Why OPEC won't turn off the oil
Why OPEC won't turn off the oil
By Jim Jubak
President Bush had barely finished explaining how his plan to spend less
than a billion in new money would end U.S. addiction to Middle Eastern oil
before Saudi Arabia and the rest of OPEC fired back.
If the United States reduced its dependence on Middle Eastern oil, the
Organization of Petroleum Exporting Countries would be forced, with deep
sorrow certainly, to abandon plans to invest billions in developing new
supplies of oil.
President Bush's plan to reduce U.S. demand for Middle Eastern oil would
result, producers warned, in a global crisis in oil supply.
Yeah, right. As lines in the sand go, this one certainly sounds dramatic,
but it's empty posturing. In fact, as full of too-little-too-late promises
as President Bush's Jan. 31 State of the Union address was (see my Feb. 3
column, "The state of coal stocks is strong"), I'd give the nod to OPEC's
performance over the president's for creativity and sheer chutzpah. As empty
threats go, this is a doozy.
OPEC's grand experiment
As addicted as the United States may be to Middle Eastern oil, the oil
producers, especially Saudi Arabia, are even more addicted to continued U.S.
oil consumption. The Saudis, the Kuwaitis, the Nigerians and the rest of
OPEC can't afford to stop investing in new production any more than the U.S.
can afford to go cold turkey on Middle Eastern oil.
Look at the world from the perspective of the Saudis and the other OPEC oil
To them, 2005 -- the year of $60-to-$70-a-barrel oil -- was a huge and
successful experiment. For years, oil producers had kept their target price
for oil relatively low: The official OPEC price band for crude oil was $22
to $28 at the time of the organization's Dec. 12 meeting. OPEC has kept the
target so low because it worried that high oil prices would cut global
demand for oil. OPEC has also worried that high oil prices would spur the
development of alternative energy resources, such as Canada's oil sands, and
alternative energy technologies such as nuclear and solar.
So OPEC watched with some concern as war in Iraq, hurricanes in the Gulf of
Mexico, unrest in Nigeria and turmoil in Russia drove the price above $70 a
barrel. And OPEC breathed a sigh of relief when prices above $60 a barrel
didn't stop global economic growth in its tracks, didn't lead to crash
programs of energy conservation and didn't force OPEC's customers to develop
alternative fuel sources.
Now that the world has proven quite able to live with $60 to $70 a barrel
oil, OPEC is quite happy to go along. The official target band may not move
for some time, even though the more aggressive OPEC members, such as Iran
and Venezuela, have called for official production cuts and higher official
price targets. So far, OPEC isn't inclined to go on record in favor of
higher prices. The organization will be quite happy to blame the price
increase on market forces, Chinese demand and Western speculators for as
long as possible. But the target price is now clearly above $50 a barrel, no
matter what OPEC says officially.
Despite much higher oil prices, not all is well in OPEC's world. Like the
rest of the world, OPEC has a supply-demand problem. For oil-consuming
nations, that problem expresses itself as a huge increase in the cost of
oil. For OPEC, and particularly for the Saudis, the problem is the potential
for a loss of control over the global oil markets.
Top World Oil Producers
1) Saudi Arabia
3) United States
10) United Arab Emirates
13) United Kingdom
13) Iraq (tied with U.K.)
Source: Energy Information Administration. Latest data from 2004. OPEC
members in italics.
Right now, OPEC still calls the tune in the global oil market -- and not
just because it's the source of 40% of the world's oil, although that
certainly doesn't hurt.
And Saudi Arabia isn't the most powerful country in OPEC just because it
produces more oil than anyone else in the world, although that certainly
isn't a bad foundation for power, either. The Saudis, at 10.4 million
barrels a day at the end of 2004, aren't that far ahead of No. 2, Russia, at
9.3 billion, or No. 3, the United States, at 8.7 million.
Power in today's oil market involves two questions:
Is your production rising or falling in the long run? Right now, non-OPEC
production is falling in comparison to OPEC production. That puts OPEC in
the driver's seat. (At least until Canada's oil sands projects start full
In the shorter run, do you have any excess production capacity that can add
oil to the global markets at crunch time? When global supply is running just
barely ahead of demand, as it is at the moment, countries with excess
production capacity, the marginal producers, have tremendous market power
and the ability to set prices.
