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OPEC in a Fog

We call OPEC a cartel, but if it really had control over prices, how could it let them swing so wildly?

The answer is that even a cartel has to deal with market forces. With prices down about two-thirds from their July peak, OPEC has called an emergency meeting tomorrow to hash out a plan to stop the slide.

OPEC does pursue policies that raise the world price of oil - most notably by restricting access to the world's lowest-cost oil and gas fields. But over a period of time, even a cartel has to deal with the realities of supply and demand. If it jacks up prices too high, people cut their use or find alternatives. In the well-worn phrase of former Saudi oil minister Zaki Yamani, the Stone Age didn't end because the world ran out of stones. Then again, the Stone Age had a pretty good run.

It isn't easy for a cartel to figure out the price at which it's doing more harm to its interests than good. In his book "Genie Out of the Bottle; World Oil Since 1970," the famous Massachusetts Institute of Technology economics professor M.A. Adelman wrote that, "Like soldiers peering into the fog of war, sellers do their best with what information they have. Even before a situation has worked itself out, it is already changing."

He said that to describe OPEC around 1970. But it seems like a good description of the organization going into tomorrow's meeting. OPEC is trying to figure out how much production it needs to close off in order to bolster prices. But its information about world demand, world economic growth, and the response of non-OPEC countries to falling or rising prices is imperfect.

In October, OPEC cut its oil output by 1.5 million barrels a day. That seemed like enough to do the trick. But then the world economy continued to collapse, and so did oil prices. Tomorrow OPEC will try to take around 2 million barrels a day off the world market. Maybe that will work. Maybe it won't.

It's easy to imagine either outcome, successful or unsuccessful.

In the first scenario, OPEC's new production cut deal works. Gradually the size of world inventories, which have grown to 57 days' supply, return to a more normal level of 52 days and prices stabilize. This is basically what happened in the winter of 2006-2007, when oil prices that had been over $75 in mid-2006 tumbled down to around $50 a barrel. OPEC cut production, then cut production again; then prices stabilized and began to climb (and climb, and climb).

There's another scenario, though. In this one, the world economy stays weak. OPEC sticks to its lower production target, but prices stay low. How could this happen? One theory about international oil prices suggests that the price is more sensitive to the amount of excess production capacity rather than to the amount of oil in inventory. In this theory, the excess production capacity acts a bit like inventory in the ground (as opposed to in tank farms or floating tankers). Earlier this year, the world's capacity to produce oil fell to less than 2 million barrels a day, virtually all of it in Saudi Arabia. But new OPEC cuts could bring the world's idle oil production capacity to 4 million to 5 million barrels a day.

Recently Saudi King Abdullah, who is used to issuing edicts, said that the price of oil should be $75 a barrel. But this is an area where issuing an edict may not be enough.

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Comments (22)

tropicalfolk Author Profile Page:

Of course, the price of oil is NOT driven by supply and demand, but by speculation. The record peak this summer was the work of the same crooks who had previously led the world into the subprime bubble: Goldman Sachs, Merrill Lynch, Citigroup (controlled by Saudis), and the like. When oil was around $100, those wizards announced it would be $200 by December 2008. So, everybody with cash ran to buy oil futures.

George Soros wrote extensively about the role of speculation on oil prices. Paul Krugman -a man with many fans but little substance- denied Soros' claims as "unfounded rumors".

Soros testified before the US Congress, as several agencies began investigating such claims. They found lots of problems, including international networks conspiring to manipulate oil prices. Speculators ran for the exits. The price of oil fell like a rock.

Then the world's economy collapsed ==> Demand actually fell ==> Prices keep falling

So, what does the OPEC meeting mean? Not much. Let's say they agree to cut production by a large amount, and inventories go back to normal. So what?

1. Financial powerhouses are not financing oil speculation anymore.
2. Investors are scared to death of risking their cash on such an uncertain bet as oil.
3. The world is in recession: actual demand won't go up in the foreseeable future.

Landknelson Author Profile Page:

Europe Awash in Alternatives.

Unfortunately Technology and Infrasturcture take time and capital. Still

The largest solar engergy company is in Germany. It is now by some measures the largest solar energy company in Arizona, in Tucson.

A large European windmill / electric generation maker has annouced and I beleive is builing a factory in Iowa so it it will be close to the wind coridor on the Great Plains.

Maybe the alternatives are coming - subject of course to supply and demand pricing and public works and other subsidies. And many are European.

FUZZYTRUTHSEEKER Author Profile Page:

Hey, Steve!

Want some self-satisfying delusion?

Be my guest.

