Economics: Is OPEC Committing Suicide?

(Drivebycuriosity) - It looks like that OPEC is committing suicide. The cartel cut oil production in order to hike the price of oil. The production cuts are already hurting their economies. Saudi Arabia`s, the world largest oil producer, slipped back into a recession: Gross domestic product, adjusted for inflation, shrank 2.3% from the previous quarter in the April-June period, after dropping 3.8% in the first quarter  (bloomberg   reuters). Higher prices for oil weren`t enough to compensate for reduced oil production & exports.

The losses would make sense if OPEC could sell oil much dearer in the future. Saudi Arabia & other OPEC members have still huge oil reserves in the ground and they have to plan - and to manage - their oil production over many decades to come. This reminds me of a discussion I had with my doctoral thesis adviser after OPEC`s oil embargo in the 1970s (to punish the West for Israel`s victory in the Yom Kippur War). We agreed that OPEC has to decide what to do with their oil reserves. There are two options: They can sell their oil today and invest the proceeds in their non-oil economy and other assets like stocks & bonds (Norway did that later and started their Government Pension Fund, known as Norway´s oil fund) or keep the oil in the ground and sell it later. The second option makes sense if the expected oil price gains (the interest rate on oil in the ground) are higher than the interest rate they could earn in the markets today.

Things have changed since then. Oil has an uncertain future. China, the world's largest auto market, is working on a plan to ban the production and sale of vehicles powered solely by fossil fuels. Bejing has already announced that any automaker producing or importing more than 30,000 cars in China must ensure 10 percent of them are all-electric, plug-in hybrid, or hydrogen-powered by 2019. That number will rise to 12 percent in 2020 (cnn  bloomberg). Germany, France, UK and other countries want also get rid of fuel driven engines. So in some years the global demand for gasoline will shrink dramatically.

That´s bad for OPEC because crude oil is mainly used to produce gasoline. In some years the demand for gasoline will be replaced - at last to a large part -  by demand for electricity. The chart below shows that in the US oil is already irrelevant as power source for electricity production: Just one percent of the US electricity comes from petroleum.

It´s similar with heating (chart below: source eia.gov/). Less than 20% of US households use oil for heating, the majority is heating with natural gas and electricity (produced mainly by coal & natural gas).

So, most of the oil - about 70% -  is used for transportation and just around 30% for petrochemical products ( energy).

After 2020 oil prices could fall well below $20 thanks to the shrinking gasoline demand. Saudi Arabia and other big producers, who are sitting on huge oil reserves that should last many decades, would be well advised to sell their oil now. The current production cuts may hike the price of oil temporary - that will only heat up the trend to electric cars. It seems OPEC is causing her own death.