EIS Idea — June 11, 2007: It's Called Hoarding

In days of yore, oil exporting countries produced as quickly as they knew how. After all, it only cost a dollar or two per barrel to bring the stuff up and it sold anywhere from $10 to $30. So present value analysis said convert it into cash ASAP for maximum return.

Then producers formed OPEC to keep prices closer to the top end of the range than the bottom by asserting production discipline. Problem was, every Oil Minister wanted all his peers to restrain their production so he himself could sell all he wanted at the higher price, i.e. there was a lot of cheating. So for many years the wise heads of Wall Street called OPEC a failed cartel. Some said all cartels are doomed to failure.

But guess what's happening now that oil is in the $50 to who-knows-what range? All of a sudden OPEC is discovering discipline. Has the nature of the humans who make up OPEC changed? Doubtful. What has changed is the business model. Suddenly the Oil Minister sees the future differently. Instead of assuming that future oil prices will fluctuate in a relatively narrow range, he sees the price trending ever higher. In that world, present value analysis says to slow down production today to save it for a day when it is valued more highly. (Incidentally that is exactly why the U.S should not be developing oil in the ANWAR now.)

If you could draw a line between yesterday's OPEC mindset and today's, and then extend it into the future, you can see tomorrow's OPEC mindset. That's when OPEC countries on their own, without OPEC pressure, make laws restricting the amount of oil that they will pump. Kuwait has already passed a law restricting production to a percent of "reserves" which is a number controlled by the state. Russia is restricting production by withholding funds from the development of their Siberian oil deposits. And on June 6th, the Secretary General of OPEC, Mr. el- Bardi announced that OPEC would "rethink" their plans to expand capacity beyond 2012.

The fig leaf that Mr. el-Bardi is using to justify OPEC's new plan to avoid expanding production is doubts about future oil demand in view of current efforts by the West to develop alternative fuels and to restrict demand though higher mileage requirements for cars. While such concerns are semi-legitimate, some analysts believe OPEC's new ideas simply reflect their own doubts that they actually possess the capacity to increase production, given that many members' production is already in decline, having reached it's geologically possible peak.

So let's review the bidding: OPEC and Russia are seeing that Peak Oil is coming - or may have passed - and are therefore starting to act as though they would rather not increase their production, given the prospect of nothing but rising prices. That is called "hoarding." Therefore, this is not a time to bet against OPEC. Unlike in the past, OPEC's actions to restrict production are today pretty much what it's members want to do anyway. No discipline problem now.

Incidentally, hoarding is not limited to producers of oil. How about the strategic reserves being built by the U.S., China, Japan and others? That is also hoarding.

It seems hard to imagine why the global trend toward hoarding would reverse. Some observers think that a new synthetic "super fuel" will be invented - maybe cellulosic ethanol. This new fuel would have lower production costs than ethanol currently does, would not consume food inputs, and could be mass produced in scalable quantities. If that dream comes to pass, there will be a new paradigm, the price of oil would decline and producers would be back to selling all they can as fast as possible. But until then, the new paradigm for oil is called "hoarding."