. The OECD countries as a group matched the 17% decline in U.S consumption. During that period half of the loss in worldwide consumption could be attributed to the U.S. In contrast, consumption in the Middle East increased 25%.

Most will recall from previous articles that the decline in consumption could be attributed to fuel switching and capital investment in efficiency. Included in the investment was the purchase of more efficient vehicles. Some of the lower consumption was attributable to laws such as the CAFE standard for autos and tax breaks for more efficient heating and industrial processes.

The problem for OPEC is that most of the increase in efficiency and the fuel switching was more or less permanent. Much of that loss was in heating and process applications. It took a decade for worldwide petroleum consumption to return to the 1979 level and 15 years for the developed OECD countries. Put another way it took 2 1/2 times as long to regain 6.5 million b/d of consumption as it did to lose it.

The Green Movement and concerns about global warming add to the problems faced by OPEC. Even if consumers where not facing the second highest prices since the discovery of oil in the U.S this has the potential to slow worldwide consumption growth. However lower prices would mitigate that influence. The simplest example has been the increased popularity of SUVs in the U.S. during a period in which Americans expressed ever increasing concern about the environment. Their use increased dramatically during the late 1980s and 1990s during a period of low to moderate oil prices.

The other factor impacting OPEC market share was the increase in non-OPEC production. Because of the long exploration and production cycle non-OPEC production was still increasing in 1987.

Had it not been for lower production associated with the economic problems and eventual breakup of the Soviet Union non-OPEC production would have continued to increase well into the 1990s. In the last 2-3 years the rate of growth in Russian production has slowed with the apparent re-nationalization of the petroleum industry. Russia may wish to slow the growth rate, but experience shows that national oil companies under perform private corporations and Russian production growth would be slower in any case.

By 1985 OPEC's production had fallen to half the level of 1979. Part of the decline was a consequence of the Iraq-Iran War but most was an attempt by OPEC, primarily Saudi Arabia, to abate the price collapse that came with higher non-OPEC production and lower world consumption.

The dilemma for OPEC is whether or not to invest in more capacity and increase production to reduce prices and maintain its market share. We noted earlier that it took 10 years for consumption to recover after its post 1979 decline. The last graph on the right shows that it took 25 years before demand for OPEC petroleum was sufficient to reach the level of the late 1970s. OPEC members risk a more or less permanent loss of market for their product unless they move to lower prices substantially and soon. This requires expansion of production as well as capacity. Every day that they fail to bite the price bullet is another day in which alternate energy, conservation, and efficiency can erode OPEC's share of the energy market.

Enactment of a single law in the U.S. funding a public transportation infrastructure that would allow the average American an alternative to driving would be devastating to OPEC. A breakthrough in battery technology that provided lighter batteries with quicker recharge and a longer range to electric vehicles would be worse.

James L. Williams is an oil industry analyst and publishes a regular email newsletter. His web site is WTRG.com.

Times Article Viewed: 25706
Published: 03-May-2007

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