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OPEC: A Lesson in Why Cartels Fail

Thursday, March 16, 2017 5:18
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This article was published by The McAlvany Intelligence Advisor on Wednesday, March 15, 2017:

OPEC countries

OPEC countries

Every cartel comes together when individual members think they can obtain a greater economic benefit working together than they can alone. Every cartel breaks apart when members think they can do better alone. If a cartel is sanctioned by a government, it becomes a monopoly.

Since 1960, OPEC has largely stayed together with the collusion of governments and Big Oil interests around the world. But the fracking revolution, operating in the free market, is blowing up the model. Specifically, improving technology has pushed breakeven points in the US oil patch down so far that it is creating an existential threat not only to the recent so-called “production cut agreement” hammered together last fall, but to the cartel itself.

That agreement, one will recall, was supposed to cut production sufficiently to raise the price of crude to levels “acceptable” to the cartel. It managed to obtain agreements from nearly a dozen non-cartel members to go along with the scheme. It was supposed to cut world production by 1.8 million barrels a day (mbd) – enough, it was thought, to push the price up sufficiently to satisfy the cartel members and keep them in line.

Tuesday’s report from OPEC ended the dream, likely the agreement (due to end in May), and possibly OPEC itself. Before the agreement, OPEC was producing 32.5 mbd. By the end of February, the cartel was producing – ready? – 31.96 mbd!

Thanks to exceptions given to Nigeria and Libya (which increased their production by 300,000 mbd and 400,000 mbd respectively), and Russia’s only partial compliance, the net impact of the agreement was essentially zero.

Also thanks to the US fracking industry, which has seen its breakeven point drop to $25 a barrel. The norm in Dunn County, North Dakota, which sits above the vast Bakken oil reservoir, is $15 a barrel. Since last summer, the industry has added 600,000 mbd to world oil supplies.

Last week, eight more idled rigs went into production, bringing the total to more than 600 – up from just 450 last summer.

So instead of continuing their rise in the month following the OPEC agreement, crude oil prices have fallen. Last week the dam broke when evidence surfaced that inventories were building faster than ever, causing oil traders to reduce their long positions and forcing oil prices to break through the $50 a barrel “resistance” level. They are now lower than they were before the ill-fated OPEC agreement was cobbled together last November.

In what may qualify as the year’s greatest understatement so far, Germany’s Commerzbank said, “There is little to suggest as yet that this market tightening [by OPEC] has begun.”

OPEC has run out of options. The present failed agreement ends in May, with OPEC member Kuwait’s oil minister supporting “the extension of the agreement … [a move that will] accelerate the rebalancing of the global oil market and … contribute to the return of prices to levels acceptable for [OPEC] and for the petroleum industry in general.”

What a great example of expressing hope over experience! Extending the failed agreement will allow US frackers to fill in any void, gaining market share and keeping prices low. But ending the agreement will be a virtual admission that such agreements no longer work, as well as a tacit agreement that the OPEC cartel itself doesn’t work anymore either.

After 75 years of being bullied by the hubris of sheiks who thought they could control the price of crude at the expense of the rest of the world, oil consumers are gratified to see the neutering of such agreements and the existential threat to the cartel being posed by the free market, the US fracking industry, and its ever-declining breakeven points.




Background on OPEC

The Wall Street Journal: OPEC Cut Back Crude Output Amid Rebound in US Shale Supply

The Wall Street Journal: Oil Prices Pressured by Growing US Crude Supplies

The Wall Street Journal: Energy Ministers Stress Commitment to Curb Production and Boost Oil Prices

The Wall Street Journal: Oil Selloff Continues on Strong US Supply

US Oil-Rig Count Climbs by Eight New Oil Price War Looms As The OPEC Deal Falls Short Leaner and meaner: US shale greater threat to OPEC after oil price war


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