OPEC Theater: Does the much-maligned cartel really have the market power it's claimed?

• Author: Kemp, David

There is perhaps no economic indicator more potent in American politics than oil prices. When prices soar, gasoline price hikes are advertised on street corners and felt by consumers at the pump. Plummeting prices aren't great either because they can lead to domestic bankruptcies, layoffs, and the turning of oil field boom towns into ghost towns.

In the scramble to do something about oil prices, the ire of the public, media, and politicians is frequently directed toward the Organization of Petroleum Exporting Countries (OPEC). Consisting of 13 member nations accounting for about 40 percent of global crude oil production (including Saudi Arabia, which alone accounts for about 13 percent), the widespread perception of OPEC is that it controls oil prices by changing the amount of oil its members produce.

Last year, for example, OPEC and its allies (10 oil-producing non-OPEC countries including Russia, collectively known as OPEC+) angered U.S. commentators and politicians after announcing a cut in oil production. Through the summer of 2022, amid the Russian invasion of Ukraine, oil prices rose to their highest inflation-adjusted level in nearly a decade, over $120 per barrel (even though OPEC+ production targets had cumulatively increased by more than 2 million barrels per day between December 2021 and May 2022 as the world recovered from COVID). Despite pressure from Western leaders to further increase production, including during a visit by President Biden to Saudi Arabia in July, in October 2022, as oil prices fell to a little over $90 per barrel, OPEC+ announced a decrease in their targeted production level of 2 million barrels per day.

The move was seen as a snub to the United States and Biden and a decision by Saudi Arabia to align with Russia. Editorials in the Washington Post and Wall Street Journal criticized Biden, calling the situation a "failure" and a "diplomatic humiliation," while a New York Times opinion headline claimed Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman were "laughing at us." Though Saudi Arabia claimed the move was purely economic, members of Congress introduced legislation to punish the Saudis by ending arms sales and allowing lawsuits against OPEC for price fixing. The Biden administration said it was going to re-evaluate the U.S. relationship with Saudi Arabia and that there would be consequences.

The whole affair raises questions about what OPEC does and whether the common view of OPEC is correct. The lack of enforcement and frequent cheating on OPEC quotas by members suggests that it is more a political club than an effective oil cartel. In fact, from 1993 to 2022, the production volatility of three key OPEC members--Saudi Arabia, Kuwait, and the United Arab Emirates (UAE), whose production levels are determined by monolithic nationalized oil companies--was rarely different from that of the United States and its decentralized oil industry.

OPEC membership has less to do with oil production and more to do with geopolitical and domestic political benefits. OPEC nations appear to use oil production as an international bargaining chip to provide the regimes with domestic legitimacy. Politicians in western nations like the United States are more than happy to play into the perceived role of OPEC in oil markets because it provides them with a convenient scapegoat. When oil prices skyrocket--a result that politicians cannot control--they respond by calling on OPEC members to change their production, like rounding up the usual suspects in Casablanca.

WHAT CAN OPEC DO?

Popular discourse about OPEC emphasizes quota announcements and market power. Allegedly, OPEC members--especially Saudi Arabia--can decrease or increase oil production in the short term as easily as one would vary water flow from a spigot. Moreover, OPEC nations supposedly could invest in their oil fields and produce more in the long run. But there are some serious problems with this story.

Changing production In the short term?/ An oil reservoir is a formation of porous rock where oil has accumulated and is trapped by surrounding non-porous rock. The oil is extracted by drilling into the reservoir and allowing it to flow to the surface, initially driven by natural pressure and then forced to the surface through artificial methods like pumping or injecting water or gas (such as carbon dioxide) into the reservoir.

Petroleum engineers consider various factors, including the oil's viscosity, the permeability of the rock, and the natural reservoir pressure, when they plan reservoir development. Oil wells and reservoirs follow a typical production path: the production rate peaks early, plateaus, and then declines because reservoir pressure drops as oil is extracted. This is known as the "decline curve." The rate of decline depends on the geological factors and can be moderated with technology (e.g., pumping, injecting water or gas, and enhanced oil recovery techniques) but ultimately cannot be prevented. Because production from individual oil wells and reservoirs declines, simply maintaining a constant rate of oil production requires the drilling of additional wells and the development of new reservoirs, and increasing the rate requires even more drilling and development.

Furthermore, while technology can sometimes be used to temporarily increase production, prolong an oil field's production plateau phase, or moderate the decline, it requires additional investment and involves temporal tradeoffs. For example, maintaining a field's plateaued production level for longer typically leads to a higher rate of decline when the plateau phase finally ends. One extreme case of these tradeoffs is Mexico's offshore Cantarell field. As Cantarell's production rate began to decline in the 1990s, Pemex, Mexico's state-owned oil company, invested in a nitrogen injection project to maintain the reservoir pressure. This brought the field's production up to a peak of more than 2 million barrels per day in 2004, making it the second most productive field in the world. But production then crashed...