10/23/2006 03:31 am ET Updated May 25, 2011

What's Up?? OPEC Agrees To Production Cuts Yet Prices Are Down!

A funny thing happened last week on the way to the oil market casino. The Organization Petroleum Exporting Countries (OPEC), agreed to cut its daily output by 4.4 percent or 1.2 million barrels a day starting November 1. The leading proponent for this surprisingly large production cut (1 million barrels had been anticipated) was spearheaded by Saudi Arabia who agreed to shoulder 380,000 bbls/day of the cutback. Worse, it forecast more to come. As its oil minister, Ali Naimi threatened upon the conclusion of Thursday's meeting "the possibility of another cut is there".

It didn't take long for the media and energy analysts to weigh in. The Financial Times, ever looking for ways to rationalize rising oil prices predicted, "The news is likely to push oil prices sharply higher this morning". Cambridge Energy Research Associates, ever a leading singer in the higher oil price cantata, proclaimed "...sometimes OPEC can surprise. The market is going to be caught off guard today by this decision".

But Friday, miraculum dictum, something unusual happened. Not only did the spot market prices not go up, they actually fell by $l.68/bbl or 2.7%! For once the oil consuming public long conditioned these past years to react with Pavlovian obedience to every OPEC and oil industry's pronouncement that peak oil is at hand, that oil will soon be running out, has, at last, taken a different tack. Why? I believe the market is finally recognizing that oil at current levels is not scarce. This post has long argued, that the oil industry has used the "shortage fiction" to ratchet up oil prices to undreamed of heights. What might, just might, be true at a $10/bbl price point has no basis in reality at the current price level, nor even near current level of oil prices.

It's true that cartels have functioned brilliantly in times of shortage, or perceived shortages of supply. And so it has been with the OPEC cartel. The greater the fear of shortage the greater the ability to drive up prices. But when a commodity--and that is exactly what oil is--goes from shortage to oversupply the dynamics of a cartel begins to erode and the power of a cartel diminishes. Where discipline was readily maintained while supplies are short and prices rising, it quickly erodes in the face of oversupply and lower prices. Producers begin to look to make up the shortfall by violating quotas and moving to increase market share.

Over the last few months the perception has been growing abroad that we have been hoodwinked by the oil industry. That there is far more oil around--and far more new supply coming into production--than we have been conditioned to believe. The scales have fallen from our eyes, and we see that the oil we need is there. Not only is it there with more to come, but storage facilities that are brimming over at levels significantly higher than the five year average for oil and downstream products

Will oil prices continue their decline? Given free market forces and the realities of current supply and demand, they should. But also remember that as OPEC's efforts clearly show, oil is not a freely traded commodity. And the oil interests are vastly powerful and wealthy. They may try to rig many elements of the market to curtail the slide, not least of which is manipulated trading on the commodity exchanges as BP has been accused of doing (see post "Gasoline Over $3.00/ Gallon. Why? BP knows..." 07.12.06) as example.

The government may intervene in some way or other for reasons yet to be imagined. Look at the history: when the oil industry is under pricing pressure our oil industry friendly government has acted forcefully, be it generous depletion allowances, special tax breaks, honeymoon royalty agreements, stepped up purchases for the Strategic Petroleum Reserve (SPR) and so on. When prices are high, government is happy to let us pay up, never putting meaningful policies into place to lessen the oil industry's stranglehold on us, the consuming public.

Promptly after Opec's announcement of their 1.2 million production cut the International Energy Agency, which advises 26 countries on energy policy, said the oil cartel's decision was ill timed because demand will increase as the heating season nears. Executive director Claude Mandil expressed his outrage: "I think this cut comes at the worst time possible. I don't like the idea
of OPEC trying to defend prices of $60 a barrel. That is not helpful to consumer nations and poorer countries."

Compare this to our government's silence, especially the silence of our Depatment of Energy. In saying nothing they reminded us where their true loyalties lie. Clearly, what may be bad for OPEC is bad for the oil industry. And the rest of us be damned.

However, should prices continue to decline and decline significantly from here, a valuable lesson has been learned and experienced. That OPEC, its handmaidens in the oil industry, the oil interests generally, in government and elsewhere, are ravenous in their greed and not to be trusted as suppliers of a vital economic resource. In the march to $78 barrel oil (the price reached on July 14, 2006) they exposed themselves for what they are, and will be again given the opportunity- shrewd extortionists and manipulators. The bottom line is clear. We have all learned an extremely valuable lesson. For our economic self interest alone, we must end our fossil fuel dependency because the oil industry has shown they will take us, the consuming public to the edge of economic catastrophe and beyond any time they can get away with it.

A major reduction in fossil fuel consumption would break the back of OPEC and bring the hubris of the oil patch and its interests back into line. The environmental reasons for reducing fossil fuel consumption are paramount and have been clearly articulated--global warming is potentially catastrophic to us all .

What is not readily evident is that environmental concerns and economic issues in dealing with the oil industry have converged. Much could be gained by an alliance of these interests. By working together to assure that policies are in place that continue our focus on identifying alternative sources of energy and that the volition to reducing fossil fuel consumption continues irrespective of the decreasing price of oil.

Less consumption of oil will have environmental, economic and national security benefits. Less consumption will lead to low oil prices which would be good for the economy, our trade balance and for our national security. Given the nature of those we are dealing with, it is high time we had an energy policy that embraces all these issues not only in our interest but in the interest of future generations.