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Crude Economics
Oil Guru Says OPEC’s Era Is Over

What use is OPEC? For decades, the oil cartel has leveraged the large percentage of the world’s oil supply its members produce to try and keep prices up, and during previous price slides would (led by Saudi Arabia) lower its collective output to help induce a rebound. But five months after oil prices started their tumble from a June 2014 high of more than $110 per barrel, OPEC members meeting in Vienna decided to not to do anything. Riyadh pushed this strategy of inaction, preferring to fight for a share of a market that had quickly become crowded, thanks to the rapid rise of U.S. shale.

Now, nearly two years after prices began their tumble, OPEC members are preparing to meet delegates from other petrostates in Doha next week to moot a deal to freeze production at current levels. But while prices have been edging upwards in the lead-up to that meeting, that strategy isn’t likely to produce the kind of rebound OPEC would like to see, which again brings us back to the question: what good is OPEC?

In an interview with the FT, famed oil historian Daniel Yergin paints a grim portrait of the once-powerful cartel:

In an interview with the Financial Times, Mr Yergin, who is also vice-chairman of data provider IHS, said the recent disagreements among Opec members have revealed how weak the organisation now is. Mr Yergin said: “The era of Opec as a decisive force in the world economy is over. It is clearly a very divided organisation.”

…[T]he 69-year-old argues the current oil slump has exposed the organisation’s inability to act in a unified way. […]

Mr Yergin said he did not think a freeze was possible until Iran clarified how much it could export. As for Saudi Arabia, Mr Yergin said it was thinking differently about oil.

“I remember when the operating code was: save the oil for our grandchildren. Now the grandchildren are in charge and they are looking at it in a very different way,” he said. “They are not looking at it as precious resource . . . but rather asking how do you monetise it?”

Thanks to hydraulic fracturing and horizontal well drilling, we’ve blown well past the days of peak oil prognostications, into an era characterized by problems of overabundance rather than scarcity. Crudely speaking (excuse the pun, please) this has been good for consumers and bad for producers, but while U.S. shale firms have been able to innovate their way into staying profitable in the bearish market, petrostates have been forced to start cutting national budgest and tapping sovereign wealth funds. Both sets of producers are being squeezed by $40 oil, but the former is actively working towards a solution as it refines techniques and boosts efficiencies, while the latter is merely treading water while talking loudly about setting an upper limit on production—cuts are out of the question.

There are many reasons to be skeptical of this new freeze plan, but as we edge closer to that date prices are ticking upwards—Brent neared $43 in trading today for the first time in more than four months. But if that’s all OPEC can manage, Yergin might be proven right: OPEC’s era really could be over.

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  • Andrew Allison

    Duh! Of course the OPEC era is over: the former swing producer has ceded that role to the USA.

  • Jacksonian_Libertarian

    Time favors the American Shale Developers, as every month that goes by sees the breakeven point fall a little bit further, while OPEC’s costs are actually rising as their old wells production declines and maintenance costs rise. If the price of oil is still in the $40/barrel range a year from now, we can expect the American’s to start booming again. This means any benefits that a freeze or cuts in OPEC production would produce will mostly benefit the American’s rather than send prices higher. Since fracked wells produce 80% of their oil in the first year, financing them is easy as the loans get paid off in 12 months, and its all gravy after that. This also means that the Americans can boost production almost instantly to take advantage of any improvements in either falling costs or rising prices.

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