Energy Watch

How OPEC overplayed its hand in the 1970s

OPEC’s only a shadow of what it used to be
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The latest slump in the price of oil seems to signal the final end of the golden age of oil and has a profound impact on many fronts – from global geopolitics and economy to development in Africa. And it all started in the 1970s.

Living and working as a Washington correspondent during the late 1970s at the peak of the oil crisis I experienced at first hand the depressing influence of gas (petrol) rationing, long queues at gas stations and the impairment of mobility on the American psyche.

Suddenly the official at the South African embassy with his tiny Japanese car, which he could fill up with $5, appeared to be a wise man rather than a bit of a freak. The woman who stuffed a pillow under her dress to appear pregnant to jump the queue at the pump and then have the pillow drop out, made it onto national TV news.

Little did I realise at the time that I was experiencing the beginning of the end of an era dominated by the ‘oil economy’ or anticipated the spirit of ‘never again!’ that would take hold of the US.

Now, 35 years later, some market commentators are of the opinion that the latest evolving market dynamics may cause oil to be viewed increasingly as a “20th century commodity” in the global economy. Factors like alternative sources, more efficient technologies in exploration and consumption and the development of renewable energy have broken oil’s stranglehold on the world.

In an article last week for the website Barry Aling writes: “OPEC’s decision to exercise its cartel power in the early 1970s, which resulted in a quadrupling of the price in just 24 months, kick-started a process of substitution and utilisation efficiencies that has continued, almost uninterrupted, throughout the intervening four decades.

“While oil’s short-term demand inelasticity caused a significant lag for such processes to take effect, the trend towards a lower ‘oil-intensity’ of the global economy has been inexorable since 1975 despite wide swings in the oil price.

“Global oil consumption in 1975 of 19.8 billion barrels corresponded to a global GDP figure of $18.58 trillion, expressed in constant 2005 $, equal to an oil/GDP ratio of 1.07 bbls/$ but by 2013, this ratio had fallen by 44% to less than 0.6 bbls/$.”

A new reality

A complex set of factors, like strong Chinese growth (now slowing down considerably), geopolitical disturbances in North Africa and the time it took for American hydraulic fracturing and shale gas-related production to come onstream, saw a fivefold increase in oil prices between 2 000 and 2008. It peaked at $145.61 per barrel in July 2008 in what now seems to have been a watershed moment.

“Advances made over the last decade in the recovery of unconventional resources, notably from hydraulic fracturing of ‘tight oil’ formations represent the ‘game-changer’ in global oil supplies while the ongoing process of substitution and application efficiencies are making a significant impact on demand growth,” writes Aling.

Quite apart from competition for the OPEC cartel from new entrants to the market in recent years, like Brazil and Angola, U.S. oil production has been increasing monthly at an average of 62 000 bbl/d since 2010. American authorities forecast that previous production highs, set in the 1970s, will be surpassed before the end of 2015.

Since the 1970s the use of oil for electricity generation has also virtually been eliminated in the economies of the Organisation for Economic Cooperation and Development (OECD) member states, replacing it by coal, gas and renewables, which are also incentivised and driven by concerns about global warming.

And the transport industry in particular, which accounts for 64% of oil use globally, has seen significant efficiency gains. While the number of vehicles globally has increased by 3.5% annually between the 1970s and 2012, its oil consumption has only grown by 1.6%.

Overall OPEC’s ability to manipulate the oil price by virtue of the near-monopolistic hold it has had over supply to the market has largely evaporated over the last four decades. Going forward, oil prices seem destined to follow more classic market principles of supply and demand.

Wider implications

Against this background of greater competition and prolonged excess supply capacity in the global supply chain, a prolonged period of oil prices below the $100 per barrel can be expected.

This has, among other things, the implication that the proliferation of discoveries of oil and gas reserves – 30% of global discoveries in the last five years – on the African continent, might not be as big a development boon as originally anticipated.

It might also impact on the financial viability of the development of renewable sources of energy, having to compete against cheaper oil. And could also see coal-exporting countries, including South Africa, find prices of their commodity under pressure since historically international coal and crude oil prices tend to correlate.

Already in recent months, the lower oil and resultant lower fuel prices have seen a reversal of the trend towards smaller and greener hybrid vehicles in the American automobile market.

On both the economic and geopolitical front these developments in the oil markets could hardly have come at a worse time for Russia. With its economy already badly affected by American and European sanctions over development surrounding the Ukraine, prolonged low oil prices could see it slip into recession.

Its exchange traded funds (EFTs) are energy-heavy and Russian finance minister, Anton Siluanov, recently said the country will grow by less than 1% in 2015, even if oil prices hold steady at present levels and sanctions do not expand. But a recession is inevitable if the oil price dips further to $60 per barrel.

The new ‘oil reality’ also impacts on the geopolitical front. It leaves the Russians with less leverage in the renewed tension with the West. Threats to cut off oil and gas supplies to Europe could, as happened with OPEC, just serve to speed up plans for an energy supply line from Africa, which is already in the offing.

On another front, if the Islamic State (ISIS) does disrupt the supply of oil in the West-Asia/North Africa region, especially from Iraq, it could speed up the seemingly endless negotiations with Iran in the nuclear/sanctions standoff to see it return as a meaningful exporter of crude.

The flexing of its oil muscles by OPEC in the 1970s has set a process in motion which, 40 years later, stripped it from the position of controlling the game-changing levers on the global stage.

by Piet Coetzer

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