Friday, 26 May 2017

OPEC’s Next Mistake

DANIEL LACALLE: The OPEC meeting has failed, again. The decision to cut production was announced months ago as a great triumph because it included countries outside the organization. And it was a mistake. The result, several months after the largest production cut in history, could not be further from what the organization expected. Oil inventories in the OECD rose to five-year highs, the United States also recorded record levels of crude oil in storage despite a healthy demand, growing by more than a million barrels a day in annualized terms. However, oil prices remained far below those levels desired by OPEC, and especially its more wasteful members, Venezuela in particular.

Why? OPEC has underestimated the reaction of new technologies and independent producers. The cut by OPEC has been the biggest gift to shale in a long time. The US achieved a production growth that has surprised the most optimistic, and the country is closer to energy independence. That the US imports less and stores more, affects oil prices in several ways. On the one hand, US producers have done their homework and increased their efficiency and reduced costs by more than 40%, which has allowed them to be competitive at $45 a barrel. This makes the price of oil lose strength in the face of evidence that the market is better supplied and more diversified than expected.

There is another very important effect. The “oil weapon” mentioned by Chavez years ago has run out of gunpowder. With the drastic reduction of US oil imports, the geopolitical premium historically added to the price of oil due to the US dependence on politically unstable countries, disappears.

Evidence from recent years shows us that the success of the American energy revolution, carried out without any support from the Obama Administration, is twofold. The dream of energy independence of the world’s largest energy consumer is ever closer, and the combination of shale, renewables, coal and natural gas, has been an essential factor in competitiveness, growth, employment and has destroyed the power of OPEC to manipulate the price of oil.

The big mistake

With this meeting, the cartel shows that its control over the price of the barrel in the medium term is non-existent. Worse, if they continue with this policy, the response of alternative technologies will accelerate. The great error of OPEC has been to think that lowering prices would displace alternative technologies and the inexorable advance of efficiency, but the suicidal movement puts at risk OPEC’s role as the most reliable, competitive and flexible supplier. Throwing themselves into unnecessary cuts, they sent a dangerous message to their customers: it was worthwhile to continue to advance with disruptive technologies.

None – I repeat, not one – of the OPEC countries is losing money with the current prices.

None of the OPEC countries is losing money with the current prices. The production and development cost of all members is massively below the current oil price (average total costs $20 a barrel), but member states had become accustomed to financing unproductive subsidies and political spending, to squander their oil revenues. So, despite having costs well below $20 a barrel on average, almost no OPEC country balances its budget at these prices. Between $20 and the $100 some would like to see, there are hundreds of billions of dollars in political spending and subsidies.

I am sorry, because I have had the honor of attending several OPEC meetings and I value the principles that have always informed its policy: to defend an adequate supply and a price that is good for consumers and producers, to be a reliable and safe supplier. We mentioned it in the book The Energy World Is Flat (Wiley), the decision to manipulate the market will only make the market respond more quickly.

Today, OPEC is faced with the devil’s alternative. If it continues to limit production, the response of efficient operators in different technologies will accelerate, and if it recovers production levels prior to the cuts, it will not be able to finance the excessive expenditure to which the member countries have become accustomed.

OPEC’s response should only be one. Demonstrate that they are the most efficient and reliable operators and that their governments can stop irresponsible spending. Only in this way will these countries, full of wonderful opportunities, remain relevant and prosperous.

“Low” oil prices are a blessing in disguise to producers, even if they do not believe it. It is the shock they need to wake up from the nightmare of the petrostate, that wastes billions of oil revenues and thinks it will go on eternally. Disruptive technologies are here to stay and have only one future: brilliant. | Daniel Lacalle | Friday, May 26, 2017

© Daniel Lacalle

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Daniel Lacalle has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

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