For much of its 47-year existence, the Organization of the Petroleum Exporting Countries (OPEC) has been a cartel in name only. It could not, in practice, control oil prices because many of its members regularly breached the production quotas that were intended to regulate the market. So OPEC generally followed oil prices up and down, as supply and demand conditions shifted. But now OPEC may be the real deal: a cartel that works. If so, that's bad news for us.
Look no further than last week's OPEC meeting in Vienna. Oil ministers declined to increase production despite a fairly obvious case for doing so. Not only were oil prices fluttering just above $100 a barrel, but the United States is either in or near a recession and much of the rest of the world faces a noticeable economic slowdown. The OPEC ministers were unmoved. Indeed, they indicated that they might actually reduce production if weak demand-presumably reflecting weak economies-threatens to depress prices. Not good.
What's wrong is that a fall of oil prices is one of the mechanisms by which a recession or economic slowdown corrects itself. Lower prices for gasoline, home heating oil and diesel fuel improve consumer purchasing power. They muffle inflation and increase confidence. In this sense, they're an important "automatic stabilizer" for a faltering economy. If the automatic stabilizer is disarmed-or, worse, transformed into an automatic "destabilizer"-then the slowdown or recession may get worse.
Oil producers don't much care. High prices have been good to them. Since 1999, annual oil revenues for OPEC countries have more than quadrupled, to an estimated $670 billion in 2007, says energy economist Philip Verleger Jr. What's less clear-to experts, at any rate-is whether OPEC has merely benefited from good luck (tight oil markets) or has acted as a true cartel, restricting output and raising prices. The right answer is: both.
Of good luck, there's little doubt. Two massive oil miscalculations both aided OPEC. First was a widespread underestimate of world demand, especially from China. Since 1999, China's oil use has almost doubled, to 7.5 million barrels a day (mbd) in 2007. (In 2007, world oil use was 86mbd, up 13 percent from 1999. American oil use was 20.8mbd, up 7 percent.) Second was an overestimate of supply. War, civil strife and nationalization have depressed production in Iraq, Nigeria, Iran, Venezuela and elsewhere. Total global capacity might be 4.5mbd higher without these setbacks, says the Energy Policy Research Foundation (EPRINC), an industry research group. The combination of higher demand and stunted supply has pushed up prices.
But that's only the half of it. Go back to late 2006. Crude prices were slipping from about $70 a barrel in August toward $50 a barrel (a level that, a few years earlier, seemed astronomical). A true cartel would cut production to prop up prices. That's what OPEC did. In two steps, it reduced oil output by about 800,000 barrels a day, notes economist Larry Goldstein of EPRINC. "By July, 125 million barrels of oil inventory had been wiped out," he says. At the end of 2007, inventories (measured by days of supply) were at their lowest point in three years. Prices rose. Without OPEC's supply cuts, they wouldn't now be at $100 a barrel.
OPEC's present market power dates to early 1999, says economist Verleger. Oil prices then were about $10 a barrel. The 1997-98 Asian financial crisis had cut demand; supply was essentially unregulated. Saudi Arabia undertook frantic negotiations with other major producers, including Iran, Kuwait, Venezuela and non-OPEC members Russia, Norway and Mexico. The result was an agreement to cut production sharply. Compliance with output quotas was surprisingly good; countries were terrified by the collapse of their oil revenues. "That's when OPEC started acting like a cartel," says Verleger.
To some extent, we are paying for past shortsightedness. Dependence on oil imports, now almost 60 percent of our supply, is inevitable. We simply use too much and produce too little. But we could limit OPEC's market power by curbing our demand and increasing our supply. As the worldwide gap between supply and demand rises, it becomes harder for producers to control the market. More have spare capacity; more are tempted to increase production to raise revenues. Controlling supply today is easier because most producers are operating near their potential. The surplus is concentrated in a few countries, especially Saudi Arabia, which can adjust production to influence prices.
The American approach is to rant at foreign producers on the silly presumption that they should subordinate their interests to ours. The resulting self-righteousness rationalizes a refusal to do much that would actually influence their behavior and limit their freedom of action. It was only last year that Congress raised fuel-efficiency standards for new cars and light trucks: the dampening effects on oil consumption will be years in coming. We have steadfastly rejected higher gasoline taxes to curb unnecessary driving and strengthen demand for fuel-efficient vehicles (better to tax ourselves than let foreigners tax us through higher prices). And we have consistently restricted oil drilling in Alaska and elsewhere.
It is a fair commentary that, by doing so little to check its own thirst for imports, the United States has unwittingly contributed to OPEC's present triumph. The extent of that triumph will be tested this year and next. The U.S. Department of Energy projects that non-OPEC oil supplies-from Brazil, Canada and Kazakhstan, among other places-will increase. Meanwhile, a weaker global economy may dampen demand. Even OPEC may be unable to hold prices at today's high and undesirable levels. Whatever happens, the long-term threat of a global oil cartel will remain. We should be taking the hard steps to limit its power. Considering our past complacency, we probably won't.