Currency Chatter Member Discussion Part 1
Brule WORLD ECONOMIC FORUM
What’s the future of OPEC? By Elias Hinckley
Saudi Arabia’s decision not to cut oil production, despite crashing prices, marks the beginning of an incredibly important change.
There are near-term and obvious implications for oil markets and global economies. More important is the acknowledgement, demonstrated by the action of world’s most important oil producer, of the beginning of the end of the most prosperous period in human history – the age of oil.
In 2000, Sheikh Yamani, former oil minister of Saudi Arabia, gave an interview in which he said:
“Thirty years from now there will be a huge amount of oil – and no buyers. Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.”
Fourteen years later, while Americans were eating or sleeping off their Thanksgiving meals, the twelve members of the Organization of the Petroleum Exporting Countries (OPEC) failed to reach an agreement to cut production below the 30 million barrel per day target that was set in 2011.
This followed strenuous lobbying efforts by some of largest oil producing non-OPEC nations in the weeks leading up to the meeting. This group even went so far as to make the highly unusual offer of agreeing to their own production cuts.
The ramifications of this decision across the globe, not just in energy markets, but politically, are already having consequences for the global landscape.
Lost in the effort to understand the vast implications is an even more important signal sent by Saudi Arabia, the owner of more than 16% of the world’s proved oil reserves, about its view of the future of fossil fuels.
Since its formal creation in 1960 the members of OPEC, and specifically Saudi Arabia (and in reality the Kingdom’s control over global oil markets is much larger than that 16% of reserves implies as its more than 260 billion barrels are among the easiest and cheapest to extract and before enhanced recovery techniques accounted for a much larger share of global reserves) have used excess oil production capacity to influence crude prices.
The primary role of OPEC has been to support price stability.
There are notable exceptions – like the 1973-1974 oil embargo and a period of excess supply that undermined prices and crippled the Soviet Union in the 1980s (though whether this was a defined strategy or serendipity remains in some question), but at its core the role of OPEC has been to control oil prices.
As recent events show, OPEC’s role as the controller of crude oil pricing is coming to an abrupt end.
In acting as global swing producer, OPEC relied has heavily on Saudi Arabia, which can influence global prices by increasing or decreasing production to expand or reduce available global supply.
Saudi Arabia can do this not only because it controls an enormous portion of global reserves and production capacity, but does so with crude oil that is stunningly inexpensive to produce compared to the current global market.
A change, however, has occurred in Saudi Arabia’s fundamental strategic approach to the global oil market. And this new approach – to refuse to curtail production to support global prices – not only undermines OPECs pricing power, but also removes a vital subsidy for global oil producers provided by the Saudi’s longtime commitment to price support.
The widely held conventional theory is that the Saudis want to shake the weak production out of the market. This strategy would undermine the economic viability of a meaningful amount of global production.
The theory assumes that this can be done in some kind of orderly bring-down of prices where the Saudis can find an ideal price below the production cost of this marginal oil production but still high enough to maintain significant profits for the Kingdom while this market correction plays out.
The assumption is that following the correction there will be a return to business as usual along with higher prices, but with Saudi Arabia commanding a relatively larger share of that market.
An alternative rationale is that Saudi Arabia is fighting an economic war with oil; a strategy designed to economically and in turn politically cripple rival producers Iran and Russia because the governments of these countries that depend on oil exports cannot withstand sustained low prices and will be significantly weakened.
While there may be some truth to both of these theories, the real motivation lies somewhere closer to Sheikh Yamani’s 2000 prediction. Saudi Arabia has embarked on an absolute quest for dominant market share in the global oil market.
The near-term cost of grabbing that market share is immense, with the Saudis sacrificing potentially hundreds of billions of dollars if low prices persist.
In a world of endless consumption, this risk would be hard to justify merely in exchange for a temporary expansion of global market share – the current lost revenue would take years to recover with a marginally higher share of global supply.
But in a world where a producer sees the end of its market on the horizon, then every barrel sold at a profit is more valuable than a barrel that will never be sold.
Current Saudi oil minister Ali al-Naimi had this to say about production cuts in late December: “it is not in the interest of OPEC to cut their production whatever the price is,” adding that even if prices fell to $20 “it is irrelevant.”
Implied, if not explicitly stated, is that Saudi Arabia wants its oil out of the ground, regardless of how thin its profit margin per barrel becomes.
Saudi Arabia is seeing a new and massively changing energy landscape. The U.S. and China have agreed to bilateral carbon reduction targets. 2014 is now officially the hottest year recorded in human history, a record set almost impossibly without the presence of El Nino.
And on January 7 a report released in Nature lays bare the fossil fuel climate change equation by concluding that to achieve anything better than a 50/50 shot at keeping global warming under 2 degrees centigrade (the most widely accepted threshold for avoiding catastrophic climate change) 82% of fossil reserves must remain in the ground.
