Will OPEC Survive?

Mar 06, 2015

The Organization of Petroleum Exporting Countries (OPEC) has a 65-year history of striving to manage world oil supplies in such way as to achieve price targets.

2015 03 06 OPEC Oil Graphic

Founded in 1960, OPEC has long been comprised of many of the world’s largest oil-producing nations, based mainly in the Middle East, but also including Libya, Algeria, Nigeria, Angola and Venezuela.

Saudi Arabia, though, is the dominant partner and it has almost always worked in cooperation with the others to the benefit of the group as a whole.

No more. Over the past eight months, Saudi Arabia has veered onto its own separate path. Whether this has been due to geopolitics (i.e., to punish Iran and Russia) or it’s a measure to strike down the competition (i.e., to discourage, in whack-a-mole style, investment in U.S. hydraulic fracturing) continues to be a source of speculation.

Whatever the reason, the Saudi royal family has depressed the global price of oil by providing a supply glut. An ultra-cheap cost of production and vast reserves of cash are allowing their country to weather the economic storm. Many other OPEC members – especially Iraq, Iran, Libya, Nigeria and Venezuela − are far less fortunate.   

The current President of OPEC, and Nigeria’s Petroleum Minister, Diezani Alison-Madueke, has suggested the need for an emergency meeting of the cartel to address the damage being done by crude’s price drop.

Saudi Arabia’s journey of solitude isn’t occurring in a vacuum. The fissures developing in OPEC on economic grounds are coincident with the fractures that have been occurring along religious lines.

The Sunni-Shia polarity, represented most emphatically by Saudi Arabia and Iran, is being spun off its axis by the rapid and unforeseen emergence of the fundamentalist and terrifying Islamic State, along with its international affiliates.

Internecine Islamic conflicts have brought Middle-Eastern OPEC-member Iraq and non-OPEC nations Syria and Yemen to the brink of political chaos.

ISIS-linked forces in Libya and Nigeria (e.g., Boko Haram) are threatening the same in those two countries.

Furthermore, with the exception of Saudi Arabia, oil production by individual OPEC members no longer stacks up to the same extent as in the past versus other major producers.

About even with Saudi Arabia for output are the U.S. and Russia. Next in line are China and Canada. Mexico also appears in the Top 10.

There would seem to be validity in wondering whether or not OPEC will continue to survive.

Probably not much will happen right away. Let me provide an example of the dynamic that may unfold. There was a time when I was younger I used to belong to a social and sports club. Long after I stopped attending events, I still sent in a check every time I was approached for my annual membership fee.

I’d justify it by thinking, “Hey, you never know. Maybe one day I’ll get back into the swing of things.” Plus I understood that if I ever wanted to re-enter after leaving, I’d be faced with a certain degree of hassle and extra financial cost.”

I’m guessing this is why a lot of people retain their health club memberships past their stale dates. As I think back on events, though, what mainly guided my response was inertia. Once I did finally sign out, and stopped paying my ‘tuition’, I wondered what had taken me so long.  

Since the Great Recession, there has been much speculation about the possible break-up of the Euro Zone. Maybe some of that curiosity will begin to spill over into doubts about OPEC.

Speaking of the Euro zone, a number of years ago I wrote several articles on the advantages of the U.S. and Canada adopting a common currency.

That was when the value of the Canadian dollar climbed 7% above parity with the greenback and appeared set to soar even higher.

What stopped the exchange rate advance? The Great Recession, of course. The world-wide surge in demand for commodities, during which Canada particularly benefitted from China’s ‘thirst’, wilted.

On the surface of it, the problems Euro-members have been experiencing keeping their common currency afloat seem to have negated any arguments for currency union.  

But is that really true? For all the naysaying, no country has yet left the Euro. Even the new leaders of Greece say that’s a route they don’t want to travel. The benefits of being in the Euro zone are too numerous.

(There may yet be a Greek exit or ‘Grexit’, but many of the Euro’s pre-credit-crisis failings have been identified and tackled, especially the reining in of public sector spending in order to reduce debt. These are helping the region forge better long-term prospects.)

Canada’s central bank is counting on a drop in the value of the loonie (i.e., the nation’s one-dollar coin) to lift the domestic economy. This will be achieved through exporting more manufactured goods.

But Canadian manufacturing capacity has shrunk over the past decade-plus, partly because the value of the loonie once soared past the greenback. The large investments required to re-gain production strength in steelmaking, auto-making and even the processing of breakfast cereal (e.g., Kellogg’s just shut down a 75-year old plant in London, Ontario) won’t be easy to win.  

Had currency parity been in place over the past ten to fifteen years, it would have provided a more stable environment in which to make investment decisions.

With the loonie at 80 cents to the U.S. dollar, consumers in Canada will soon be bitterly complaining again about the enormous price premiums they’ll be paying versus the same goods sold south of the border.

There’s a simple difficult-to-swallow way to express this state of affairs. It’s called losing one’s standard of living.

A U.S.-Canadian dollar union? It’s at least important to ask the big questions.

I’m not trying to flog a dead horse, nor even revive one that’s comatose.

What I am wondering, though, is why this beast has been carted off to the burial grounds without a further examination? 

Commodity price indices
Commodity price indices
Based on actual prices in U.S. dollars.
Data source: Data source: Bank of Canada.
Chart: CMD.
Energy commodities price index
Energy commodities price index
The energy commodities price index includes oil, natural gas and coal.
Based on actual prices in U.S. dollars.
Data source: Data source: Bank of Canada.
Chart: CMD.

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