Are we watching the death of OPEC?

The problem confronting OPEC is that it increasingly looks like it would take huge production cuts to just stabilize the price of oil. OPEC agreed to cut production by 500,000 barrels a day in September and then an additional 1.5 million on Oct. 24. It now looks like those two promised cuts -- not completely carried out -- reduced production in November to 30.98 million barrels a day, down from 32.2 million barrels a day in October.

Even cuts of that magnitude haven't stemmed the decline in the price of oil, however. And now some OPEC members are calling for production cuts of at least 1 million more barrels a day and perhaps as much as 2.5 million.

Taking (another) one for the team?

The burden of the cuts so far has fallen most heavily on Saudi Arabia. The Saudis accounted for about 44% of November's projected production cuts. And as OPEC's biggest producer, Saudi Arabia would be expected to pick up the bulk of the next round of cuts, too. The Saudis produced 9.45 million barrels a day in September. That's roughly a third of OPEC's total production.

OPEC's Nov. 29 meeting showed that the Saudis aren't yet willing to step up to the plate with another 500,000- to 1-million-barrel-a-day cut in production at a time when the government is announcing cancellations and delays in its plans to diversify the Saudi economy. Adding up all the cuts actually delivered showed that OPEC had cut production by only 850,000 to 1.2 million barrels a day instead of the 1.5 million promised in October.

And the Saudis seem convinced that Iran, OPEC's second-largest producer, and Venezuela have cut their output by less than they claim. No wonder that the Saudis wanted to wait for more production data before agreeing to further cuts. If what the Saudis hear, or think they hear, is that they've made cuts but that other OPEC members have reneged on their promises, then you can expect them to agree on Dec. 17 to cuts that are much less than Venezuela and Iran are talking about.

The Saudis also got in a not-so-subtle dig at Iran and Venezuela at the Cairo meeting by calling for a $75-a-barrel price for OPEC oil. That would be a huge improvement from current levels but noticeably short of the target championed by Venezuela and of the $90 to $100 a barrel that many experts believe Iran and Venezuela need to balance their budgets.

OPEC's inability to agree on any additional production cuts in Cairo means oil prices will fall further and that the problems confronting the governments of oil producers such as Nigeria, Venezuela and Iran will ratchet up toward crisis. That would pressure OPEC to do something dramatic at its Dec. 17 meeting.

Where Russia fits in

At the same time, the lack of production cuts in Cairo will increase short-term pressure on Iran and Venezuela to cheat on the October production targets and keep production above quotas. (Due to a near civil war in its oil fields, Nigeria's production is falling with or without OPEC quotas.) That, in turn, will make the Saudis even less likely to want to cut production to bail out OPEC members who haven't kept to their quotas.

Even though it isn't an OPEC member, Russia will play a big part in deciding how the future of OPEC plays out. Russia, which produces roughly as much oil as Saudi Arabia, has made noises about coordinating its production policies with OPEC. So far, those noises are exactly that, and the country shows no signs of following OPEC's lead by intentionally cutting production. The sight of a non-OPEC Russia taking advantage of improvements in oil prices created by Saudi Arabia's cuts in production will just increase Saudi resistance to disproportionately sacrificing for the profit of others.

If the September and October production cuts don't do the job (and almost nobody in the oil industry thinks they will) and OPEC goes into its Dec. 17 meeting faced with tumbling oil prices and massive quota flouting, the cartel could slip into public disagreement. An increased level of suspicion and recrimination entering 2009, a year that will see massive budget distress for many OPEC countries, could make it impossible for OPEC to agree on any course of common action.

A shadow of its powerful self

That wouldn't be enough to cause the formal breakup of OPEC. But it would be enough to reduce the cartel to a powerless shell. OPEC might effectively break up into regional or ideological subgroups, each pursing its own market agenda. A further breakdown could see individual oil producers inside and outside OPEC pursuing strategies based only on self-interest.

Consumers around the world would cheer at the breakup of OPEC or even at its devolution into a powerless shell organization. Without OPEC, individual oil producers would pump as much oil as they could in the short term, and oil prices would fall.

That's not good news, of course, for companies that make their money selling oil field infrastructure, because lower oil prices would mean less money to invest in oil field development. It would be really bad news for companies developing more-expensive unconventional sources of oil because they couldn't make a profit competing against cheaper oil. And it would be potentially devastating to emerging alternative-energy technologies, which would be forced back into reliance on government subsidies at a time when governments have plenty of other things to do with their money.

If you believe in some version of peak oil, which I do, then a post-OPEC free-for-all in the oil markets looks like a disaster. As it becomes more and more expensive to extract conventional and unconventional oil, the world is already looking at a bad case of underinvestment. The International Energy Agency has warned that a huge supply crunch awaits the world on the other side of the current supply glut because of underinvestment in new supplies of oil. Lower oil prices would just make that underinvestment worse.

Continued: Developments on past columns

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