Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.
On Friday, Paris was full of people trying to change the world and Vienna was full of people trying to cope with a changing world. This is not a coincidence.
As the latest round of global climate talks were drawing toward the end of their first week, OPEC's ministers were talking about what to do about $40 oil. The truth is there's precious little they can do right now -- which is why they effectively did nothing on Friday. But if delegates in Paris cheer at OPEC's impotence, they aren't considering all the implications.
OPEC's world has been turned upside down. Its power as a cartel derives from the notion that it holds the lion's share of a finite set of an essential commodity, oil, as well as most of the world's swing capacity. Both those assumptions can no longer be taken for granted.
Oil's finite nature has proven remarkably slippery. Peak Oil theories dictate that there can only be so many barrels beneath the ground, and at some point the world will have pumped more than half of them, and it's all downhill from there. But how many barrels are available is a function of money as well as rocks: If you make it cheaper to get at barrels, then more of them "exist." Consider that since 1980, the world has produced just under 900 billion barrels of oil -- and its proved reserves actually went up by just over 1 trillion barrels in that time.
Are some countries overstating their proved reserves? Probably. Yet there's a recent example of new oil reserves suddenly showing up that is hard to overlook: Advances in technology, financing (particularly the use of hedging to raise capital), and operational efficiency have made a mockery of the notion that U.S. oil production is in terminal decline.
At the very least, this offers tangible evidence that, with enough effort, supposed geological truths about who has access to oil and who doesn't can be overturned. The shale boom brings its own problems, of course, most notably the risk of environmental damage and an impending crash in high-yield debt as overlevered exploration and production firms struggle amid low oil prices.
OPEC can't count on those issues to solve its problem, though. Environmental concerns could conceivably halt shale exploitation; but the record to date suggests that regulations will tighten, but not to the point that fracking halts completely. History also shows that the bursting of financial bubbles certainly shakes out industries, but doesn't necessarily destroy them -- as anyone who uses the railroad, the internet, solar panels or, yes, oil can tell you.
So OPEC now lives in a world where the value of its barrels in the ground won't necessarily just go up over time as everyone else's reserves run out. Worse, it has watched as rival producers have worked hard to push down the cost of their production. Instead of being a monopolistic cartel holding supply off the market in order to extract higher prices from addicted consumers, OPEC is in a more competitive environment where it must fight for market share. If it cut output now, it would merely create room for others to fill.
By standing firm, Saudi Arabia in particular can at least hope that low prices will squeeze some investment out of the global oil industry and thereby help it regain some market share and set up the next upswing in prices. Yet such hopes must also be tempered by the knowledge that, because oil doesn't look so finite anymore, any upswing will likely be capped as higher prices bring rival barrels back into the market.
Those talks in Paris add to this pressure. Almost exactly a year ago, Saudi Arabian oil minister Ali al-Naimi had this to say at a gathering of his peers:
“Is there a black swan that we don’t know about which will come by 2050 and we will have no demand?”
It is easy to scoff at the idea of the world weaning itself off oil dependence, but the important thing to remember is that OPEC now cannot afford to simply scoff. The Paris talks may contain a large measure of theater, but they still represent the latest in a grinding process of legislative, technological and financial innovations that work against oil and encourage rival energy sources. The latter don't just include electric cars. They also include natural gas -- and guess what, there's a glut of that, too.
OPEC doesn't actually need the black swan of "no demand" to suffer. It just needs demand for oil to stop growing. Oil prices began tumbling last year not because of a lack of demand, which actually went up by more than 800,000 barrels a day. They fell because demand was swamped by non-OPEC oil supply rising by 2.1 million barrels a day.
Sure, non-OPEC supply will likely have fallen this year and will fall further next year. Yet that may offer only temporary relief for OPEC, because it can no longer necessarily count on monopolizing the sources of future oil production. And apart from competing with rival oil producers, it must now factor in the growing competitive pressure among different energy sources, as concepts like fleet electrification start nibbling at the barriers that long protected certain markets for certain fuels (like oil for cars and coal for power plants).
So, given all this, why should environmental advocates in Paris keep their champagne corked? Because one of the biggest favors OPEC ever did them was to lose control of the oil market a decade or so ago and unleash triple-digit prices, a powerful incentive for every alternative energy source available, including efficiency gains. And now, with fossil fuels still by far the largest source of energy on the planet, OPEC has awoken already to the deflationary threat posed to its oil reserves -- which gives it an equally powerful incentive to pump more today rather than wait for tomorrow.
The upshot is that oil will by default fight back in this nascent, but intensifying, battle for the global energy market with lower prices. That is not great for oil bulls. But, as the chart below hints at, it also raises the competitive bar for the renewable energy industry.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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