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Wednesday Morning Rant

Blink

There is a problem with high-stakes and costly agreements among many parties, whether those agreements are secret or open. They can hold up only so long as everyone involved is willing to hold the line and do what they agreed to do with the other parties. In order to accomplish this, there must be both incentives and long-term gain - and all of the parties have to participate and not fight each other. If the incentives change or become irrelevant, or if the playing field suddenly shifts and throws the old assumptions out the window, or there is major infighting, it creates a major stability problem.

This is a basic problem for cartels. In order for a cartel to work, it has to be able to fix price, and fixing price requires rigid control of supply. This can increase profits for the cartel's members, but it is a dangerous game unless there is absolute control (or, at least, near-absolute control) of supply, adequate incentive to not cheat and for members to not work against each-other. If any of this breaks down, cartel members will cheat or leave the game because it is no longer in the member's best interest to play by the rules or remain in the game. On a long enough timeline, this will always happen and it appears that it just happened with everyone's favorite cartel.

Yesterday, the UAE announced that it was leaving OPEC, and is doing so more or less immediately. The country is withdrawing from the cartel on Friday. OPEC will survive and still represents a significant amount of global oil production - especially if one considers "OPEC+" psuedo-members like Russia - but the loss of its third-largest member is going to have major consequences for the organization. Its ability to control price is going to be even more sorely tested - and seriously questioned - than it already is. Especially because unlike many OPEC members, the UAE has spare capacity - and spare capacity is a major control mechanism. The loss of the UAE is probably a very big deal.

It is also the consequence of two things that have moved rapidly against the cartel's stability. The first is the Iran war. Iran is an OPEC member that has spent more than a month hurling missiles at its fellow cartel members in direct attack and now is interfering with shipping through the Strait of Hormuz - something that has direct negative effects on its fellow members and particularly on the UAE. Iran broke the most basic rule of cartels, which is that you don't attack your fellow conspirators. But it is not just Iran. Iran may have been the final straw, but there are bigger structural problems facing OPEC, namely supply and politics.

OPEC+ ostensibly controls about 80% of global supply, but there are some big asterisks next to that. First, most producers in OPEC aren't all that big and don't have much slack in their production capacity and need to keep pumping to keep their petrostates from collapsing. A lot of the supply is in OPEC, but much of it is in the "must produce" column. Another is policy competition. For a long time, the cartel has had a monopoly in oil-as-policy-tool. There were major non-OPEC members like Russia, but they also didn't usually use oil as a policy tool. That was OPEC's game - until Trump. Trump does use energy as policy, and he has worked to make the US as productive as possible. There is now another party playing policy with energy, and it is a very big party indeed.

OPEC cuts supply? We can raise it and blunt the effect to some degree - and the market will take care of it all on its own. OPEC gives a sweetheart deal we don't like? We'll sanction the country on the receiving end, install tariffs or do other trade-as-policy-tool things to interfere with it. The US is not a petrostate. Oil here is an industry - a hugely important one, but still just one of many. We have flexibility that petrostates do not, and Trump has been using that flexibility. Someone blinking was inevitable, and the UAE clearly sees first-mover advantage in doing so.

The UAE sugar-coated its departure as best it could:

"This has nothing to do with any of our brothers or friends within the group," Al Mazrouei said. "We've been working together for years and years. We have the highest respect for the Saudis for leading OPEC."

The UAE remains committed to market stability and will continue to cooperate with producers and consumers to that end, the Energy Ministry said in its written statement. Its departure from OPEC will give the UAE more flexibility to respond to market dynamics, the ministry added.

"We reaffirm our appreciation for the efforts of both OPEC and the OPEC+ alliance and wish them success," the Energy Ministry said.

"Good luck in your future endeavors." The Saudis want to cut supply given the long erosion in oil price (Iran war notwithstanding), but the UAE does not.

The UAE has the ambition to achieve 5 million barrels per day of capacity by 2027 and wants more freedom of action to pursue that goal, the energy minister added. The decision to leave OPEC is not a response to years of production cuts led by Saudi Arabia, he said.

"We want to increase production and you want us to cut it, but we promise that's not why we're leaving" is such a boldly contradictory statement that one can only laugh.

Some, of course, keep whistling past the graveyard. The Guardian, desperate to maintain the party line, has blamed UAE's departure on ... so-called "decarbonization:"

The shift to low-carbon energy is also likely to have played a role in the UAE's exit. Producers that are able to pump more crude, and can tolerate lower oil prices, are expected to abandon any limits on crude production in favour of monetising their remaining reserves before demand for fossil fuels begin to decline.

The Guardian's Jillian Ambrose missed her true calling as a comedienne. You don't have to go grasping for straws to see what happened here, and it isn't a consequence of the energy-hating envirocommunists. The ground simply shifted, all at once. The global oil market has been changing for years, Iran is shooting missiles at its putative partners, too many OPEC members can't cut production and at least one of the few who meaningfully can no longer wants to help carry the rest at the expense of its own ambitions.

The world changed and it was only a matter of time before someone blinked.