Current low oil prices are largely OPEC's own fault

By Gwynne Dyer

LONDON (JP): "We are overproducing, yes. But I have contacted everybody and I hope we will have cooperation."

This time, the man giving the sound-bite was Abdullah Salem al-Badri, president of the Organization of Petroleum Exporting Countries (OPEC) and Oil Minister of Libya. Every OPEC president since the late 1970s has voiced the same hope that the cartel might finally show some discipline. They have all been disappointed.

That is why crude oil prices, in real terms, are now lower than they were before the 1973 Middle East war that sent them soaring into the stratosphere. They have fallen by almost 30 percent since January -- benchmark Brent crude oil now sells for just over US$18 a barrel -- and there is little chance that the OPEC meeting in Vienna next month will turn the price decline around.

But geology and economics will turn it around, and soon, too. In the current issue of Nature, the respected British science journal, American geologist Craig Bond Hatfield concludes that "the world will probably reach its maximum oil production in the next 15 years." Prices should begin rising steeply well before that.

Hatfield, a professor at the University of Toledo, calculates that even if global oil consumption remained steady, worldwide oil production would go into absolute decline by 2036. But the current surge of economic growth in industrializing Third World countries means their oil consumption is rising fast, so the remaining oil gets depleted much more quickly. The date when total production starts to fall moves up to 2011, only 14 years from now.

That's not when the world runs out of oil entirely, mind you. That date is probably more than a century ahead (though the time when the remaining oil is too valuable as a chemical feestock for any of it to be burned for fuel is probably much nearer than that). But 2011 is the date when commercial oil production, after rising steadily for 140 years, peaks, stalls, and starts back down.

The writing is already on the wall, for those who can read. Since 1985, each year's newly discovered oil reserves all around the world have amounted to only about 40 percent of that year's global oil consumption. So why are prices low and still falling? Because 'the market' is a stupid, short-sighted beast.

The market is very good at panicking in response to this morning's rumours. It is moderately good at guessing next month's prices. But it regards six-month futures as long-term, and five years ahead as a geological time-span.

Individual traders may be aware of what is going to happen to oil supplies in the relatively near future, but this knowledge has not yet affected the mob psychology of the market as a whole. So oil prices are historically low -- and given the nature of OPEC, poor Abdullah al-Badri cannot get them back up no matter how much he exhorts the members to practice self-discipline.

Looking for self-discipline from OPEC's members is like trying to get Coke from a cow. The cartel's collective interests are best served if everybody limits production to keep prices up -- but each individual member's interest is best served by raising production and increasing market share.

In a sense, the current low prices are largely OPEC's own fault. OPEC members produce much less than half of the world's oil: 27 million barrels per day out of a global total of 69 million bpd this year. But the cartel accounts for the great bulk of the oil that is traded internationally, and only the OPEC countries can raise and lower their production at will.

"In 1985, global oil production was 59.7 million barrels per day," Hatfield wrote in the Nature article. "By 1995 it was more than 69 billion bpd." OPEC members accounted for almost all of the extra production, since the industrialized countries that have major oil reserves -- Russia, the U.S., Britain, Canada -- are already producing close to the limit of their capacity.

Yet OPEC's total revenues actually dropped in 1985-1995, because almost every member cheated on its quota to make more money. Supply was usually a couple of million barrels per day ahead of demand, and price drifted steadily downward.

Indeed, if a UN embargo had not excluded Iraq's large oil production from the world market for the past five years, prices would be even lower than they are. And now Iraq is gradually returning to the market.

OPEC doesn't work very well because cartels rarely do. But within five years, the coming decline in oil production will have moved from the realm of specialist articles in scientific journals to mainstream common knowledge. And then, even before demand actually outruns supply, oil prices will really start to move up.

How high? Who knows? But an excess of just a couple of million barrels a day in the market has made the price per barrel tumble to historic lows. Would a shortage of a couple of million barrels, or even the certain knowledge of a coming shortfall, double the price?

Triple it? Around 2002-2003, we are going to find out.

We will find out a number of other things at the same time. We will learn to what extent the current high rate of economic growth in so many Third World countries depends on low energy costs.

We will discover if the world's banking system is any better prepared to handle a new flood of 'petrodollars' than it was in the 1970s, when its crude 'recycling' efforts (making huge loans to any country with a fixed address, just to get the money out the door again) were directly responsible for the debt crisis of the 1980s.

And we will find out if 'geopolitics' is really more than a bunch of underemployed strategists looking for fat consultancy fees. They talk as though 'strategic regions' (i.e. oil-producing areas) are pawns in some great-power game, not independent countries entitled to charge the going market rate for their products. They even hint that too high a price might be brought down by military force, if you have enough of it.

Personally, I think they are stuck in a 19th-century time- warp. Military force was not applied to oil prices even back in the 1970s, when the world was a much more militant and militarized place.

But we shall see.