New Investment Theme: Distributed Energy Production

OPEC: A Cartel Toppled by Technology

Investing Daily Article of the Week

by Ben Shepherd, Investing Daily

Despite advances in alternative energy technology, the world still largely runs on oil. Whether it’s fueling our automobiles, generating electricity or making plastics and other petrochemicals, oil is the single most-traded commodity and probably the second- or third-most consumed in the world.

As a result of that insatiable thirst for crude, the Organization of the Petroleum Exporting Countries (OPEC) has long been one of the most powerful cartels in the world, literally bringing countries that displease it to their knees. One need only look to America’s energy crisis of the 1970s, which would help push our economy into stagflation, for an object lesson in OPEC’s power.

But the cartel’s influence has been on the wane in recent years, not because the world’s thirst for oil has been slaked — if anything, it has only deepened — but because oil production has become an increasingly localized proposition.

Thanks to the revolution of hydraulic fracturing (fracking), unconventional resources such as shale oil have become easier and more economical to produce than ever. Fracking technology isn’t in use everyone around the world; less developed countries in many emerging markets are yet to implement the technology. However, its existence has made more than 2.8 trillion barrels worth of once uneconomic oil resources at least theoretically producible.

Shale formations can be found on every continent with the exception of Antarctica, though that’s probably only because no one has really looked yet thanks to the international Antarctic Treaty and the harsh operating conditions there.

Thanks to the unlocking of our own shale formations and the effects of the recession, the US alone has been importing less and less energy. According to data from the World Bank, the US imported a quarter of all the oil it consumed in 2008; last year, it imported just 15 percent.

Similar, though less dramatic, trends are in place all around the world. While the fracking process was largely refined here in the US, over the past 20 years or so the process has come into varying degrees of use in countries as disparate as Australia, Germany, Poland, China and South Africa.

That’s making a serious dent in demand for OPEC’s crude oil and helping to diminish its power. According to the organization’s most recent World Oil Outlook, it expects its share oil the oil market to slip by nearly 8 percent over the next five years alone, taking nearly 1.1 million barrels per day of its production out of the market. OPEC also admitted the possibility that demand for its oil could slip even further thanks to greater fracking implementation and technology refinements.

But one need not wait until 2018 to see declining OPEC geopolitical influence. The latest US rapprochement with Iran is an excellent case in point.

Saudi Arabia has long been one of America’s key Arab Middle Eastern allies and it is also a dominant force in OPEC. Saudi Arabia and Iran have been enemies for years, with the Saudis fearing that Iran would export its Islamic revolution into their country even as it supports their political foes in the region.

While US engagement with Iran is still very much in its infancy, just 15 years ago the Saudis, through their OPEC influence, would use its energy supplies to help steer US policy in a direction it sees as more favorable. But in that time Saudi Arabia and OPEC have been forced to look more and more to the East to market its oil, as Western consumption of its oil has been in decline.

But even Chinese demand for OPEC’s oil is likely to wane in the coming decades. Last year, China’s new oil reserves rose by 13 percent largely thanks to new discoveries, hitting 1.52 billion metric tons. The country’s natural gas reserves also shot up by 33 percent, reaching 961.2 billion cubic meters.

Considering that China consumed 4.1 million barrels of oil per day in 2011, that’s not a huge reserve. But much of China has yet to be explored and, with the addition of new technologies such as fracking, it’s extremely likely that its own domestic reserves will continue to grow.

It’s still entirely too soon say that OPEC has been defanged; even under the worst case scenario for OPEC it is still exporting about half of all oil traded internationally. With that dominant market position it could still cause serious disruptions to the global oil market. But thanks to growing local production meeting more and more of the local need, if OPEC were to take such an aggressive approach to getting its way, it could find itself increasingly marginalized.

From an investment perspective, these shifting dynamics make local exploration and production plays increasingly attractive, particularly in younger markets where there aren’t already a handful of firms that already drive the market. As is always the case, energy investments will remain volatile, but waning OPEC influence makes their prospects much more attractive.