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10 November 2001

Thinking About Downstream Oil - 2

Thinking About Downstream Oil
Non-OPEC Oil Producers Change the Dynamics of Oil Markets

I continue to be amazed -- check that, "dismayed" is a better term -- at the decline of critical reading skills. And although my own libertarian/conservative leanings are well established here, I cannot identify this as a problem confined to the Left. Indeed, the latest example comes from the conservative OpinionJournal "Best of the Web" blog that appeared on Friday.

OpinionJournal cites an article by Lynne Kiesling in the following manner:

How come oil prices have gone down since Sept. 11, when every past Middle East crisis has led to price increases? Lynne Kiesling [sic] the Reason Public Policy Institute says it's because oil producers outside OPEC and the Persian Gulf have grown in importance....

Now, I have previously identified the two main reasons oil prices have declined since 11 September: 1) sharply reduced demand (directly related to the U.S. economic downturn and greatly decreased use of jet fuel) and 2) perceptions (markets clearly do not expect a skirmish in Afghanistan to disrupt global oil supplies or capabilities). As I also noted, if the war turns more directly to the Gulf region, then expectations will change and so will prices of existing oil as well as oil to be extracted in the future (since oil is a fungible commodity).

In my initial reading, I was a little surprised to find only three passing references to reduced demand for crude in Professor Kiesling's column, and was all set to criticize it. However, in rereading it I came to this realization: Professor Kiesling's column is not intended to answer the question the OpinionJournal attributes to her! In other words, OpinionJournal has misread Professor Kiesling in order to answer a question she has not attempted to answer!

That is unfortunate, as Professor Kiesling's column is interesting on its own terms. Kiesling's thesis is that OPEC's ability to control crude prices has significantly declined with the emergence of large non-OPEC exporters Russia and Mexico. She notes that crude prices remain depressed in these times of significantly lower demand (which she acknowledges in her second and third paragraphs) because OPEC has not been able to persuade non-OPEC producers to lower THEIR production, thereby effectively creating a surplus (which the market will clear, via lower prices). Note that Professor Kiesling does identify reduced demand as driving down prices, thereby confounding OPEC's intentions -- which is not how OpinionJournal presented her piece.

The really interesting question that emerges from her column is whether OPEC's relative decline in importance will endure (as Professor Kiesling intimates) or whether it is temporary.

I think the decline of OPEC's relative importance is temporary, and that is because I think the circumstance of reduced crude demand is temporary. When the American and global economies begin to recover, demand for crude is going to surge initially, and then return to its pattern of long-term growth. When that happens, OPEC's spare capacity will allow it to recapture any market share lost during this period of surplus production. Since Kiesling cites Russia and Mexico, it is important to note that Mexico saw its highest production in 1998, and has strained to reach those production levels since then (a major reason Mexico is considering opening its CLOSED industry to foreign investors). Although it is approaching capacity, Russia does have significant reserves, but needs to attract foreign investment to ramp up its production much higher than what it is currently. And even if Venezuela could be persuaded by the United States to ignore OPEC and boost production -- which is a questionable proposition, given the quirky leadership of Chavez -- I've been told by a relative of the former head of PDVSA that Venezuela just does not have much spare capacity at present. OPEC members, in contrast, do possess the spare capacity to ramp up production significantly if need be, and development is less technically challenging in their countries as well. Long-term, I do not think the relative importance of OPEC has declined significantly (and I even question whether Professor Kiesling's graph, which shows increased gross production from non-OPEC members, really supports her argument, since OPEC production has increased in the same rough proportion).

None of this should suggest I am a big fan of OPEC. But United States policymakers need to be realistic in their assessments of American energy security, and need to be careful not to underestimate the enduring strength of the OPEC cartel. They need to avoid asking the wrong questions (a la OpinionJournal) in order to produce pre-conceived answers (which are useless). Only in that manner can we properly consider whether OPEC's enduring strength is a threat to American security -- and what to do about it, if anything (ranging from opening ANWR and areas offshore FL and CA to allowing American companies free rein to explore in political dubious places like Sudan and Angola to pursuing a hemispheric energy strategy focused on Latin American development).

[Posted @ 02:45 PM CST]

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