I well remember suffering through my college macroeconomic class, steeling myself to stay awake through the consumption of gallons of coffee. However, one of the rare things that piqued my interest was the theory of cartels. Properly defined, an efficient cartel possesses three basic properties: the ironclad discipline of its membership; a commanding market position; and formidable barriers to interlopers entering the closed market. By every one of these analytical benchmarks, Opec – the most famous and feared cartel in the world – shows itself to be in its death throes. If this is so, beyond the compelling headlines of the current oil war lies a truly game-changing moment for the global economy.
The November 2014 meeting – when the cartel could not agree to cut production in response to tumbling world prices – signals just how fractious Opec has become. Both inefficient Iran and Venezuela, acutely suffering from an oil price that has halved over the last six months, were desperate for the cartel to do what it has so often done in the past: support global price stability for its membership. But Saudi Arabia has made it quite clear that its interests fundamentally diverge from those of Opec’s more hard-pressed members. Little interested in price stabilisation, the Saudis care primarily about protecting market share. This fundamental disagreement simply can no longer be papered over.
Without the Saudis (who account for more than 16 per cent of the world’s proven oil reserves that are the easiest and cheapest to extract), Opec is a paper tiger. All along – and in contradiction to tardy conventional wisdom – I’ve believed Saudi oil minister Ali al-Naimi, who has clearly stated that the Saudis want Opec to continue pumping 30m barrels per day (bpd) come hell or high water. Recently, al-Naimi stirred the pot further, insouciantly claiming that the kingdom was perfectly content to let prices fall to $20 a barrel, as the Saudi’s production costs run to only a meagre $5 a barrel. One can hear the whimperings in Tehran, Moscow, and Caracas from here.
If Opec clearly lacks discipline, its position in the global market isn’t what it used to be; its market share has declined from around 50 per cent in the 1980s to merely one-third today. Oil prices falling out of the sky reflect a supply shock as much as anything else, with non-Opec members Russia and the US flooding the market over the past few years, while the cartel merely treads water.
The US shale revolution alone has placed an additional 3m bpd onto global markets over the last three years; shale has become the grand disruptor. Russia has followed suit, with Moscow pumping a post-Soviet record of 10.58m bpd in 2014. So the third property of cartels – that there are high barriers for outsiders to market entry – also fails the laugh test in regards to Opec.
A series of startling changes follow on from Opec’s demise. First, all of these intractable realities mean that, in the short term of the next six months, the oil price is set to continue downwards. There is a floor to the oil war, however – Saudi geopolitical sensitivities. On the one hand, they want nothing so much as to drive a stake through the heart of the US shale revolution; on the other, they certainly do not want an open economic confrontation with Washington, which remains the ultimate guarantor of Riyadh’s security in a very rough neighbourhood. As such, the American shale industry can suffer, but not too much.
Second, while the Saudis are certainly on course to win the short-term oil battle against the Americans, they could well lose the war. Riyadh can extract and make money at a far lower global price than the shale industry; this, coupled with the kingdom’s massive foreign reserves of $900bn, mean that they are well-placed to begin to drive some US producers temporarily out of the market in the second half of this year.
But by knobbling Opec, Riyadh is unwittingly anointing a new global swing producer – its shale rivals. For the shale industry can far more quickly ramp up and dial back drilling operations in response to price movements than the conventional oil industry. In other words, American shale has the scale and a better capacity to nimbly add and subtract barrels from the global total than anyone else in the post-Opec era. If this proves true, the most startling long-term reality emanating from the present oil war is that America, of all places, may find itself the new global swing producer over time.
And that does nothing less than change the world.
Dr John C Hulsman is senior columnist at City A.M. He is a life member of the Council on Foreign Relations, and author of Ethical Realism, The Godfather Doctrine, and Lawrence of Arabia, To Begin the World Over Again. He is president and co-founder of John C Hulsman Enterprises (www.john-hulsman.com), a global political risk consultancy, and available for corporate speaking and private briefings at www.chartwellspeakers.com