Oil Economics Weekly

Last week's oil news underlined two things that everybody knows or should know. First, crude oil is a market based commodity. Second, OPEC has never controlled oil prices. Many will take issue with the fact that OPEC has never controlled prices, but it is true nonetheless. To effectively control prices you must control production volume. To control production volume you must do so for all of the members of the cartel. OPEC has never done that for any extended period of time. The details will be the subject of a future column. But before you point to 1973-1974 remember it was an Arab Oil Embargo not an OPEC Oil Embargo. Furthermore, the motivation behind the action was political not economic.

The news of the week underscores the problems facing OPEC's thus far feeble attempts to control prices. "It's not my fault," would be a good summary of recent news coming out of OPEC.

Venezuela continues to march toward its goal of achieving 6 million barrels per day production in the next four years. It passed the halfway mark in mid 1996 and has added over one half million barrels per day since then. Energy and Mines minister Erwin Arrieta says that they are producing all of the oil that they can and that it was other countries over producing even more than Venezuela that were at fault for the price collapse. Arrieta has continually expressed no interest in leaving OPEC but rather calls for OPEC to explore methods other than quotas to control prices. What alternatives are there to quotas? None. At best, this is a bid to have an increase in Venezuela's quota at the expense of other countries. Of course every country with the ability to increase its production wants the same thing.

Thursday Arab Gulf papers blamed western countries for the low prices. The West was pressuring Venezuela to overproduce. The UN timed a doubling of the value of Iraq's exports. And industrial countries were trying to exterminate OPEC by developing energy resources outside of OPEC.

Maybe the Gulf papers are correct. A survey reported by Reuters Friday concluded that 1997 non-OPEC production had increased by a million barrels per day over 1996. That's a 2.5 percent increase. The Energy Information Administration in its March Short-Term Energy Outlook has world consumption up almost 2.7 percent for an increase of 1.9 million barrels per day. That means that OPEC could have increased production by almost a million barrels per day to make up the remainder. They didn't. OPEC increased production by 1.6 million barrels or 5.7 percent. The balance of the oil went into increased petroleum stocks which are nearing capacity. This doesn't look like a Western conspiracy to destroy OPEC. Of course most of the increase in world demand did come from Asia.

If OPEC wants to control oil prices it needs a long term policy. That policy is rather simple in its structure but not quite as easy to implement. OPEC needs to examine the cost of other sources of energy including non-OPEC crude oil. Then it must set its production high enough to keep prices below the level that would encourage development of those sources. Of course, the ongoing problem remains that OPEC must have a mechanism to control its total output and it needs to get all member countries to accept the prices and volumes that would result.

James L. Williams
WTRG Economics http://www.wtrg.com