World Energy Monthly Review

The March 15 meeting of the OPEC ministers in Isfahan, Iran, will be remembered as a tipping point in the history of the energy business.

By now, everyone knows that during that meeting OPEC agreed to hike its production by 500,000 barrels per day, bringing OPEC’s stated quota to record 27.5 million barrels per day. The move was an effort to slow the recent surge in prices. The increased quota doesn’t matter. The real issue is this: For the first time in more than seven decades, the world oil industry does not have a controlling cartel. OPEC — and the pricing power that it has held for decades — is disintegrating.

A cartel only has power if it can affect the movement of prices both directions: up and down. If it wants to move prices up, it cuts production. If it wants lower prices, it increases production. Last month, OPEC effectively admitted that it has lost the ability to move prices downward. Algeria’s energy minister, Chakib Khelil, said that OPEC “does not have the production capacity to increase its quotas.”

OPEC’s spare production capacity — the trump card it has relied upon to control prices since the 1973 oil embargo — has disappeared. All of the member countries are running their wells at maximum capacity. Its members are in disarray. Iraq, long one of the most important members of OPEC, verges on chaos and its oil infrastructure is under constant attack by insurgents. One member, Indonesia, cannot meet its quota. In February, Indonesia was able to produce only 942,000 barrels per day, far below its OPEC quota of 1.4 million barrels. Indonesia is now at its lowest level of production in 34 years. And it faces the real possibility of having to drop out of OPEC altogether: analysts are forecasting that Indonesia will be a net crude importer by the end of this year.

Indonesia may be replaced in OPEC by Ecuador. It won’t matter. Ecuador’s current export capacity is about 400,000 barrels per day — a million barrels below Indonesia’s stated OPEC quota.

The disintegration of OPEC will likely lead to two things: greater price volatility and even more focus on Saudi Arabia and Russia. Ever since the 1930’s, when the Texas Railroad Commission began controlling the oil spigot, there has been a cartel that has effectively managed (for better or worse) the balance between oil supply and oil demand. Now that OPEC has lost the ability to move prices downward, there is no effective control on the oil spigot. That means that the market will likely be spooked by every supply disruption.

But price volatility may not matter when compared to the greater strategic importance now held by Saudi Arabia and Russia. Those two countries are the only ones that– at least on paper — are able to substantially increase output enough to make a difference to the 83-million-barrels-per-day global market. Neither country has yet proven that they can achieve that feat. And as their strategic importance grows, so does the possibility of armed conflict.

Of course, OPEC still has leverage over the market. The group still accounts for more than a third of daily global production. Its 11 members (10 of which are predominantly Muslim) will continue to be a counterweight to America’s global presence, and they still hold some 75 percent of the globe’s conventional oil reserves. Furthermore, individual members of OPEC — Venezuela and Iran, in particular — now have the power to move global oil prices upward unilaterally, if they should decide to cut production by as little as one million barrels per day.

The world oil market already has plenty of reasons to be skittish. The decline of the OPEC cartel only adds to that growing list of worries.

Key Dates in Oil Cartel History

October 3,1930: the giant East Texas oilfield is discovered by Dad Joiner, leading to a frenzy of drilling. Within months, oil prices fall from $1.30 per barrel to as little as three cents.

August 16, 1931: Texas Gov. Ross Sterling declares an emergency and sends the Texas National Guard into the East Texas oilfields to shut down all production. Oil prices rally.

February 22, 1935: After years of legal fights, the Connally Hot Oil Act becomes federal law. It authorizes the Railroad Commission to limit oil production, making it the de facto cartel.

1959: Led by Saudi oil minister Abdullah Tariki, representatives from Venezuela, Iraq, Kuwait and Iran meet at a yacht club outside Cairo and form a “Gentleman’s Agreement” that later becomes the Organization of the Petroleum Exporting Countries.

October 19, 1973: In retaliation for U.S. support for Israel during the Yom Kippur War, OPEC raises prices, then begins an oil embargo, prohibiting oil sales to the U.S. Within months, prices quintuple.

1973 to 2005: OPEC raises or lowers production at will, thereby maintaining control of pricing.

March 16, 2005: OPEC meets in Isfahan, raises production by 500,000 barrels. Algeria’s energy minister, Chakib Khelil, admits OPEC “does not have the production capacity to increase its quotas.”


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