In Oil & Companies News 12/07/2016
The Organization of the Petroleum Exporting Countries, known to most people as simply OPEC, has been widely unpopular in the U.S. since the 1970′s. In October 1973, in retaliation for the West’s support of Israel in the Yom Kippur War, the Arab members of OPEC – The Organization of Arab Petroleum Exporting Countries (OAPEC) – stopped supplying the U.S. and Western Europe with oil. U.S. oil production was in decline at that time, and the U.S. was unable to make up the supply shortage caused by the embargo. As a result, oil prices quadrupled in a very short period of time, contributing to a deep global recession.
For many in the U.S. this created a deep-seated mistrust of the Middle East and OPEC when it comes to energy policy. The embargo showed that oil could readily be used as an economic weapon by those with sufficient export capacity, and those at greatest risk of being impacted were big oil importers like the U.S. In the ensuing years since the 1973 embargo, the view of most Americans has been that OPEC controls the world oil market, and OPEC’s interest are often in direct contradiction to those of the U.S.
In response to the embargo, important changes were made to U.S. energy policy. President Nixon instituted price controls and began rationing oil to states. The month after the embargo began the Nixon Administration announced Project Independence, which promoted conservation and alternative energy initiatives with the goal of ending oil imports by 1980. That same month, Nixon increased funding for mass transit, and authorized the Trans-Alaska Pipeline by signing legislation that disposed of legal challenges from the project’s opponents. Soon after, the National Maximum Speed Law was passed, reducing the maximum speed limit nationwide to 55 miles per hour.
President Ford promoted expanded use of coal and nuclear power to shift electricity production away from oil, as well as the development of synthetic fuels and oil shale resources. In December 1975, the Strategic Petroleum Reserve (SPR) was established when the Energy Policy and Conservation Act (EPCA) was passed by Congress. The law was designed “to reduce the impact of severe energy supply interruptions” such as the OPEC embargo. The fuel efficiency of autos improved quickly following adoption of the Corporate Average Fuel Economy (CAFE) standards in 1978. A 2002 study by the National Academy of Sciences concluded that motor vehicle fuel usage was 14 percent lower in 2002 than it would have been in the absence of fuel efficiency standards.
The net impact of these changes was that OPEC’s market share peaked in 1973 at 51.2% of global crude oil production. By 1985 it had fallen to 27.6%, and OPEC’s power was clearly on the wane. But then a funny thing happened. Over the next decade OPEC’s share again began to rise to about 40% of the world’s crude oil production, and it has held pretty steady at that level for the past 20 years:
In 2014 – when OPEC made the decision to defend market share that would ultimately help send oil prices below $30/bbl – OPEC’s production share had only declined from about a 43% market share to a 41% market share. This loss amounted to less than 2 million barrels per day (bpd) from an organization that produced 38.2 million bpd last year. This is why I previously characterized OPEC’s move as a Trillion Dollar Miscalculation. Not only has it cost the group tremendous foregone revenue, but it has led to a great deal of questioning about whether OPEC’s power is again waning.
On that question, I would say that those who are writing off OPEC are getting ahead of themselves. Whether the group can effectively manage itself internally to maintain production discipline is a legitimate question. But if they manage to cooperate on a more aggressive pricing strategy, it should be pretty clear that an organization that produces ~40% of the world’s oil has tremendous pricing power (in theory).
Yes, had they adopted such a strategy in 2014 it would have meant giving up maybe 2 million bpd of market share. Over the next 5 years they may have had to give up another 2 million bpd. But shale oil production in the U.S. would have likely begun to decline within a decade, and OPEC could have then started capturing back market share without giving up a trillion dollars or more of revenue. They could make a lot more money selling 36 million bpd of oil at $75/bbl than selling 38 million bpd at half that price.
It is also important to note that OPEC controls 71.4% of the world’s proved crude oil reserves. Thus, it is highly possible that the group’s global market share will increase substantially as non-OPEC reserves are depleted. Writing the group off as dead or impotent is to ignore some very real risks to oil importers given OPEC’s still-dominant role in the global petroleum market.
