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It's All About Oiiiiiiiiil!
Or, Cartels Are Hard

Kevin Drum gives me some oil-related stuff to worry about, and worry I shall, though I fear the Avian Flu more. This, however, I shall not worry about:

For example, OPEC has the capacity to supply about 30 mbd. Question: what incentive do they have to continue pumping this amount? Economically, they have very little. If they cut production by 20% (6 mbd), that would reduce global supply to 78 mbd. Prices would immediately double to around $100/barrel, maybe even higher, since there would be no other source to make up the shortfall. As a result, OPEC's revenues would skyrocket — not all at once, since most oil is delivered under futures contracts, but soon enough. In addition, most Middle Eastern fields are being overproduced right now, so cutting production would have beneficial long-term effects as well.

So why not do it? In the past, it was partly because Saudi Arabia kept the rest of the cartel in line by threatening to increase its pumping capacity to make up any shortfall. But Saudi Arabia no longer has much spare capacity left, and the Iranians and Venezuelans might decide someday that they don't care all that much about a global recession in the west. They'd rather have the money.

Nice work if you can get it. But you can't. Yes, if every OPEC member cut production by 20 percent they'd all be better off. But any given OPEC member would be even better off if the whole cartel agreed to cut production 20 percent, but then your country went around and cheated on the quota. So if you cut the quota, everyone will just cheat, and everything will stay the same. This is easy to see if you look at how the quotas got so high in the first place. What happened is that they used to be lower, but everyone was cheating, so OPEC raised the official quota up to what everyone was, in fact, producing in order to maintain the illusion of control. So the profit-maximizing case for deliberately provoking a peak oil scenario is a non-starter.

The rest of the worries, though, I'll buy. I'm now Officially Worried. And then there's the Avian Flu.

April 14, 2005 | Permalink


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Or, Cartels Are Hard

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Tracked on Apr 14, 2005 5:22:29 PM


Seems to me, doubling the price would be waaay more profitable for every OPEC member than cheating to sell 20% more for the current price. So, it's not at all obvious that everyone will just cheat when our Saudi freinds indeed lose their leverage. These are not children we are talking about, these are rational businessmen.

Posted by: abb1 | Apr 14, 2005 11:02:16 AM

I think you're wrong to dismiss this concern. When a given country can realize more revenue themselves by taking a bit of production off line and, thereby, jacking up the world price, they have an incentive to do it regardless of what other OPEC members do. This is just the sort of market manipulation that occurred during the California energy 'crisis', and it doesn't even require collusion.

The effectiveness of this strategy depends on the system running near peak production. If other producers have reserve capacity they can quickly bring on line if you cut your production, then it may not work.

The reason, by the way, that the Saudis have worked to keep the price of oil relatively low and stable is also one of self-interest. If oil prices go so high that alternatives become viable and stay high long enough that the alternatives are actually developed on a large scale, then oil producers could be deeply hurt in the long term. So the Saudis have worked to keep oil cheap enough to forestall the development alternative energy sources. But they may not have the excess capacity to do it any more.

Posted by: mw | Apr 14, 2005 11:02:45 AM

I'm wondering when some of the Oil countries will realize that oil appreciates in the ground faster than T-bills.

Gee, why should I boost oil production, when I can get a 10-15% rate of return by pumping it later?

Posted by: Matthew Saroff | Apr 14, 2005 11:06:47 AM

Cartels are hard, but they're not impossible, and they're easier to maintain when there are fewer members to keep in line and greater profits to be made with smaller reductions in production. With Saudia Arabia at capacity and capacity equal to demand, the chances of successful cartelization increase, as Kevin said.

Posted by: AF | Apr 14, 2005 11:10:43 AM

My worry is that we are approaoching the point when NON-collusive supply manipulation can occur. When demand is inelastic, and supply is at demand, a single producer can cut back and cause enough of a price rise to still benefit (this happened in the CA enenrgy market, and almost happens in the CA gasoline market).

Once this point is reached, the cartel becomes irrelevant because you can win (although not quite as much) WITHOUN having your cartel-mates cooperate and also cut production.

Posted by: Nicholas weaver | Apr 14, 2005 11:19:22 AM

The rest of the worries, though, I'll buy. I'm now Officially Worried.

I haven't said a thing to this, but now I will. I'm not buying it exactly. (Keeping in mind that I think we have had thirty years to change our energy policies, and we have flubbed it repeatedly, and I've been mad about it for 25 years.)

Peak oil as a long-term phenomena depends on 1> not finding any new, large fields, and 2> oil-recovery technology not improving. If both those are true beginning now, you will eventually run out of oil, assuming that oil is actually a fossil fuel (still the consensus of geologists). When oil production will peak given those assumptions is unknown, but presumably fairly soon. (1-30 years say.)

