Is OPEC still relevant?

June 1, 2012
The Financial Times recently published an article in which the author predicted the days of OPEC, the Organization of Petroleum Exporting Countries, are numbered.

The Financial Times recently published an article in which the author predicted the days of OPEC, the Organization of Petroleum Exporting Countries, are numbered. The basis for the statement is that new technology has helped make the extraction of gas and oil from vast unconventional resource plays in the western hemisphere economic, and this has diminished the cartel's influence on oil supply and, thus, the price of oil.

While there is merit to this argument, it may be premature to count OPEC out of the game. OPEC member countries such as Venezuela, Iran, Iraq, and Saudi Arabia still control vast reserves of crude and have eager customers, particularly emerging energy consumers China and India, whose economies are growing faster than those of more developed nations in the West.

Nevertheless, something is happening in the West that is beyond OPEC's ability to control. American and Canadian oil production is expanding rather than contracting for the first time in decades and that, combined with reduced fuel demand in both countries, may soon lead to less reliance on crude imports. However, that tipping point has yet to be reached.

If the US were to adopt an energy policy that encouraged the transition to natural gas vehicles (NGVs), we could reduce our appetite for refined crude oil products even further. Raymond James' Pavel Molchanov recently pointed out that a number of leading US companies – General Motors, Chrysler, Navistar, Hertz, General Electric, and others – have jumped on the NGV bandwagon as natural gas prices have plummeted. However, the NGV market has expanded more rapidly overseas than in North America.

Molchanov noted that the US has over 20% of the world's oil demand, but less than 1% of the NGVs (somewhere between 120,000 and 150,000). The market penetration for natural gas is still tiny here – less even than the small nation of Armenia (population: 3 million), which has nearly as many NGVs on the road as the US. Brazil and Iran each have millions of NGVs on the road, and even Italy, a gas importer, has 700,000.

So the US has a long way to go to catch up. A US energy policy promoting natural gas as a transportation fuel would help. This should be a no-brainer. As a rough estimate, the adjusted leaving-the-refinery cost of gasoline is approximately $2.65 per gallon versus about $1.31 per gallon for compressed natural gas (CNG).

Getting back to OPEC, it is still possible for that bloc of countries to impact the market by strategically increasing or reducing production. In the past, Saudi Arabia alone has shown that it is capable of affecting market prices in this way. With a declining production curve for many OPEC members, it is problematic whether the cartel can continue to exert this degree of control over the market. Its influence is clearly waning.

Over the years, oil markets have demonstrated that they are highly reactive to geopolitical events and instability – or perceived instability – in oil-producing countries, particularly in the Middle East. Sometimes a mere statement from a mullah in Iran or an Israeli government official can push up oil prices. When a crisis breaks out in Libya, Egypt, or Syria, the market reacts to that as well.

In recent years, civil strife and other political events appear to have had more influence over oil prices than the machinations of OPEC.

Increased petroleum production in the West will also impact prices. Continued development of the oil sands in Canada, the exploitation of unconventional resources in the US, and the recent oil discoveries offshore Brazil are all likely to move these countries into the ranks of the world's largest energy producers in the next 20 years, if not sooner. For the first time since the early 1950s, oil production actually could match consumption in these countries, reducing or eliminating the need for them to import oil.

When this occurs, it will provide greater market stability than we have today. Markets also will be less reactive to political unrest in other oil-producing nations. Politically stable producers mean stable prices. We may care if tensions increase between, say, Israel and Iran, or if terrorists were to target oil facilities in a Middle Eastern country, but such events would be less likely to cause chaos in global markets because their share of the market would be diminished.

So, arguably, the strangle-hold that OPEC has had over the world will continue to weaken. Although no one outside Saudi Arabia, not even the late Matt Simmons, knows for certain how much oil the Saudis have left, it is likely that country's production has peaked.

Given the present and future developments described above, the flow of oil from OPEC countries will diminish in absolute quantities and as a percentage of the total market. As that occurs, the cartel will become less and less relevant.

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