Earlier this week, the Organization of the Petroleum Exporting Countries tried to aggressively assert its influence in order to raise the global price of oil. But its actions—and the reaction—were extraordinarily weak. OPEC announced on Wednesday that it would slash oil supplies by 700,000 barrels per day, or about 2.5 percent of its collective daily production of about 33 million barrels. In response, the price of oil shot up by an underwhelming 5 percent.
That won’t do much to help the ravaged economies of OPEC members. Saudi Arabia, whose deficit is proportionately the largest among the world’s 20 biggest economies, is slashing public employee bonuses and salaries. Venezuela has become an economic hellhole. Kuwait is embarking upon an austerity program.
Once, OPEC’s loose affiliation of 14 petro-states, oil satrapies, and dictatorships could arouse terror in the developed world. In An Extraordinary Time, his new book on the economic upheavals of the early 1970s (thanks, Nixon!), Marc Levinson describes how the U.S. economy first stalled and then came to a halt thanks to OPEC. On Oct. 16, 1973, amid the Yom Kippur War between Israel and its neighbors, OPEC jacked up the price of a barrel of oil by a stunning 70 percent, from $3.20 to $5.11. Soon after, it stopped selling oil entirely to the Netherlands and the U.S., which were supplying weapons to Israel.
At the time, of course, OPEC accounted for about 70 percent of world oil production. So it really mattered when OPEC flexed its muscles. But things have changed in the past four decades, especially over the last one. And OPEC’s ability to dangle the global economy over a barrel is now sharply diminished.
Yes, the world remains as dependent as ever on oil as a transportation fuel. But in most developed economies, higher fuel efficiency standards and, at the margins, the rollout of vehicles that run on electricity and natural gas (thanks, Obama!) are tamping down demand growth. Meanwhile, both the actual and potential supplies of petroleum have been blossoming because non-OPEC countries have been boosting exploration and production. Especially the United States.
Thanks in large measure to the shale revolution, U.S. oil production has boomed. Production rose from about 5 million barrels a day in 2006 to 8 million in January 2014 and hit a peak of 9.6 million barrels per day in April 2015. That’s an increase of about 70 percent in a decade. Add in higher production in Russia and elsewhere in the world, and OPEC has seen significant erosion of its market share over the past several decades. The cartel may have about 80 percent of global reserves, but in 2014 OPEC only accounted for about 41 percent of global production.
It’s tough to control markets when your market share is declining. And in recent years, the need to control the price of oil has been something of an existential imperative for OPEC’s members. Why? The public and private sectors of most OPEC members depend almost entirely on oil for revenues. So when the price falls, the natural immediate response is to pump more oil—pushing down the price even more. That impulse to pump both reduces the tendency and desire for collective action as a cartel and further aggravates the problem.
Another thing has changed. OPEC members have historically been able to produce at lower price points than other producers—the oil in Saudi Arabia is remarkably easy to get to. So when it drove down prices through higher production, OPEC would effectively make it difficult for many non-OPEC oil producers to keep pumping, see its global market share rise, and thus enhance its ability to influence markets.
No longer. Even as the price of oil has fallen sharply, from the mid-$50-range per barrel in April 2015 to as low as $30 earlier this year, production in the U.S. has been quite steady. Yes, some rigs have shut down. But the industry has innovated, rationalized, renegotiated contracts, and generally lowered costs so that it can keep producing lots of oil even at lower break-even points. According to the U.S. Energy Information Administration, U.S. crude oil production has fallen in 11 of the 14 months since the spring 2015 peak—to 8.7 million barrels per day this June. That’s only a reduction of about 9 percent.
The continued high production in the U.S. has further limited the capacity of OPEC to influence the global markets. In July, the cartel accounted for less than 35 percent of global production (see page 69 of this OPEC publication).
In tight markets, the power goes to the swing producers, those who can ramp supply up or down quickly and who can profit even when prices are low. OPEC’s constituents—especially Saudi Arabia—were always the world’s swing producers. Now? Not so much. When you only control one-third of a market, your capacity to exert unilateral power over it is sharply reduced. And when the biggest supply cut you can muster is 700,000 barrels per day—less than 1 percent of global daily use—it’s pretty much impossible to move a market on an enduring basis.
In the past couple of years we’ve also realized that the U.S. itself is something of a swing producer. Since February 2015, the U.S. has removed about 900,000 barrels a day of production from the global supply mix. In other words, America’s oil complex is sitting on big pools of crude that it can start pumping again once the price-per-barrel rises to the mid-$50s.
In 1973, when OPEC engineered a 70 percent increase in the price of oil, America collectively ran out of gas. In 2016, if OPEC were somehow to engineer a 25 percent increase in the price of oil, the U.S. would fire up its oil engine. Thanks, America.