That report puts hard numbers on the percentages of fossil fuels that must “stay in the ground” and calls for 38% of proven Mideast oil reserves to never to be pumped from the ground. That 38% represents some 260 billion barrels of oil – worth tens of trillions of dollars – much of that not held in Saudi reserves.
All of these threats to oil use are occurring against a backdrop where the acceleration of costs-effective alternative technologies expands the potential of viable alternatives to our current fossil fuel-based energy economy.
Yamani’s prediction no longer seems a fantasy where no one outside of science fiction writers could envision an alternative to the age of oil, but rather a stunningly prescient analysis of the future risk to the value the largest oil reserve on the planet by a man who once managed that reserve.
Saudi Arabia no longer needs OPEC. Global action on carbon dioxide emissions is gaining global acceptance and technological advances are creating foreseeable and viable alternatives to the world’s oil dependence.
Saudi Arabia has come to the stark realization, as Yamani foretold, that it is a race to produce, regardless of price, so that it will not be leaving its oil in the ground.
The Kingdom has effectively open the valve on the carbon asset bubble and jumped to be the first to start the race to the end of the age of hydrocarbons by playing its one great advantage – a cost of production so low that it can sell its crude faster and hoping not to find itself at the end of the age of oil holding vast worthless unburnable reserves.
The end of the age of oil, of course, remains many years off (and almost certainly well beyond Yamani’s timeline of 2030), but to Saudi Arabia, that end is clearly not so far away that the owner of the largest, most accessible crude resource is willing to continue to subsidize higher prices for other producers at the risk of leaving its own oil untapped one day in the future.
Much has been made of the catastrophic economic consequences to Russia, Iran, Venezuela and other oil exporting nations caused by these low oil prices, as well as, the profound damage to their economies and impending political turmoil.
Meanwhile in the U.S., there has been endless analysis of the impact (or lack of impact) on the nation’s resurgent oil production and speculation about the price at which U.S. production will begin to decline.
Less well documented is the impact on access to capital for drilling operations (and given the disastrous economics of North American coal, perhaps fossil fuel extraction broadly).
Drilling for oil requires huge amounts of capital with a significant appetite for risk, as both production uncertainty and market volatility can undermine the value of investments. In the current production boom, market volatility was wildly underpriced.
When combined with pent up appetite for yield due to persistently low interest rates, capital, including tremendous amounts of high-yield debt, has flooded into oil companies.
As low crude prices persist there will be substantial losses by investors. This will cause volatility in crude oil markets to be re-priced, and access to low cost capital will disappear for all but a select group of oil production investments.
OPEC will continue to meet and hold itself out as a cartel that can control the oil markets, but that time has passed.
The cartel was dependent upon Saudi Arabia to use its outsized swing position to control spare capacity in the market. With the Saudis no longer interested in that role, the influence of the cartel is gone.
It would be no surprise at all to see Saudi Arabia actually increase production (though how much additional output is readily available is unclear) as prices stabilize and begin to climb later this year because excess capacity will be shed from the market and global economic growth will accelerate.
The direct oil markets impact and the geopolitical fallout will likely be the defining headlines of 2015, but there is a much much bigger story unfolding: the carbon asset bubble is deflating.
The value of effectively every asset class on Earth is influenced by the assumption that a fossil fuel-based economy will persist for so long that any potential for future change to asset values can be ignored.
That assumption is wrong. The global industrial economy operates on an assumption of available and relatively inexpensive energy, either in the form of electricity or liquid fuels.
If the form, availability of, or cost of, those energy sources changes it will fundamentally change the cost to use and produce virtually every other asset on Earth. And that will necessarily change the value of every one of those assets.
There will be both positive and negative impacts, and understanding this change, in both scope and speed, will provide insight on one of the largest wealth shifts ever experienced.
The owner of the most valuable fossil fuel reserve on Earth just started discounting for a future without fossil fuels. While they would never state this reasoning publicly, their actions speak on their behalf. And that changes everything.
This article is published in collaboration with The Energy Collective. Publication does not imply endorsement of views by the World Economic Forum.
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Author: Elias Hinckley is a strategic advisor on energy finance and energy policy to investors, energy companies and governments.
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Kimberley Thanks Brule,....It's interesting that he says he is a "strategic advisor to investors, energy companies and governments"
If that's true, he pulls a lot of weight......advisor to energy companies and GOVERNMENTS,.... thats pretty Huge..... HMMMMM
Mike Good stuff, Brule, thanks. As a kid growing up in the 70's, this is great news, OPEC has lost it's power. And here's Iraq, 95% dependent on the sale of oil to pay for everything in their country.
"The ramifications of this decision across the globe, not just in energy markets, but politically, are already having consequences for the global landscape."
Almost all the member nations of OPEC now have budgets that are underwater. It's not just Iraq that's going to feel the pinch, all but maybe the Kuwaiti's and Saudi's are going to face very difficult times beginning in 2015.
Heck, look at what it's done to Russia, I read an article this morning talking about how rapidly the ruble has depreciated against the dollar. It sounds like Abadi realizes this and wants to take Iraq into the future with a diverse economic plan that's outside the oil markets. Here's hoping.