But when you write " OPEC is trying to figure out how much production it needs to close off in order to bolster prices. But its information about world demand, world economic growth, and the response of non-OPEC countries to falling or rising prices is imperfect", you give more knowledgeable people the impression that you have never heard of IKE -- imperfect knowledge economics.

Don't advertise your ignorance to widely.

edbyronadams Author Profile Page:

The largest US oil company, ExxonMobil, is 14th in the world. The holders of the petroleum deposits, not US corporations, call the shots. The only thing that curbs them is the market, which right now says the current cutback in production isn't going to help.

Comparing the US to Europe is foolish in many ways. We simply do not have the density that Europe has that makes rail sensible.

SWadvocate Author Profile Page:

It is time for the USA to get serious about alternate energy strategies and develop a plan to deal with the fact that dependence on foreign oil is: a) a national security issue by causing dependence on unstable regimes and nations, plus major military outlays to protect these "allies" with whom we have a purported "special relationship"; and b) an economic drain of epic proportions (we are sending about $500 - $700 BILLION of our national wealth overseas each year meet our voracious need for oil).

Hopefully, President-elect Obama will be true to his promises to make alternative fuel and "green jobs" a centerpiece of his priorities.

America has the ability to migrate away from its dependence on oil. The government should take the lead in spurring this development and the marketplace will follow.

SeaTigr Author Profile Page:

-If taxing up oil prices led to more alternatives then Europe with their high oil tax for decades should be awash in alternatives...-

How about:
better public transportation systems
better rail system
cars with better gas mileage, on average

Other benefits:
less sprawl
fewer cars (or, at least, more people in a car on average)

When I lived in London, I could take the Tube or a bus anywhere I wanted to go within the city - assuming it wasn't close enough to walk. When I went to Spain, I took the Tube to one station, a train to the Chunnel, can't remember if that train went through the Chunnel or if I had to transfer, then on to Paris, and another train to Madrid. Total travel time? About 24 hours. Could I have flown? Yes, but it was more expensive. Taking the train, I got to see a lot of beautiful countryside, so there was a plus side too such a lengthy trip.

julie16 Author Profile Page:

Nationalize energy-including oil price regulation
for the people of the US. Why should Exxon et
al reap windfall profits when the rest of the country sinks? No not socialism. We CAN keep
a free market in most areas. Let's protect ourselves and our country when it comes to health care and energy. Trusting others NOT to be greedy at our expense is silly.

pace_coor Author Profile Page:

I am trying to figure out where our oil companies (Exxon & Chevon) are positioned in OPEC. Their names are never mentioned even though they probably run OPEC. I am still trying to see why they are in an organization with rough countries that are against the U.S. Irans economy is in free fall without high oil prices. Should we give them higher oil prices to help build the bomb. Who do our oil companies represent themselves or the U.S.All these rough countries will not negotiate if oil goes to 75+ a barrel.

theobserver4 Author Profile Page:

movette Author Profile Page:

None of this makes sense! Its impossible to believe that in a matter of 2 months all the world is conserving so much oil that the supply leaps to excess, and the price drops 75%!
The entire system is being manipulated! Who is doing it I dont know. But I hope they can find a market for sand.
We have been lied too and cheated way to much and I hope this is the just dessert we all hear about. I only hope that Exxon doesnt get in line for economic assistance, when their next quarter show a drop in revenue!

-The banks don't have the capital to play with anymore so there's a lot less speculation going on. What you're seeing now is much closer to the true value of Oil according to supply and demand alone. What we had before was just another bubble pushed by the financial world when they realized that housing couldn't be pushed anymore.

kcbrady Author Profile Page:

"In this theory, the excess production capacity acts a bit like inventory in the ground (as opposed to in tank farms or floating tankers). "

of course, there is no one who has any incentive to tell the truth about how much oil they have. cf. Carlos Fuentes "Hydra Head"

gulickr Author Profile Page:

Interestingly, Europe, while not "awash in alternatives" does have:
- better public transportation systems
- a more extensive railway network
- several 'budget' airlines
- a development model that often focuses on what American planners are hoping to do - ie., mixed-use commercial and residential neighborhoods with higher population density (rather than sprawling suburbs) to enable people to spend less time driving, more time walking
- tighter emissions regulations
- larger entitlement spending per capita due to higher per capita tax revenues (which we can debate as a good thing or a bad thing 'til the cows come home, I'm sure)
Perfect? No. Better? Yes.

cballer Author Profile Page:

How about we agree with King Abdulla that the price of oil should never be lower than $75/Barrel? Whenever it's less we would tax the excess and use that cash to fund the gov't and keep rates on tbills as low as possible.

