Monday, December 8, 2014

OPEC's changed strategy

Okay, I understand that this is Smart Grid Realities, and that this interrupts my discussion of Net Metering, and that what OPEC is doing might seem a bit out of my usual area of discussion, but I think there is a connection between the larger efforts of which Smart Grid is a key component and what is happening in oil prices, and having put this down in writing, it seemed appropriate to fling it out into the ether for comment.

It may sound la bit like the kind of tinfoil-hat conspiracy theorist stuff that I have derided elsewhere, but this supposition is based on a very simple, perhaps simplistic, observation:
  • In the past, when oil prices have fallen, OPEC member states have reduced production, particularly after their annual meeting.  This is the economically rational action of any effective cartel, when prices fall, you reduce production to maintain scarcity and push those prices back up.
  • This time, after OPEC's annual meeting, member states have maintained their production levels, and may have even increased production. (It's a little too soon to tell if there is a planned increase, as production does normally vary a bit, but it is clear that nobody in OPEC is intentionally backing off production.)

The question is: Why?  What is the change in thinking that is driving the change in action?  I have a theory, and it is based on the same kind of "how would a cartel rationally operate" thinking.

In the major markets for oil, an extended period of high prices for fossil fuels has helped push the development of alternatives to fossil fuels, and the search for more "friendly" sources of those fuels.
  • In the former category are things like solar (both PV and direct thermal), wind generation, electric vehicles, and even some resurgence of nuclear.  
  • In the latter, we have electric and natural gas vehicles (since electricity from fossil fuels and CNG is often from a domestic supply of fossil fuel), fracking*, shale oil*, and its transportation*.
* Please note, I'm not talking about the morality or environmental impact of these energy sources, merely the fact that high international oil prices have made them more economically viable, and therefore pursued.

There have been other influences, but rising international prices for a barrel of crude oil have certainly played a part.

These alternatives to fossil fuels (including crude oil) all have technological legs because the core product - energy is pretty fungible.  If you need energy, and have the technology to use different forms of energy, the products become pretty interchangeable.

Finally, the world demand for energy is increasing, even as the demand for international crude oil is falling a bit.

With me thus far?  Good.

Now this assumes that the folks over at OPEC aren't dumb.  (Whatever else you may think of them, "stupid" isn't an accurate description.)  Many of these alternatives are in their market infancy, and will be harder to dislodge if they are allowed to grow to maturity.

So how does a rational cartel respond when:
  1. The overall demand for your core product (energy) is increasing.
  2. The demand for your specific product (crude oil) is stalled or even in decline.
  3. The decline is, even in part, attributable to the development of alternative sources for the core product among your biggest customers?
Under those conditions, a rational cartel will take a reduced profit, or even a loss in the short term, in order to starve the alternatives out of the marketplace for lack of interest.  Price low, undercut your competition, take a short term loss to maintain your market power.  Once the competitors are driven out of the market (or the public eye), go back to your previous pricing plans.

In short, I suspect that the brains at OPEC realized that they needed to keep production up, and let prices fall, so that their competitors (who don't have the resources to sustain the loss as long) fall away.

The economic impacts have already begun.  Look at the stock prices of the shale-oil producing companies in North America.  They're starting to drop, because the cost of a barrel of crude oil in the international marketplace is perilously close to their cost of production.

If I'm right on this, we need to keep up our efforts at seeking alternatives to crude oil and fossil fuels, including the technologies that make up part of the realities of Smart Grid, even if the short-term economics don't seem to be working out, because it will save us from getting massively gouged later.

1 comment:

  1. Our financial system focuses on the very short term. OPEC, in the mid to long term, will win; the US and emerging technologies in energy production and utilization will lose, sad to say.