Will The OPEC Cartel Break Up?

Because the OPEC cartel provides about 40% of the world’s crude oil, it has been able to control the crude oil price.  Its members meet and set the amount of crude they will produce for sale opposite the forecast world demand.  They can reduce or increase production to raise or lower prices. Other major crude producers outside of OPEC have been able to sell all their crude oil but acting independently are unable to displace OPEC’s role as the selling price arbiter.   As you would expect, OPEC wants the price to be high but recognizes that if they set it too high, demand will drop and competitors will be encouraged to prospect for more crude.   Within OPEC, the members have their own issues that make setting the production levels and thus the price, not easy.  However, Saudi Arabia, currently the world’s largest producer of  crude oil,  is said to be the primary voice in this process.  When the OPEC members meet, as they did on May 31^st, to set the production level/price, one big factor was how much of their government’s budget is derived from the oil revenues.  And what is the price of crude oil that makes that budget whole? The graph below, from the American Interest’s posting “OPEC Sweats: How Low Can Oil Prices Go?” illustrates the price needed to balance their government’s budget:

The posting describes the graph as follows:

“In this graph are contained the hopes and fears of the world’s petro-states. That black line represents the Brent price for a barrel of crude oil, a benchmark used for European, African, and Middle Eastern oil. Countries whose fiscal breakeven oil price—the price at which oil needs to be in order for the country to balance its budget—exceeds that black line are projected to run budget deficits this year. Countries coming in under the black line would run a surplus if oil prices hold steady. So the hope is that that line stays above one’s breakeven price, but the very real fear is that it will dip down below.”

Some of the OPEC nation’s economies are just about “one trick ponies”.  The CIA World Fact Book reports that Algeria (60%), Bahrain (70%), Iraq (90%), Kuwait (95%), Libya(99%) and Qatar (70%)  get most of the money into their treasuries from crude oil sales.   The trickle down of the crude oil money to their citizens in many of the countries has become more of a stream since the beginning of the “Arab Spring”.  This results in the need for more crude oil revenue.   Iran is experiencing UN sanctions which are complicating the nation.  Venezuela, an OPEC member from South America is having serious economic woes and is worrying about any lowering of the crude selling price.  In December 2012, this site posted “Russia’s Federal Budget Depends On High Price Crude Sales”. In that posting it was noted that to balance Russia’s budget a crude prices of $114 and $106 dollars per barrel were needed in 2013 and 2014 respectively.

The biggest threat to OPEC is fracking.  The US is on its way to becoming the largest crude oil producing nation in the world, according to a number of studies.  Some say by 2020 and other say 2030.  The US crude output reached 7.29 million barrels per day at the end of May which was the most since February 1992.  This additional capacity plus that of other countries with eyes on fracking,  China, Poland, England, to name a few, could make supplies of crude oil large enough to require large cuts by OPEC that would be untenable for many of their members, considering their need to finance their government by selling crude oil.

There is another internal divide with in OPEC.  The American Interest posting explains it thus:

“That’s because US shale oil is pitting African members against Arab members. The new American oil bounty is of the light, sweet crude variety. It’s higher quality than the heavy crude produced by Gulf OPEC members. But countries like Nigeria, Algeria, and Angola have typically exported sweet crude to the US, and the shale boom is hitting them hardest. Exports from those African members dropped 41 percent from 2011 to 2012.”

The May 31 OPEC meeting left production quotas essentially unchanged.  They also indicated that they would commission a study on the effect of shale oil on global markets for OPEC crude.  The next meeting will take place December 4, 2013.

The world’s economy is still in the tank.  China’s economy is beginning to slump  and they are reducing the amount of crude purchased.  Cartels typically do not have infinite lives.  Is OPEC’s command of the world’s oil price finally coming to an end?

According to Wiki :

” Empirical studies of 20th century cartels have determined that the mean duration of discovered cartels is from 5 to 8 years. However, one private cartel operated peacefully for 134 years before disbanding. “

“Game theory suggests that cartels are inherently unstable, as the behaviour of members of a cartel is an example of a prisoner’s dilemma. Each member of a cartel would be able to make more profit by breaking the agreement (producing a greater quantity or selling at a lower price than that agreed) than it could make by abiding by it. However, if all members break the agreement, all will be worse off.”

OPEC has exceeded the 5 to 8 year mean life but the members do cheat.  Not enough to cause OPEC break up because Saudi usually tries to back off some of their production to keep in balance.  But, the factors of increased fracked oil supplies and the need to keep peace within their countries by share more of the money may yet make cheating inevitable.

cbdakota