Right now there's really only one country in the world with any surplus
production capacity. That's Saudi Arabia. And that puts the Saudis in a
position to defeat Venezuela's proposals on price and to overrule Iran on
But this power -- for Saudi Arabia and for OPEC -- isn't guaranteed for the
long term. It's based on the ability of the countries in the organization as
a whole to increase production to meet demand, so that oil consumers don't
have a reason to get more aggressive about finding other sources of energy.
And for the Saudis, in particular, it's based on their ability to increase
production so that the country remains the global source of excess
Meeting those goals won't be easy. And it will require massive investment in
the region's oil reserves.
Drilling for the dregs
Even if you don't believe in peak oil -- the theory that global oil
production either has peaked or will soon peak -- the problems facing the
global oil industry, OPEC and Saudi Arabia are immense. The current
generation of peak-oil theorists, building on the work of the late M. King
Hubbert, predicts that world oil production will decline -- slowly at first
and then more quickly -- as the rate at which new oil is discovered falls
behind the depletion of current proven reserves.
Buttressing the theory are signs that some of the biggest proven reserves
are indeed showing their age. For example, the United Kingdom, which has
been a net exporter of energy for the last two decades thanks to the huge
oil and gas deposits discovered in the North Sea about 35 years ago, became
a net importer of natural gas in 2005. Oil analysts estimate that the United
Kingdom has pumped between 50% and 75% of the available oil and gas in its
North Sea fields. From its peak at the end of the 1990s, United Kingdom oil
production has fallen by about 30%.
I think it's too early to tell if the is right -- and to predict when the
peak might come. Another part of the theory, however, seems to me undeniably
accurate. Peak Oil theories predict that production from a field will peak
and start to fall long before all the oil is extracted, since the more
easily pumped oil deposits are extracted first. And that extracting the
remaining oil will get increasingly more difficult and more expensive.
Want proof? Just ask Royal Dutch Shell (US:RDS.A, news). The company just
reported disappointing fourth-quarter results that showed the company
continuing its recent trend of replacing just 70% to 80% of the oil it pumps
each year through new discoveries. The company has vowed to get replacement
figures up to 100% by 2008, but that's going to take a good bit of money.
Spending on exploration and development will climb to $19 billion in 2006.
"The theory of peak oil," CEO Jeroen van der Veer, told investors and
analysts, "that oil production has peaked, is correct if you look at easy
oil close to markets, like West Texas and the North Sea. But think about
deep-water drilling, think about the Arctic."
I do think about deep-water drilling and Shell's projects on Russia's
Sakhalin Island, and I see big increases in the cost of finding and
The Saudis and the rest of OPEC aren't exempt from this process. About 50%
of Saudi Arabia's current reserves are locked up in just eight fields,
including the giant Ghawar field -- the world's largest with remaining
reserves, by official Saudi oil industry count, of 70 billion barrels.
Ghawar, however, is quite old and while reserves remain huge, production
rates are declining as it gets harder and harder to extract the oil. The
Saudi state oil company Aramco says that production from Ghawar and other
old fields is falling by 800,000 barrels a day. (Outside critics say the
depletion rate is much higher.)
But whatever the correct figure, the Saudis clearly need to spend big bucks
just to maintain current production. So in March 2005, for example, the
Saudis announced contracts to foreign firms to develop new fields that would
start production between 2006 and 2009 and that would add 2.7 million to 3.1
million barrels a day to production. The cost: $8 billion.
Keys to the kingdom
The Saudis -- and other OPEC members -- have the cash to spend much more
than $8 billion to find and develop new fields and to improve the technology
at existing fields in order to retrieve a higher percentage of the oil in
proven reserves. Spending those billions would keep OPEC and the Saudis in
control of global oil markets.
Not spending those billions would gradually move OPEC and Saudi Arabia out
of their current position of control. Losing control of the global oil
markets isn't exactly an option that the ruling regimes in these countries
can face with equanimity. After all, it's only oil revenue that keeps the
ruling families in power in much of this region and that funds the regimes
in Nigeria, Iran and Venezuela.
You judge exactly how likely it is that the folks who rule the OPEC
countries will risk their own fortunes and lives by cutting investment in
their oil resources.
Even if it would give them the satisfaction of showing President Bush who's