Thursday, September 11, 2008


Yes Gertrude Stein might have said that, But she didn't. She was distracted by roses. And for now the bloom is off OPEC's rose.

The death of OPEC or Biz as Usual?
Like roses OPEC has some desirable attributes and some thorns. We all like it when OPEC supplies a lot of oil but sometimes it doesn't seem to supply enough. With the Saudis pledging to supply all the oil that the market wants, some have called this the death of OPEC. But this is really life as usual in the house of OPEC.

OPEC as real estate:
The house of OPEC has many rooms and each one has a different view on the world and the oil market.

OPEC fails stability test: it's not OPEC it's about OPEC
OPEC always has been an unstable cartel. Its instability comes from two factors an unstable market share and members with very different resource endowments. As we look back in time OPEC has not always accounted for enough of the world production to control prices, that is the first source of instability: fluctuating market share. But when OPEC has been in the catbird's seat for pricing its dispersion of self interest has often gotten in its way of making a lasting oil policy. The second source of instability is that different reserve endowments that give members different incentives on pricing.

Different strokes for different to the high oil prices
OPEC is made up of countries with lots of oil reserves (the Doves especially Kuwait and Saudi Arabia) and those less endowed with oil (the Hawks). There are also those (like Iran and Venezuela) that are trying to use oil riches to support non economic policies, call their agenda, global reorganization. This gives them different short run objectives. Of course should the cartel ever conspire to cut output and boost prices another instability common to all cartel kicks in. That is the incentive to cheat and pump more oil to get more revenue while prices are high. That incentive can undo and override the group decision to curtail production.

OPEC's Oil Hawks and Doves and 'Agenda Hawks'
Hawks want high prices because their oil resources are low so they want to to sell oil while they still have it at the highest possible price. For example, Indonesia once a hawkish OPEC member has dropped out of the cartel and become a net oil importer. Oil doves have large reserves and will have oil for years to come; they are interested in keeping the price just high enough so alternatives are not developed to undercut the value of their reserves. Those with a policy agenda are hawks for obvious reason. Chavez in Venezuela wants to afford an ever larger thorn to stick in the side of the US.

OPEC: The 'LOCKHORNS' of the Middle East
Although the papers are touting as 'new' the schism in OPEC with the Saudis vowing to fulfill market demand for oil a 180-degree shift from OPEC's 'alleged decision', it is nothing more than business as usual in this bickering family: the 'Lockhorns' of the Middle East.

Geopolitics meets supply and demand:
When prices are high and rising the hawks have the upper hand. Indeed, we can argue that some of the geopolitical unrest stemming from Iranian statements over the past year was aimed more at the oil market than at setting a clear foreign policy. The irony is that when oil prices are highest the hawks want to pump more to get more revenue while that very act will help to drive prices down.

Everything old is new again, with a twist
The oil market is global with lots of players and many of the key players are not exactly aligned with US interests. With the new conflict with Russia, over Georgia, Europe is feeling more at risk to Russian energy supplies. Oil has become a weapon - again. As I wrote yesterday: everything old is new again. but now maybe some new players have an itchy finger on the trigger.

INELASTICITY breeds 'terroricity'?
One last thing that makes oil special is its relative inelasticity. Supply is hard to expand in the short run and demand is hard to curtail in the short run as well. This is a set-up for large price swings. Also oil facilities are very capital intensive, oil is flammable. These facilities make good targets for terrorists. Oil facilities and pipelines have been terrorist targets in Nigeria, Iraq and in Kuwait; when Saddam left, oil wells were set on fire as Iraq departed after its failed invasion. When Russia penetrated Georgia its bombs came very close to a key pipeline that serves Europe, though the line was not hit. Some thought it was a veiled threat.

Instability is instability is oil
These steeply sloped (inelastic) supply and demand curves have always been problems for setting oil's prices. Since expectation are part of supply and demand. As stockpile demand interacts with peoples' perceptions of market imbalances, oil is subject to great price swings. It is hard to imagine oil stockpiles large enough to make the global economy immune to such swings.

Been there, done that
The Saudis are still trying to learn how to cope with all this. While Iran and Venezuela's agenda's may require high oil prices the Saudis are tying to stabilize oil at a more moderate level. The Saudis know that prices that are too high can crash the global economy and another move up from current levels could 'seal the deal' on a very nasty global recession. Eventually that would drag oil prices much lower. The Saudis are trying to avoid that. They've been there, done that. The Hawks seem to have no fear that high prices might get too high in a way that has negative repercussions for them too. This may reflect in part that the 'agenda hawks' are mostly trying to disrupt the world order and they may not care exactly how it happens. Neither Iran nor Venezuela seem at all concerned about raising their living standards of their own people all that much.

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