Economics: The End Of Opec As We Know It

 (Drivebycuriosity) - Oil prices are in a free fall. Since last year Brent Crude, the gauge for international oil, dropped 59% to $27, WTI, which represents US oil, crashed 65% to $20 (charts below). Oil prices had been already under pressure for a while because the US frackers raised the global oil supply. The spreading coronavirus crisis - and factory shutdowns & travel bans -  cut the oil demand sharply and accelerated the oil price drop and then Saudi Arabia started a price war and began flooding the global market, which lead to the crash in the recent days.

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What brought the Saudis to it? In the beginning of the year the Saudis, who control Opec, wanted to cut the oil supply, as response to rising US production and sinking global demand. Opec alone is not strong enough to hike the global price, their market share is too small. So they need the cooperation of Russia. But Putin refused and the Saudi´s responded in a childish way and started to flush the already oversaturated market.

Today the Saudi`s - and maybe also the Russians - try to destroy the US competition, especially the frackers, by driving the oil price sharply down. The Saudis claim that they can produce oil even for just $10 a barrel which would ruin most of the US frackers (many of them are highly indebted).

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The price war reminds of the years 2015/16 ( driveby). "Opec is about to crush the US oil boom", wrote Bloomberg in October 2015 ( bloomberg). Then the Saudis also flushed the market, to get rid of the frackers like today, and oil prices melted from about $120 to around $30 (chart above). Their aggressive strategy worked for a while, many frackers went out of business. As a result global oil supply dropped and the oil price shot up again and reached $80. But - unfortunately for Opec - rising prices made oil production profitable again for the frackers and the US production came back - stronger than before. In the beginning of this year US oil production climbed to new record highs and the oil market was oversupplied again.

The current oil price crash might squeeze most of the US frackers out of the market and might give Opec the chance to curb global oil supply and hike oil prices again, as they did in 2016. But the recent history shows that this strategy works only temporarily. If the oil price swings back then fracking will become profitable again and the frackers will come back - as they did in 2017 and the following years.

The US oil in the ground won´t disappear, however deep the oil price might drop. And the technology behind fracking will not be forgotten either. The recent crash might even be an initiative to cut cost and to make fracking even more efficient. The productivity of fracking is rising swiftly which leads to shrinking costs (economics21  oilprice  econbrowser). A study by BP explains that fracking is "a standardized, repeated, manufacturing process" and "manufacturing productivity has led to a trend decline in the prices of goods relative to services" (forbes). So the break even point for producing oil has been moving lower and will continue to fall in the coming years, making it more challenging for Opec to hike the price of oil to former highs.

Opec has a big enemy, called technology, which will destroy the cartel - even if Opec survives this crisis. Machines are getting more & more energy efficient thanks to technological advances. Cars, trucks, airplanes & ships burn on average less fuel per mile. Refrigerators, washing machines and other devices need less electricity. And electric cars are getting more & more popular, even though these vehicles are still expensive.  The pioneer Tesla is not alone, traditional automakers, including Volkswagen, Honda, Toyota, Renault, Chevrolet, Mercedes and more, are already offering electric cars as well. 

The next oil flood is already around the corner. We are observing the end of Opec as we know it.