The price of crude oil has fallen to a level at which it is causing acute financial pain among OPEC states which rely on the oil rent to pay their bills. Later this month, the organization will address these issues at a meeting in Vienna, but the oil ministers would do better to save the air fares. The business model of the cartel is utterly broken. Its market share is shrinking; demand for oil is weak and the organization is driven by conflict.
Saudi Arabia is the only OPEC member that has the economic power to even contemplate a big cut in export volumes. But the Kingdom has little reason to make the sacrifice and arguments why it should continue to fight for its share of the market and undermine its competitors.
The world has changed; oil consumption is over the hill in Europe and America, where demand peaked in 2005. The oil market is no longer global. North America is awash in oil and Europe is stuck in low gear. The only place where demand is still rising significantly is Asia and its biggest motor, China, is slowing down. China's growth in economic output retreated to a five-year low in the third quarter. Expansion of the car fleet is slowing and China's oil demand growth is weakening.
That is acutely worrying if you are a one-horse economy and the biggest player in the bizarre club that is the OPEC cartel. The OPEC nations might seem to be sophisticated manipulators of prices but at a fundamental level, OPEC is more like a collection of street gangs whose objective is to capture an economic rent and who periodically engage in turf wars to protect the flow of cash on which, like drug addicts, their populations depend.
OPEC has been unable to maintain consistent output discipline since the 1990s when Saudi Arabia last tried to kill competition by flooding the market with crude. With the oil market fragmented and weakening demand, Saudi Arabia's problems are even greater today. Moreover, OPEC is full of casualties, nations that are politically chaotic and in economic terms, deeply vulnerable to the collapsing price.
Iraq is at the heart of the mess. The oil minister, Adel Abdul Mahdi, recently told the Iraqi parliament that the country faces bankruptcy if government overspending continues. The budget for 2014, predicated on a $90 (U.S.) oil price, was $26-billion in deficit, which has risen to $84-billion. Iraq needs an oil price of $106 to break even. However, after Thursday's market plunge, oil seems to be heading in the direction of $70. Yet, the country cannot afford but to keep the taps wide open, selling every barrel it can squeeze out of the ground.
Instead of supporting higher oil prices, Iraq's civil war is having the opposite effect. The fragmentation of the country and the region is boosting oil output: the Islamic State gangsters are selling crude for cash to any willing buyer; the Kurdish Regional Government seems to have abandoned any pretense of economic loyalty to Baghdad and has taken control of northern oil exports. Output through the pipeline to Turkey, currently 300,000 barrels per day, is expected to rise to 500,000 in early 2015.
The political and economic dismemberment of Iraq is a nightmare for Saudi Arabia, both in the threat it poses to Saudi Arabia's oil markets in Asia and the opportunity it offers for Iran, sworn enemy of the Kingdom, to expand its political influence in the region. The Iranian government is openly providing military assistance to Baghdad, raising the prospect of de facto Iranian control in the oil-producing region in the south of Iraq.
In the circumstances, Saudi Arabia has every incentive to carry on loading as much product as possible into Very Large Crude Carriers bound for India and China. In a world in turmoil, being a reliable and good-value supplier is worth something. It may also stimulate appetites in economies where the cost of energy is a critical factor, and if it denies economic opportunity to a financially-challenged rival or an enemy, so much the better.
In such a world, OPEC is redundant. The organization emerged in the 1960s and had its heyday during the 1973 Arab oil embargo when the crude price quadrupled and European countries were forced to ration gasoline. Back then, OPEC accounted for about half of total world oil output, but that share has dwindled to less than a third and is falling rapidly. The organization last week acknowledged in its annual World Oil Outlook that demand for OPEC crude would decline by 5 per cent by 2018 due to rising shale output.
Of course, low prices will take their toll on investment in new oil production and that is part of Saudi Arabia's logic. It may take some time, however; the oil industry is notoriously lax in its spending habits and the shale producers will cut their cloth to suit a leaner fashion. Existing shale wells can continue pumping at prices as low as $40.
OPEC was born in a globalizing oil market. It is now at risk of disintegration in a market ripped apart by technological change. For a brief period it served its purpose, seizing power from the multinational oil companies. But instead of delivering economic prosperity to oil-producing nations, its legacy has been economic dependency, authoritarian government and political stagnation. It should be disbanded.