Wednesday, December 31, 2014

Oil: Post OPEC

(Drivebycuriosity) - It seems we are witnessing the dawn of OPEC. The cartell formed in the 1960s and came to power in the 1970s. In 1973 the organization cut oil production drastically (oil embargo  wikipedia) in order to punish the US and Western Europe's for their support of Israel`s Yom Kippur War against an alliance of Arabian states. Then the oil price quadrupled and jumped to $60 which caused the infamous oil crisis ( state.gov). Oil stayed expensive until the early 1980s which caused sharp recessions and a decade of economic stagnation and a dormant stock market.








In the early 1980s the table turned again. Non-OPEC nations countries outproduced OPEC again and despite repeated cuts by OPEC the oil price fell back into a range between $10 and $20 where it stayed until 2002 (seekingalpha). This allowed a decade of a prospering economy and a rally on the stock market during the Dow Jones climbed from 1,000 to 10,000.



In the years that followed 2002 OPEC got their strength back and kept it till last summer. A series of wars, conflicts and sanctions with, in and against Iraq, Syria, Lybia, Iran and Russia reduced oil supply from these important producers which allowed the rest of OPEC to keep oil scarce and expensive. Hedge funds and other speculators set huge bets that geopolitical conflicts will lead to a severe disruption of the oil supply. And Goldman Sachs & other banks hyped the peak oil theory, which claimed that global oil supply had already peaked and that we were experiencing shrinking oil production and rising energy  costs. As a result the oil price jumped from around $20 in 2002 to a peak of $148 in 2008 and stuck in the range $110-120 from 2009 till summer 2014. It is not surprising that we got a sharp recession and an economic development which resembled the 1970s.


The situation began to change dramatically in summer 2014. Suddenly the market recognizes that OPEC is losing power. There are at least 3 developments responsible for that:

1. Oil production from war countries like Iraq, Lybia & Syria is coming back. These big producers are flooding the global oil market again.

2. Oil demand is curbed by technological progress which leads to more efficient cars and other machines (demand destruction bloomberg).

3. Rising oil production outside the OPEC. The US supply is rising sharply thanks to fracking and horizontal drilling.


Today OPEC has just 40% of the global market and their market share is melting. Saudi Arabia and other OPEC leaders, who had fought for high oil prices in the years 2008-2013, remain now passive and accept sharp falling oil prices. OPEC claims that they want to fight US producers with prices below $60 in the hope that American oil wells will become unprofitabel and these competitors will leave the market.







                                          A New Decade Of Cheap Oil

If this is the strategy of OPEC - they will fail. The costs for alternative oil exploration (fracking and horizontal drilling) is falling and producers are becoming more efficient. This will lead to further declining oil prices and the rise of oil production outside the OPEC will continue. OPEC´s market share will shrink in the coming years making the organization mediocre again as it was in prospering 1990s and before 1972. Maybe OPEC will fall apart.




Here some quotes:

"U.S. producers battling OPEC for market share may increase output further from the highest rate in more than three decades as costs decline almost as fast as oil prices, says Goldman Sachs (bloomberg). The oil price slump is driving producers to move drill rigs to lower-cost fields, according to the report."

"Data from the state of North Dakota says the average cost per barrel in America’s top oil-producing state is only $42 — to make a 10% return for rig owners. In McKenzie County, which boasts 72 of the state’s 188 oil rigs, the average production cost is just $30, the state says. Another 27 rigs are around $29." (marketwatch)



I reckon that the US oil producers will soon be accompanied by oil producers from China and other countries."In June 2013, the United States Energy Information Administration (EIA) released a world shale oil and gas reserve assessment that showed 32 countries outside the United States have substantial reserves locked up in 137 different formations - units that can be exploited using Bakken-like technology....The EIA placed China third behind Russia and the U.S. in tight shale oil reserves - with 32 billion barrels considered technically recoverable." (bismarck).


And there is another danger for OPEC: Alternative energy. The efficiency of solar panels is rising, reducing the costs of solar energy. In some years cheap solar electricity will compete against oil. According to the Washington Post some home owners in California use already electricity gained from solar panels on their roofs to fuel their electric cars (washingtonpost).


Maybe Saudi Arabia and other OPEC leaders have a long term planning horizon. Maybe they are planning for decades. Then they might be aware that solar energy could destroy their market in some years. In this case it would make sense for them to sell oil now for a still good price. Maybe the recent passivity (decison to not cut oil production) is not just an attack against US tracking, it might be also a preemptive strike against solar energy or just capitulation.



Welcome cheap oil!




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