Technology generally improves; maybe it won't but it usually does. The improvements will cost. In addition to the South China Sea (basically Sultan of Brunei verse two), the very large Iraq fields are not really back online, Siberia is a question mark, and the countries bordering the Caspian KNOW there's oil there, so they haven't settled their differences and established territorial drilling boundaries. But Kevin is correct: it takes awhile to bring new fields online.

In the _short_term_, therefore, we are obviously facing a crunch, whether or not an oil peak exists or is just a mirage.

I remember 1973-1985. (I certainly remember 1986 - that's when I got out of high school, and right when the great oil glut started which created a localized, long-running depression here.) The initial shock was certainly political, but the increased profits encouraged people to bring a lot of new stuff up, so that when the glut started, there was a lot more capacity to be had. (Reagan asked the Saudis to help destroy the Russians by pumping lots of cheap oil and so they did. Now I know why Dick Cheney demonstrated a serious lack of principle by asking for a 10$/barrel tariff on imported oil.)

I also remember the Population Bomb (Paul Erhlich. Go read it!). We were all supposed to be dead by 2000, more or less.

There is a serious long-term problem: poverty amelioration. For our purposes, all wealth is energy. Have enough energy and you can pretty much do or make anything, given the raw materials. Have enough energy and you can synthesize it, if you can't dig it out of the ground cheaply. (Possess cheap enough energy and you clean anything up, too.) To bring up the livings standards of ye olde Third World, we need a LOT more power. (Remember the old saw about not being able to eat gold? You can't eat paper either. Never mind that that confuses the medium of exchange with the things you want. What you, me, and the Third World needs is STUFF.)

Oil crunch (short-term or long-term) == poorer poor people.

Of course, I'm a 'hysteric' (snicker) so I think our government is going sour in that bad way - like it stops being what it used to be and becomes something much nastier. Bad economies breed 'progressive politics'...and panic, demagogues, Men On Horseback and the like.

Bad economy + anti-constitutionalist government comprised of power-happy liars == You Don't Wanna Go There

That's an excellent reason to worry. Peak oil itself, as a concept, is mostly a distraction.

['Of course, the flu or any interesting new plague is immediately dangerous.']

Posted by: ash | Apr 14, 2005 11:26:19 AM

I don't think, too, that the OPEC will reduce their output. They don't want to be strong-armed by the rest of the world. After all, all they have to do is wait 5 years, as you can see on the chart at Drum's site:
When the oil producing countries can't satisfy the demand anymore, there will be the next oil shock. It will look like '73 on this chart:

I just can't understand why everybody is talking about a possible price of $100/barrel in the future. The chart clearly shows that we have to expect price increases of 200% and more. The economic crisis of 73/74 had global dimensions. This is what is waiting for us around 2010. Then many of us won't be thinking about reducing their driving, but they will brood if they should sell the car to pay the rent.

Posted by: Gray | Apr 14, 2005 11:26:27 AM

Of course! The entirety of Bush strategy and actions were always all and only about oil. It seems to be the only thing he deeply understands and cares about, other than tax breaks for the very wealthiest Americans.

Posted by: Deborah White | Apr 14, 2005 11:26:52 AM

Matt, you seem to be ignoring hundreds of years of history that say otherwise. Price gouging and insider fixing of whole industries by a few powerful monopolies has a well documented history. It does work. In the US it took Teddy Roosevelt to break these trusts. We have no one on the international stage (besides the US threat of arms) to break OPEC if they decide to artificially inflate prices. Hell, they've been doing it for decades anyway.

Quit being naive.

Posted by: manyoso | Apr 14, 2005 11:32:41 AM

The optimal pricing strategy for an oligopolist supplier is to price just below the price that would attract major new supply. In 1980 OPEC let the price go to high and with a lag major new supplies came on line. Consequently they suffered 20 years of weak prices and revenues until that new supply was used up.

With major new supplies available at half of the current $50 to $60 dollar price they are making the same mistake all over again.

Posted by: spencer | Apr 14, 2005 11:32:57 AM

Due to the assistance of the U.S.Government, the cartels which deliver health care in the U.S. have a much easier time maintaining their pricing power than does OPEC.

Posted by: Will Allen | Apr 14, 2005 11:47:39 AM

Depending on countries cheating on their quota requires them to have excess capacity. Presently, no country except Saudi has excess capacity. If one country (say Venezuela) reduces supply so much that Saudi can't make up the difference, no other country can step into the breach.

But why would Venezuela do such a thing? Cutting output so drastically would, despite the rise in price, reduce its oil income. So it won't happen.

So it always comes back to the same thing. As long as the US and Saudi are allies, OPEC can't gouge the US (and the world) -- which brings us back to Sept 11.

