OPEC Is Collapsing, With Oil Prices Right Behind

While you and I prepare to enjoy our turkeys, OPEC officials will be in Vienna pretending to control oil prices. The truth is that the global oil cartel’s best days are behind it. Larger forces are rendering OPEC powerless.

OPEC, as an organization, is falling apart for the same reason many organizations do: greed.

Each member state naturally acts in its own best interest. This was fine for decades because their self-interests weren’t too different. Each member wanted to sell all the oil it produced at the highest possible price.

What’s different now? OPEC is seeing the other side of its own success. Surging Chinese demand drove oil prices sharply higher over the last ten years. This fattened OPEC’s profit margin, but also created new competition. High oil prices effectively financed three new energy sources.

First, unconventional production methods that were previously too expensive unlocked massive shale oil deposits in the U.S. and Canada. If crude oil had never gone above $60, North Dakota would still be a wasteland instead of a booming oil field.

Second, oil prices over $100 gave multinational oil producers incentive to explore previously inaccessible offshore and Arctic energy deposits. The sanctions on Russia shut down some of this activity, for now, but much of the development work is finished. Even if production never starts, the mere presence of these reserves serves to cap oil prices.

Third, alternative energy technology leaped forward in the last five years. Concerns over climate change and price pressures made solar, wind, and other “clean” energy sources practical and cost-effective in many places. The same forces that hurt utility companies are hurting OPEC, too.

Those three factors, along with a rapidly strengthening U.S. dollar, set up this year’s oil price collapse. The mid-year trigger was lower demand from the same buyer who drove prices higher: China. Last week, the People’s Bank of China (their version of the Federal Reserve) cut key interest rates in an attempt to prop up growth. This was PBOC’s first such action since 2012.

China is going through more than a simple slowdown. Measured by GDP, they are still growing at a rapid pace, but the nature of the growth is changing. Instead of energy-intensive infrastructure construction, economic activity is shifting to the technology, financial and consumer sectors. These industries don’t need mass quantities of raw material.

So what will OPEC do? Iran wants to cut production quotas by a million barrels a day. Think about what this means. To accomplish this goal at $75 per barrel, some combination of OPEC members need to reduce their own income by $75 million per day – or $27.4 billion per year. That’s big money.

Such a cut might still make long-term sense if it drives prices up enough to offset the lower production. That assumes the cuts would actually happen. In practice, OPEC has little ability to police cheating by its members. Venezuela, Iran and others desperately need cash. If they see a chance to sell oil above their quotas, they will grab it.

Saudi Arabia knows this, which is why I expect them to resist production cuts. Their goal is to defend their market share, and the only way to do it is by keeping prices low for an extended period – probably years.

This will be very bad for U.S. shale producers, clean energy technologies, and high-cost producers around the globe. The Saudi’s don’t care… and that attitude will mean the end of OPEC as a price-setting cartel. The only drama will be in the particular course of its collapse.

OPEC is doomed. I’d like to say this means we can expect “cheap” gas again, but that may be too much to ask. Nevertheless, I don’t see crude oil going sharply higher from here, no matter what OPEC does from here.

If you like where energy prices are right now, go ahead and get used to it. I think they will be here for a long time.