Tuesday, January 08, 2008

OPEC's Strategy

For many years there was a general sense in the oil world that OPEC had learned an important lesson from the energy crisis of the 1970s: let the price get too high for too long, and their customers will find ways to reduce their demand, by becoming more efficient and switching to other fuels. Until recently, analysts and pundits liked to guess at whether $50, $60 or $70 per barrel constituted the level at which that worry would kick in again, and the floodgates of supply would open. A snippet in Sunday's Washington Post started me wondering whether this paradigm were not only outdated, but has actually been supplanted by a new strategy of near-term revenue maximization. What if, aside from the serious challenges impeding the construction of enough new production capacity to keep up with rapidly growing global demand, OPEC has considered the implications of our growing concerns about climate change and energy security, and concluded it only has a few decades left in which to extract the most value from its resources?

While I read with amusement the satirical conspiracy report from former CIA Director James Woolsey in the Post's Outlook section, I don't imagine OPEC frets much about the prospect of food-based biofuels eroding their market share and profits. The entire 15 billion gallon-per-year "conventional biofuel" (a.k.a. corn ethanol) mandate in the new US Renewable Fuel Standard will add less than 400,000 barrels per day of oil-equivalent volume to a world market currently running at 85 million barrels per day , and cellulosic ethanol is not yet ready for prime time. OPEC can do their sums as well as we can, and they can see that with China and India growing as rapidly as they are, there is ample room for both oil and biofuels. However, they might not be so sanguine about the prospect of a serious effort to reduce greenhouse gas emissions by 70 or 80% by mid-century in the US and Europe.

What would emissions reductions of that magnitude mean for oil producers? Well, the EU and California--assuming it wins it suit against the EPA--are targeting specific tailpipe CO2 reductions that would require cars to consume 20-30% less fuel than the current fleet, within a few years. That will be achieved through a combination of hybridization, dieselization, downsizing, and the incorporation of other efficiency technologies. If the rest of the US follows California's lead, or even just meets the new 35 mpg CAFE standard, then together with Europe we're looking at several million barrels per day less consumption in 10-15 years, and that's just the beginning. Furthermore, the introduction of plug-in hybrid cars opens the door to a more serious potential competitor to oil than biofuels: electricity. And since oil accounts for a small and declining share of the world's electricity generation, that's a game in which OPEC won't participate, though it will benefit some OPEC countries like Iran and Algeria that are also large exporters of natural gas.

So if OPEC is facing a demand curve that may be going up today, but looks like it might peak within a decade, how worried should we suppose they are about the possibility that high prices might prematurely destroy some of that demand, compared with maximizing their cumulative oil revenue before the carbon era ends? If greater fuel efficiency and lower oil consumption are inevitable in the long run, anyway, why wouldn't they want to generate the highest possible income today, even if it accelerated that trend?

An editorial in this week's Economist suggests that high oil prices owe more to "peak nationalism" than Peak Oil. That's a theme to which I've devoted a lot of space for the last four years. Resource nationalism has been building for at least a decade, for reasons having little to do with concerns about climate change. But having found their way to a world of oil prices higher than they could have realistically hoped for not long ago, producers have ample reasons--including the idea that oil might go out of fashion sooner than previously expected--to want to remain there. We shouldn't delude ourselves that OPEC's interests and ours are aligned.

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