Wiz The other Elephant in the room that this article doesnt address is the other half of the OPEC deal -- the Petro dollar that previously forced all transactions to take place in USD -- the Saudi's have to compete with the rest of the BRIC's and world that is systematically unhinging from the Petro dollar and dealing direct - country to country in whatever currency they so choose -- and as they should.....
So While the rest of the world is working on real economic deals commodities and otherwise and country to country the golfer-in-chief is race-baiting and spewing the global warming agenda ... and more worried about supporting the petro dollar agenda and the Saudi's than our oh-so dangerous Canadians neighbors and Keystone XL.
Kinda funny that the one thing that the Govt has fought the most -- Fracking has done more than any economic policy or stimulous or any decision that has been done to actually have a economic benefit to the US economy that low oil prices now have done.
Sure would be nice to have adults running our country someday. Peace-- WIZ
Brule Abadi will be attending the World Economic Forum in Davos, January 21-25. Even in economic hard times, that will be money well spent to be able to spend time with the world's economic most powerful, like quality time with a rich uncle you would like to get to know better.
What hit me the hardest, and in a good way, is that even the Saudis realize that oil is not the future, and it is apparent to most that oil is going the way of the fax machine.
Thanks Kimberley and Mike. After 60 reads and not even a comment, I thought no one was understanding and grasping the gravity of this author's well-positioned opinion. But you two are too smart! :)
Diana Peace-- WIZ Thank you Wiz for the real take on things.
Brule Wiz, you are so funny! You crack me up. You know the rest of the world gets the climate crisis. The Saudis get it, the Chinese get it, all of Europe gets it, and Brazil is replanting the rain forests. You are so funny!!! :)
Mike I had to read it twice before it sunk in, Kimberly's the smart one :) That's good news about Abadi in Davos, hopefully a ton of it rubs off and he comes back with his hair on fire to open up the economy.
Mally If we really are in price slump that will never bounce back to where it was a couple years ago then why is anyone still working at prodcuing oil from shale oil. Doesnt that cost around 80 bucks a barrel to produce? I thought I had read that.
Kimberley I think it's Great news about Abadi going to Davos,...and coincidently another slap in the face of Maliki...
Davos is by invitation only..... The last 2 years it was Barzanni who was invited, and now Abadi....that is such good confirmation for the Abadi government on a world wide scale....
mekim6 Just because the rest of the world gets the so called "climate crisis" doesn't make it correct. Been debunked already, yet the libs still push it along with the rest of their BS. Getting pretty tired of it myself.
Kimberly mally....I've read numbers simular numbers to yours, at $75 a barrel. I also heard where those little boom towns of the last couple of years, are all but bust...... I beleive they continued for a while, with a fairly new technology, to get the costs down...
But I read companies were shutting down,..and people were loosing their homes....
Dinarblowyourhorn Wkipedia Break-even price of oil Real and Nominal Oil Prices, 1980-2008
The various attempts to develop oil shale deposits have succeeded only when the cost of shale-oil production in a given region comes in below the price of crude oil or its other substitutes (break-even price). The United States Department of Energy estimates that the ex-situ processing would be economic at sustained average world oil prices above US$$54 per barrel and in-situ processing would be economic at prices above $35 per barrel.
These estimates assume a return rate of 15%. The International Energy Agency estimates, based on the various pilot projects, that investment and operating costs would be similar to those of Canadian oil sands, that means would be economic at prices above $60 per barrel at current costs.
This figure does not account carbon pricing, which will add additional cost. According to the New Policies Scenario introduced in its World Energy Outlook 2010, a price of $50 per tonne of emitted CO
2, expected by 2035, will add additional $7.50 per barrel cost of shale oil.
Dinarblowyourhorn goes on to say as high as 95 per barrel and as low as 25... hmmm
Fred One small detail left out of the "crude is going away" argument. What will we drive around in??? THERE ARE NO COST EFFECTIVE ALTERNATIVES to the internal combustion engine running on gasoline or diesel.
Our latest gasoline engines are very efficient and very clean. BTW, they have been trying to come up with an alternative for almost 50 years. Electric won't cut it. Heavy batteries, slow refill, very limited range, high cost of producing the electicity, VERY natsy disposal of constantly failing batteries. CNG maybe, but everyone wants to argue that it is clean burning and good for the engine. Wrong.
Engines won't last as long. CNG is cheap now but before anyone can afford to produce it the price will need to go way up. I could go on but you get the jest.
After 50 years we have no cost effective alternative and gasoline just dropped in price over 1.00/gal. Besides all the hundreds of other products we get from crude oil.... its here to stay.
Lots of folks will be tempted to beat me up with all kinds of pie in the sky. If there is a cost effective alternative, bring it. Not some "one day soon we will" or "as soon as they", type deal.
Are you aware that it takes more energy to create a gallon of ethanol than you get from it? There are lots of hopes and dreams out there, but that is all they are.
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