OPEC: The Oil Cartel

Will OPEC Defy the Odds and Stay Strong?

By Sam Hopkins
Thursday, May 8th, 2008

Admit it. If OPEC were a public company, you'd be hard pressed NOT to want to own shares.

The world's biggest cartel is set to bring its members over $1 trillion this year, beating Department of Energy estimates by $150 billion and soaring over last year's net by 57%.

That's stellar performance...

But then again, OPEC's price-fixing ability makes increasing revenue a self-fulfilling prophecy...

Right?

Well, a few major factors could break the cycle:

  • OPEC members departing the cartel
  • Non-OPEC oil production rising in places like Brazil, Canada and Kazakhstan
  • General distaste for price-fixing in politics and public opinion
Whether a perfect storm will uproot OPEC, though, is far from certain.

Indonesia's "Wells Are Drying"

Indonesian President Yudhoyono told the world this week that the country's OPEC membership is in question because, quite simply, Indonesia's "wells are drying."

Indonesia, eastern Asia's only OPEC member, joined the ring two years after it was launched in Baghdad in 1960.

Since then, that country of over 17,000 islands has turned from an export power into a net importer—production declined from 1.66 million bpd in 1980 to 1.1 million in 2006, while daily consumption tripled over the same period.

Economic growth at over 6% a year, even factoring in the 2008 slowdown, means Indonesia has to hold on to what it's got left.

Indonesia has revisited its OPEC membership in the past, but decided to stay on to maintain high-level relations with big-time oil powers like Saudi Arabia. After all, Indonesia has the world's highest Muslim population, giving it another major tie to Gulf exporters.

Indonesia isn't the only country to consider leaving OPEC in recent years.

And declining production isn't the only reason for splitting, as Nigeria can attest.

Low Prices Almost Drove Nigeria from OPEC

It seems like it must have been a previous lifetime, but in 2002 oil was around 20 bucks a barrel.

That's when Nigeria and OPEC were at odds over the country's "undisciplined policies" and production that exceeded daily OPEC quotas by 300,000 bpd.

New Nigerian production was coming online at the time, and national leaders and companies operating there got vexed by low limits coming from OPEC headquarters in Vienna.

These days, Nigeria is making the news with illegal pipeline siphoning and rebel attacks that shut down production and refinery facilities, putting them in danger of under-producing by OPEC standards, and leading to a higher risk premium in futures trading.

Like any club, membership in OPEC comes with commitment, but benefits too. That's why the threat of attrition is balanced by new members who want to tap OPEC"s power and expert-sharing structure.

Ecuador and Angola Come On Board OPEC

Ecuador, South America's second-largest oil supplier to the United States, was a member of OPEC for two decades before leaving in 1992, to produce more oil than Vienna was mandating at the time. Ecuador rejoined under new center-left leadership in 2007, and is now like Nigeria, below quota.

Angola cast its lot with OPEC for the first time in 2007, and the country is now the third largest crude oil producer in Africa, behind Nigeria and Libya. Consumption hasn't grown at such a high rate in Angola as in Indonesia or even Ecuador, because the economy is anemic.

So there's still room for Angola to ramp up output before worrying about domestic supplies.

In non-OPEC countries like the U.S., the situation is one of trying to maximize export profits while turning away from oil for domestic use.

Some experts say what we're seeing now may be the last hurrah for non-OPEC production.

Non-OPEC Production Falters

"No non-OPEC member is in a position to produce more," says energy expert Francis Perrin. "They are selling all the oil they can."

Perrin includes reputed fossil fuel saviors like Kazakhstan's Caspian basin, Brazil's recent deepwater offshore finds, and even Canada's oil sands in that appraisal, saying declines in high-quality North Sea fields can't be offset by hard-to-get, sour crude from the latest sources.

Canada's oil has to be cooked, Kazakhstan's 1.5 million bpd Kashagan field is delayed another few years, and Brazil's Carioca field is in a "pre-salt formation," at depths that have been known to melt even uranium-tipped drillbits.

Companies like Noble Corporation (NYSE:NE), which specializes in deepwater offshore exploration, will thrive in the high-pressure environment.

The Oil Service HOLDRs ETF (AMEX:OIH) is also a great play on rising prices and interest in new resources.

What's more, commodity cartels are coming into fashion, and OPEC is always the reference point (after all, you'd probably rather draw a parallel to OPEC than to Colombian drug lords).

Iran and Russia have been talking about a "gas OPEC" for a couple of years now, and Vietnam is quietly pushing forward with the idea of a five-country Mekong Delta "rice OPEC" as grain prices skyrocket.

To make a long story short, OPEC is widely seen as a model for success with no real rival in the energy world. Until that changes, it's a force we're going to have to reckon with.

Regards,

sig

Sam Hopkins

www.energyandcapital.com


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