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Opinion

Opec-Plus Cut Decision Will Hasten Oil’s Demise

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The resilience of industrialized nations is always under estimated. Today, in the 21st century, the control exercised by the US, the EU and Japan over global markets and especially commodity prices has never been stronger. Producers of commodities such as oil, risk both current income and the entire future of their resource base by opposing these countries. The decision by Opec-plus to cut production may seal the fate of fossil fuels by accelerating efforts by the nations that control the world’s financial resources to move away from them.

William Stanley Jevons, a British economist who lived from 1835 to 1882 is one of the unsung heroes of economic theory. Jevons pioneered what is called the “marginal revolution” along with Leon Walras. While Walras is remembered, even by students who hated economics 101 because economic textbooks celebrate the “Walrasian revolution,” Jevons, who delved into energy economics, remains more of a footnote. He wrote on the “coal theory of value,” predicting the demise of the British economy due to the exhaustion of its coal resources. Jevons failed to understand the flexibility of the modern economy — even as early as the middle of the Victorian era. The UK economy thrived rather than declining as its coal production fell. The gains only ended with World War I.

This week, ministers from Opec-plus countries repeated Jevons' mistake. This time the error may be fatal for those nations that rely on the production of fossil fuels — especially oil and natural gas. It is, however, not the first time oil exporting nations have underestimated the resilience of the world’s major economies, and their indifference to them.

1973 Oil Embargo

The price increases effected by Opec nations after the 1973 oil embargo threatened the major oil importing nations for the first time since the end of World War II. The industrialized nations responded. Production by members of Opec fell from 30 million barrels per day to 18 million b/d between 1974 and 1987. Saudi Arabia’s production dropped from 8 million b/d to 3.6 million b/d while oil prices dropped by more than 75% from their peaks, reaching $10 per barrel at one point. Prices did not recover to the peaks reached in 1980 until 2004. The economic consequences for oil producing countries were harsh.

Consumer economies by contrast, boomed. The aggressive actions taken by central banks to tame inflation, caused in part by the rise in oil prices, combined with market deregulation in many parts of the economy, prudent fiscal policies and enlightened tax incentives contributed to quarter century’s global expansion.

Opec pushed consuming nations into crisis in 1970s and early 1980s. Consuming countries experienced economic pain. In the end though, it was oil exporting nations that lost. Entrepreneurialism and open markets ultimately destroyed the inflexible policies of the oil exporters.

Problem of Perception

Developments from today to 2030 will occur more rapidly and impose harsher losses on fossil fuel producers. Many in the oil industry do not understand the forces arrayed against them. This disconnect was seen at this week’s Energy Intelligence Forum in London, where Charif Souki, CEO of Tellurian told the audience that "Europe will be spending $500 billion to $600 billion in subsidies for their consumers. For a fraction of that price, you could secure long term gas reserves from the US."

That statement fails to grasp the immediacy of the problem — just as the admirals in Washington in 1941 failed to understand the immediacy of the losses experienced by the US Navy at Pearl Harbor Dec. 7, 1941. The military leaders who understood the immediacy emerged as the heroes of World War II. They did not wait, they acted. The gas Souki offers might be available in 2025. Germany’s need is today. Actions are being taken to protect the German economy now, not in 2025.

The decision by Opec-plus to cut production by 2 million b/d is not comparable to Japan’s attack on Pearl Harbor. It will, however, contribute to the mobilization by major industrialized nations against fossil fuels. The US and EU are in an undeclared war against Russia after the latter’s invasion of Ukraine. Oil exporters have seemingly chosen to side with Russia. The consequences for oil exporters could be grim. For those seeking to quickly end harmful global emissions of greenhouse gases, the actions taken by Opec in Vienna on Oct. 5 could, however, prove a boon.

Innovation Premium

In cutting production to sustain high prices and ostensibly side with Russia, oil exporting nations have picked the losing side. Today, the large industrialized countries of the world are dominated by innovative companies such as Apple, Amazon, Facebook, Intel, Microsoft, Tesla and others. Hardly a day passes when a new innovation such as iron batteries is not announced. Many of the new ideas will fail. But investors will support innovation. Microsoft’s market capitalization is today five times that of Exxon Mobil. Other companies have higher values. The discount for Exxon points to the world’s understanding of the declining importance of oil.

The cut in production by Opec-plus will only quicken the end of oil. Large industrialized economies with sophisticated financial structures have survived the demise of coal, World War I, World War II, the great Depression and many other crises. They will outlast fossil fuels as well.

Philip Verleger is an economist who has written about energy markets for over 40 years. A graduate of MIT, he has served two presidents, taught at Yale and helped develop energy commodity markets since 1980. Kim Pederson is editorial director of PKVerleger LLC. The views expressed in this article are those of the author.

Topics:
Opec/Opec-Plus, Macroeconomics
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