Why OPEC is dead

A worker adjusts the valve of an oil pipe at West Qurna oilfield in Iraq's southern province of Basra.
Atef Hassan | Reuters
A worker adjusts the valve of an oil pipe at West Qurna oilfield in Iraq's southern province of Basra.

With oil's price collapse, we can now declare that OPEC's reign as king of the market is over. However, just as certain is the fact that there is no one to assume the throne. A new oil market and industry are taking shape—and without clear leadership, there will be many positive and negative consequences for global energy security.

As we consider OPEC's fall, it is important to understand that it was never able to fully control the oil spigot at whim, nor the global economic forces most responsible for setting the oil price. In fact, at the rise of its intervention in the oil market in the 1970s, when its Arab members ordered an embargo that sent prices skyrocketing, OPEC's actions actually hurt itself more than its consumers and contributed to its eventual decline.

The price rise created long-term changes in the habits of its customers, including mandated energy conservation and shifts away from using oil to produce electricity and as a power source in many industries. Within a decade, nuclear, natural gas and other alternatives had emerged. At the same time, the embargo led to long-term loss of revenue and investment for OPEC producers—and contributed to an eventual price crash. OPEC learned its lesson and never again tried an embargo.

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Then came the rise of the non-OPEC producers, which caused OPEC's share of global oil production to drop from 60 percent in the 1970s, to 40 percent by 2000. After the fall of the Soviet Union, oil production grew rapidly in Russia and the Caspian and these and other new producers did not join OPEC. Today, OPEC cannot take meaningful action without getting non-OPEC producers on board.

This fact was clearly exposed just prior to the November 2014 OPEC summit. Contemplating a production cut, the Saudi Arabian oil minister consulted with Russia and other main non-OPEC producers. When it was clear that these countries would not join a cut, OPEC backed off and the price of oil took its most significant dive in months.

Many have asked why OPEC hasn't acted to stop the fall—but the reality of the new global market means it can only attempt to thwart downtrends by making deep cuts in its own production. Such drastic and unilateral cuts would significantly benefit non-OPEC producers, which would continue production at normal volumes.

The final nail in OPEC's coffin—and the first clear indication of where global oil markets are headed—came with the rise of unconventional oil production in the U.S. This production has both further eroded OPEC's market share, and introduced an entirely new way of producing oil that has the technical capacity to adjust to changes in price signals from the market much faster than conventional oil.

Even more importantly, U.S. producers are multiple and non-governmental. There is no president, minister, or CEO that Riyadh or anyone else can call to attempt to coordinate production. And, of course, neither the U.S. president nor the governors of Texas and North Dakota would seek to corral oil companies' behavior—nor would companies heed such a request.

And there is another important impact of the rise in U.S. production. With a keen understanding of consumption habits, OPEC always invested in ways that would keep oil readily available, and often sought ways to ensure America's continued oil consumption. When the world seemed close to recession, it kept prices moderate to prevent a shift to competing energy sources.

The new U.S. producers work differently. They couldn't care less about oil's global role and they're not concerned with protecting supplies or ensuring long-term demand. Their focus is on taking advantage of the opportunities created by an open market, on managing balance sheets, and on delivering profits for investors.

While OPEC has been weakened for some time, the current price drop has finally exposed its mortality.

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Meanwhile, the rise of independent, unconventional producers has made it clear that there is now no single country or organization that will control prices and production in the foreseeable future. As market forces take over, non-oil energy sources will more easily compete for market share in many sectors, such as transportation.

Oil's share of the total global energy mix will continue to erode.

At the same time, less planning and partnership between consumers and producers risks reducing the predictable supply of oil. Like many kings that came before it, OPEC's rule created stability—for a century consumers were never left searching for a barrel. And while OPEC's fall brings competition and economic opportunity to the market, it also brings uncertainty to the long-term, consistent supply of the world's most important energy source.

Commentary by Brenda Shaffer, a professor with the Center for Eurasian, Russian and East European Studies at Georgetown University.