Posted by: Ikram | Apr 14, 2005 11:47:43 AM

Another important piece (that KD allded to in his entry) of the argument is the pricing power of terrorists in the oil market in a time of vulnerable and limited supply...we've been talking a lot about this in some detail, including some discussion of the work over at Global Guerrillas and others. (of course, since it's a peak oil/oil price themed blog, that's about ALL we talk about *laugh*)

Here's a link to the discussion over at the Oil Drum if you're interested:



Posted by: The Oil Drum (profgoose) | Apr 14, 2005 11:50:57 AM

What was said above -- the Saudis alone could drive up the price so that it benefits them.

Posted by: MattB | Apr 14, 2005 11:54:55 AM

As long as the US and Saudi are allies, OPEC can't gouge the US (and the world) -- which brings us back to Sept 11.

well, only some of us. for some, no connection can be made and any talk of such a connection puts the speaker into the same league as Michael Moore.

Posted by: cleek | Apr 14, 2005 11:54:59 AM

This is silly. OPEC is unlikely to be able to maintain a cartel for an extended period of time, but even 6-18 months of sharp production cuts, which would be realistically possible, could be a Big Deal.

Posted by: Atrios | Apr 14, 2005 11:55:56 AM

Currently the whole of OPEC produces about 30Mbpd,
and Saudi Arabia alone produces about 10Mbpd.
If the Saudis alone decided to halve production,
then we'd have an instant shortage regardless of
what other producers tried to do. And that might
well be a rational strategy for the Saudis - if
they can get the same revenue from selling half as
much oil, then they can keep that revenue going
further into the future.

This helps to explain the intimate relationship
between the US government and the ghastly Saudi
regime - zero democracy, zero rights for women,
zero religious freedom, public beheadings,
ambiguous relationship with Al Qaeda. The deal
seems to be that we accept the status quo and
supply arms and military backing to preserve it,
and in return the Saudi regime promises to keep
the oil flowing at a "reasonable" price.

If we ever took our own rhetoric seriously and
promoted democracy in Saudi Arabia, there's a real
chance that a Saudi democracy would break this
deal and cut production.

Posted by: Richard Cownie | Apr 14, 2005 11:56:18 AM

but that's the whole point, re: OPEC/Saudi Arabia, especially if buy into the idea that the Saudi fields have already peaked (there's also a lot of information to that effect over on the Oil Drum, which I alluded to earlier, namely the Ghawar field) means that OPEC/Saudi pricing power is in decline.

Ergo, the power is in the hands of either the new oil powers or as I alluded to above, the terrorists who can disrupt the flow of oil, even just a little bit (that's the GS $105/bbl "superspike" scenario.

Posted by: The Oil Drum (profgoose) | Apr 14, 2005 12:00:26 PM

but that's the whole point, OPEC/Saudi Arabia, especially if buy into the idea that the Saudi fields have already peaked (there's also a lot of information to that effect over on the Oil Drum, which I alluded to earlier, namely the Ghawar field), means that OPEC/Saudi pricing power is in decline. The power is in the hands of either the new oil powers or as I alluded to above, the terrorists who can disrupt the flow of oil, even just a little bit (that's the GS $105/bbl "superspike" scenario.

Posted by: The Oil Drum (profgoose) | Apr 14, 2005 12:00:51 PM

"assuming that oil is actually a fossil fuel (still the consensus of geologists)"

That's only a theory. We must also give consideration to the posibility (as many geologists and other scientists believe) that oil was the product of intelligent design, and therefore we will not run out of it, unless we were MEANT to run out of it.

Posted by: rea | Apr 14, 2005 12:03:44 PM

Major new supplies at $30/bbl? What, are elves making oil now?

Posted by: Tim H. | Apr 14, 2005 12:06:21 PM

One of the commenters on Political Animal claimed that sabotage in Saudi Arabia would get a huge bang for the buck. So why raise prices by cutting back on your own production when you can so cheaply cut back on your competitor's? Isn't there enough mafiya influence in the Russian oil industry to decide that this is a profitable idea?

Posted by: Allen K. | Apr 14, 2005 12:15:36 PM

Back in the 80s when I was in school, we studided pricing strategies for oil producers. The short answer was that if you have only a few years worth of oil reserves, you want the maximum price you can get. If you have a century's worth of oil reserves, you want low prices (low incentives to conserve/find alternatives), so that you can still sell your oil a hundred years from now.

Posted by: etc. | Apr 14, 2005 12:26:45 PM

Since an avian flu pandemic would knock out oil production (at least, the refineries) and cause an oil shortage, you could conveniently combine your worries into flu-oil.

Posted by: Tim H. | Apr 14, 2005 12:27:28 PM

Without a cartel, would oil be at $50? Surely the cartel has at least SOME effect, otherwise why even buy stationery?

Any papers out there that look at historical prices for oil, and possible correlations to the U.S. election cycle? One might, cynically, expect rising oil prices before an election designed to drive a popular incumbent Dem. from office, and falling prices before an election to rescue an embattled incumbent Repub.

Posted by: Ferdinand | Apr 14, 2005 12:58:19 PM

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