Are we watching the death of OPEC?

By Jim Jubak

Is this the end of OPEC?

The plunge from $148 a barrel to $50 a barrel in less than five months has opened huge fissures in the Organization of Petroleum Exporting Countries. Some members, such as Iran and Venezuela, are desperate to raise oil prices so they can balance their national accounts. More-conservative members, such as Saudi Arabia, can balance their budgets even at current prices and have room to fear they will be the scapegoats if the global recession deepens.

We've sat deathwatch for OPEC before, but this time the cartel's future looks especially bleak. Its Nov. 29 meeting in Cairo, Egypt, ended with members deeply divided. The Venezuelas and Irans of OPEC have dug themselves into such a big spending hole that their only way out would be for OPEC to raise prices by cutting production while letting the cartel's hardest-pressed members cheat.

OPEC couldn't agree on any production cuts in Cairo but promised to revisit the issue Dec. 17. The burden of production cuts would fall almost totally on the Saudis and other conservative Middle Eastern oil producers. That's why the Saudis didn't buy into that deal in Cairo and why they might balk again. That result could leave OPEC standing but effectively end the cartel's power to change the balance of global supply and demand.

In the short run, that would be great for consumers. In the long run, it would lead to global energy chaos.

Where oil demand is growing

How did OPEC get into this mess? Consumers in OPEC countries are becoming just as addicted to oil as their counterparts in the United States. According to the latest forecast from the International Energy Agency, oil demand from the world's developed economies will fall by about 3 million barrels a day between 2007 and 2030. In that same period, the countries of the Middle East will be one of the three major sources of oil-demand growth in the world. Overall, about 43% of global oil-demand growth will come from China, according to the forecast, with India and the Middle East contributing 20% each.

• Talk back: Would OPEC's demise be a good or bad thing?

It's easy to understand why China's and India's oil demand is growing so fast. They have immense populations -- 1.3 billion and 1.1 billion, respectively -- and emerging middle classes that are just starting to buy cars and the other high-consumption trappings of developed economies.

But the Middle East? Egypt, the most populous country in the region, has just 80 million people. Iran, 70 million. Saudi Arabia, just 27 million. So why are these countries projected to add as much to global demand for oil as India over the next two decades?

• Demographics certainly play a part. These are some of the youngest and therefore fastest-growing economies in the world.

• National investment plans heavily favor oil- and energy-intensive projects, such as chemical plants.

• And subsidies. In 2007, Iran spent almost $20 billion more on energy subsidies than China did. Three Middle Eastern countries -- Iran, Saudi Arabia and Egypt -- make the International Energy Agency's global top eight for energy subsidies in the developing world. Another OPEC member, Venezuela, also makes the top eight. That group is rounded out by China, India, Indonesia and Russia. Subsidize oil prices, and consumers will buy and consume more. Pretty simple.

Governments hooked on oil

The governments that provide these subsidies are even more hooked on oil than their populations are. Politicians in oil-producing countries have gotten used to oil revenue providing the bulk of the national budget, enabling them to keep taxes low and expand services. In Iran, for example, oil revenue provides between 40% and 80% of the national budget, depending on which oil industry analyst you believe. In Nigeria, oil and natural-gas revenues account for 85% of government revenue.

No problem with that -- until oil prices start to fall. Governments that pegged their budgets to $80- or $100- or $120-a-barrel oil are in deep trouble when oil falls to $50. Russia, for example, developed its national budget for 2008 based on $70-a-barrel oil.

According to consulting company PFC Energy, the United Arab Emirates, Algeria and Qatar would be the only OPEC nations able to balance their accounts in 2009 with oil below $50. Saudi Arabia would need oil prices just over $30 a barrel, according to Merrill Lynch, or slightly more than $50 a barrel, according to PFC Energy.

In contrast, Iran needs a price of $90 to $100 a barrel to break even in 2009. And because of President Hugo Chávez's soaring spending on social programs, Venezuela needs an oil price somewhere between $60 and $120 a barrel; the consensus seems to be somewhere around $90. On Nov. 24, Chávez told a news conference that $80 to $100 a barrel would be a fair price.

2 possible solutions

There are really only two ways out of this bind:

• A government could, of course, cut spending and live within its means. (No, I mean it. That's not a joke. Stop rolling on the floor.) That's no more likely among the ranks of oil-producing countries than it is in the good ol' U.S. of IOU.

• OPEC as a whole could cut production, raising global oil prices, while allowing the most hard-pressed countries to cut production only minimally. A cartelwide reduction in production might be able to raise prices, but that wouldn't solve the problem confronting Nigeria, Iran, Venezuela and the like. To fill the hole in their budgets, they need to see oil prices climb and to keep pumping at current rates.

Continued: Taking (another) one for the team?

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