Sunday, December 17, 2006

OPEC - A New Kind of Cheating

Since the mid 70's when OPEC was bringing the pain to the US with limited gas supplies, OPEC has been plagued by one problem that all cartels face - cheating on production quotas. Thankfully with so many of these nations in poverty, there was always incentive to overproduce which kept the real power/damage of such moves in check.

My how things have changed. 30 years of repairing diplomatic relations and access to oil discovery investment with the king of OPEC - Saudia Arabia has transformed the cartel from a nasty thorn in the side of overall economic expansion, not to mention our daily commute, to one more akin to the "G8 of Oil".

Its nice having a benevolent production source, and if anyone wonders why this benevolence arose - see HRH Prince Al-Waleed bin Talal bin Abdul Aziz Al-Saud who has massive investments in the United States.

But all that aside, it is the rest of the OPEC nations who are now realizing there is a better alternative to cheating production quotas in order to gain more revenue. The creation of diplomatic turmoil between a nation and the United States causes futures traders to bid up the price of oil in fear of possible production cuts by these secondary and tertiary players.

The strategy is working so well for the minority oil producers (Iran,Venezuela,Nigeria, and recently Russia) whose combined net exports eclipse that of Saudia Arabia - that instead of investing more money in additional production, they can create market instability and convert their economic model from one of production maximization for the highest revenue to that of profit maximization.

Lets take a few cases of how this is done:

1. ) Russia - reclaiming Sakhalin 2 from BP and moving the infrastructure on its government monopoly Gazprom.

2.) Venezuela imposes huge taxes on access to oil fields in attempt to have foreign oil companies abandon production projects. Reclaims oil territories and subsequently reduces production.

3.) Iran works toward nuclear capabilities creating worry of United States invasion which would cripple oil production in the country.

4.) Nigeria for its on part is so politically unstable, most investment in their oil assets is steered toward other more stable countries.

The real reason for this new strategy is one of complete short-sightedness. Each of these countries is largely unwilling to invest on increasing production capacity. Price manipulation is the short term fix. Unfortunately because the world production capacity is now so close to world consumption, any bad news at all is good news for these minority producers.

Unfortunately there doesn't seem to be any real solution to this dilemma. Saudia Arabia can raise production a little - it has a vested interest as its revenue stream is inextricably linked to United States economic health, which would deteriorate with extreme oil prices. However, Saudia Arabia has no ability to offset production shortfalls in more than any one minority producer at a time.

What is most disturbing is the increasingly friendly diplomatic relations among these minority producers - Iran, Venezuela, Russia. Any sort of cooperation between these three countries could send us into a 70's style embargo situation again.

I'm thinking we might see OMPEC replace OPEC as the major thorn of the 21st century.