If US industry knows that mideast oil prices will never undercut an alternative that can be developed at a lower price, then we'll see some serious investment in other sources. In the short term it's only a strategy to become more energy independent, not a strategy to combat warming because China and India would be stupid to follow the same policy. However IF one of our technologies turns out to be evenutually cheaper than oil (and that's a big IF), then the US will be the center of a new global energy economy AND we'll save the planet.

The tricky part is finding the minimum oil price that does not destroy our ecomomy the way $100/Barrel likely did.

janecarroll1 Author Profile Page:

Let's not forget the fact that the Saudi oil fields and other oil regimes fund some crazy fundamentalists & terrorists, and that fact alone should make all of us want to encourage the search for alternatives to oil. Secondly, even if you don't believe in climate change, nasty, dirty, foul air is unhealthy for all Life on Earth.

edbyronadams Author Profile Page:

OPEC's effort to raise petroleum prices is a post mortem on the goose they already killed by extracting too many golden eggs. IMO, the high price of petroleum was the stressor that made the world economy collapse.

tonynelson1 Author Profile Page:

People claiming the price swings are prima facie evidence of manipulation know nothing of economics.

If 10 people desperately need something, but there is only enough to satisfy 9 of them, the price shoots up; If 9 people need something, and there is enough to satisfy 10, the price sinks.

Just moving demand one and supply one is the difference between $145 oil and $10 oil.

movette Author Profile Page:

None of this makes sense! Its impossible to believe that in a matter of 2 months all the world is conserving so much oil that the supply leaps to excess, and the price drops 75%!
The entire system is being manipulated! Who is doing it I dont know. But I hope they can find a market for sand.
We have been lied too and cheated way to much and I hope this is the just dessert we all hear about. I only hope that Exxon doesnt get in line for economic assistance, when their next quarter show a drop in revenue!

kenarmy Author Profile Page:

A significant factor in the price of oil is the futures market. It drove the price up, and when the economic downturn began the anticipation of a recession began driving the prices down. Speculators couldn't cover their losses. And with lending drying up,speculators couldn't leverage oil futures at 10:1.

An oil/gasoline tax would be OK, though not one that drives the price of gasoline to $4/gallon. A tax lets everyone know that the major consumer of oil in the world is beginning to get serious about cutting back their consumption. If you were a oil speculator what would you do? Bet higher or lower? My guess is the latter. Driving the price further down. If I'm right, a tax might be a good way to lower the price of oil, so the tax is not really noticable! And not all the oil producing countries have the financial reserves of Saudi Arabia. Eventually, they will begin to "cheat," and produce more oil. At some point in time there may be a panic, where countries will try to pump and sell it while there is still a market for it!

Clyde4 Author Profile Page:

If taxing up oil prices led to more alternatives then Europe with their high oil tax for decades should be awash in alternatives...

phil29 Author Profile Page:

Very interesting. However, how can one believe an author who wortethe following on page 1 of the post on July 27, 2008?

Although neither development made headlines, together they were emblematic of the larger forces of supply and demand that have sent world oil prices bursting through one record level after another. And while the cost of crude has surged before, this oil shock is different. There is little prospect that drivers will ever again see gas prices retreat to the levels they enjoyed for much of the last generation.

Little prospect Mr. Mufson?

keirreva Author Profile Page:

Blood from a turnip...

"tax oil so that it will be $4/gallon" - The reason that oil is cheap(er) is because PEOPLE DONT HAVE MONEY. How is taxing an already struggling economy to appease green freaks going to help anyone.

Exxon had record profits and they are investing in either new exploration or alternatives... because they don't have to. Taxing us doesnt fix this.

Mike542 Author Profile Page:

We need to get off oil. We need to be smart about doing so. Tax gasoline so it is $4/gal and let the market respond to that. Move to natural gas, incentives for plug-in cars, build 300 nuclear plants (like France).

But above all do not do anything just because of global warming for one of two reasons. First it is based on bad science and will definately prove to be a money making hoax. Second if it were real it is way, way too late to change it if only 20% of the nations respond.

yeolds Author Profile Page:

However one looks at today's price of oil, it is against the well being of Earth's residents that the oil price be so low:

1., reduces and or cuts all efforts to find new sources, which are necessary for the near future, as all old fields [Saudi Arabia, Mexico, Russia USA etc] are eclining by 7+% per annum.

2.,Low prices reduce the effort to find and finance alternative sources of energy with rerspect to global warming and or with respect to peak oil [referring to availability of cheap old oil, where the new oil cost is in excess of $ 90.00 in Canadian Oil Sands, and WILL BE higher in Colorado Shales].

3., encourages further rise in Oil consuption as happened in USA since the price decline, not withstanding the general malaise of the USA economy.

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