superrific
Master of the ZZLverse
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So I'm no expert on oil markets but I do know a few things about game theory. I'll lay out a few thoughts as to why the UAE is leaving OPEC. It isn't what people have been saying about Iran, imo. It's arguably better. This is a bit long because, after all, I'm putting forward coherent thoughts meant to inform. I like to be clear and start from the beginning.
1. Let's start with why OPEC exists. Essentially it solves a collective action problem.
Consider the situation of a small oil producing nation, call it U. It has X amount of oil that it can pump over the next century (let's say, the time period doesn't matter). Its revenue will thus be X*P, where P is the average price of oil during that time period (technically you'd integrate x*p over the century but anyway). So in the absence of other producers, U wants to pump as little as possible to make ends meet and to preserve its market. The more it pumps now, the lower the price it will receive -- and worse, it actually drives the price down. So U would want to restrict output.
Of course, the problem is that it can't influence the market price because it's small. So it will have to take the price P that is offered. Given this set of incentives, U could very well pump a lot now -- and certainly more than it would want. There is no guarantee of P being higher in the future, and obviously money now is better than money later. So even though it would prefer less pumping to more pumping, it pumps a lot. This is the familiar market economics we know -- competition drives down prices.
2. But producers have a weapon to combat this efficiency: cartels. Everyone agrees they will pump according to a schedule. The agreement is fixed every five years or so. This keeps the prices high. It maximizes that revenue X*P for all oil producers. It's also illegal under antitrust law. If private parties did this, oil company execs would be going to prison (literally -- antitrust violations can produce jail time). But sovereign nations are not subject to American antitrust law for a variety of reasons, nor European antitrust law.
And hence OPEC was born. It's a cartel designed to coordinate activity among oil producers to keep the price high to maximize the value of the stuff in the ground.
3. So what is the constraint on OPEC? Why not squeeze production to the bare minimum to keep the price high? Well, there are oil producing nations that aren't a part of OPEC, including the US, Canada and Russia. They are a first-pass limit on the cartel but it's not a strong limit. Indeed, in 2016, OPEC decided to form OPEC+, which is basically opening the cartel to other nations to participate without being full members. And even American oil producers will be happy to take advantage of high prices, so they will not pump to full capacity even if the price is high. Note that I'm using the word capacity, well, capaciously here. It doesn't matter that much.
The real constraint on OPEC is other energy sources. U isn't only competing with other oil producers. It competes with the decision not to use oil. And if they keep prices high too long, they risk undermining their market. Look at what happened after the oil shocks of the 1970s. Cars started getting more fuel efficient. Demand fell, which is not what U wants to see.
4. OPEC's solution? Price bouncing. So all through the 1980s and 1990s, OPEC pursued an expand and restrict strategy. They would limit production to raise prices, to get that average selling price up and reap the benefits. But then after a year or so, they would pull the price back down. Their goal? To prevent Americans from developing alternate technologies. They want Americans thinking that every spike in oil prices is temporary and thus there is no need to try other tech. And they were successful in that for a very long time.
5. But price bouncing doesn't work if countries are motivated to get away from oil for reasons that have nothing to do with price. This is why climate policy was/is such a threat to them. It's why they love Trump -- they can manipulate him into stifling all renewable energy endeavors. Trump hates wind farms. So does OPEC. OPEC bribes Trump and get what they want.
But it's not just climate policy, right? Renewable energy is becoming cheaper in its own right than fossil fuels. On the economics alone, they are losing market share. They know there is little they can do about that in the long term, which is why the Arab nations have been trying -- in fits and starts that are difficult because of political structure -- to diversify into high tech. AI is perfect for them. It allows them to exchange oil for cash without selling the oil. They use it.
But renewables have been limited and while there is momentum behind them, renewable capacity is still globally tiny compared to oil-driven capacity.
6. Enter the war with Iran. This is an existential threat to the OPEC model, because it is encouraging countries all over the world to make big renewables pushes. Remember: renewables are cheaper, but they have higher installation costs. Countries that maybe didn't want to spend money on installation now realize they have no choice: their dependence on oil makes them economically insecure. It makes their economies hinge on the whims of American presidents.
And once countries go through that process of expanding renewables, the renewables remain cheaper. The whole price bouncing strategy simply fails. Countries will be expanding their renewables as fast as they can, especially in Asia. It won't matter if oil is cheap. Because they know it could get very, very expensive.
7. THIS is why the UAE is exiting now. It would never do something that consequential based on a short-term conflict in the Strait. This is a profound break with their policy over the past 50 years. And while the news reporting suggests that the UAE has long been frustrated with OPEC -- yeah, they have. Guess what. Nobody likes the cartel. Everyone thinks the cartel screws them relative to other cartel members. They've lived with it for fifty years. Why now?
The UAE is exiting because they see the writing on the wall: the world is now going to move irreversibly to a renewable energy basis, or at least irreversibly in that direction. It has been moving but the closing of the Strait is accelerating that.
Why does exit help UAE? Go back to that revenue figure: R = X*P. If the UAE expects P to steadily decrease in the future, then holding oil is a bad idea. It is thinking, "we have to get all of our oil out of the ground now, when we can still sell it for good money." And that's not what the cartel will allow them to do. So they exit the cartel.
I hope everyone is with me so far. I will post the conclusions in the next post down
1. Let's start with why OPEC exists. Essentially it solves a collective action problem.
Consider the situation of a small oil producing nation, call it U. It has X amount of oil that it can pump over the next century (let's say, the time period doesn't matter). Its revenue will thus be X*P, where P is the average price of oil during that time period (technically you'd integrate x*p over the century but anyway). So in the absence of other producers, U wants to pump as little as possible to make ends meet and to preserve its market. The more it pumps now, the lower the price it will receive -- and worse, it actually drives the price down. So U would want to restrict output.
Of course, the problem is that it can't influence the market price because it's small. So it will have to take the price P that is offered. Given this set of incentives, U could very well pump a lot now -- and certainly more than it would want. There is no guarantee of P being higher in the future, and obviously money now is better than money later. So even though it would prefer less pumping to more pumping, it pumps a lot. This is the familiar market economics we know -- competition drives down prices.
2. But producers have a weapon to combat this efficiency: cartels. Everyone agrees they will pump according to a schedule. The agreement is fixed every five years or so. This keeps the prices high. It maximizes that revenue X*P for all oil producers. It's also illegal under antitrust law. If private parties did this, oil company execs would be going to prison (literally -- antitrust violations can produce jail time). But sovereign nations are not subject to American antitrust law for a variety of reasons, nor European antitrust law.
And hence OPEC was born. It's a cartel designed to coordinate activity among oil producers to keep the price high to maximize the value of the stuff in the ground.
3. So what is the constraint on OPEC? Why not squeeze production to the bare minimum to keep the price high? Well, there are oil producing nations that aren't a part of OPEC, including the US, Canada and Russia. They are a first-pass limit on the cartel but it's not a strong limit. Indeed, in 2016, OPEC decided to form OPEC+, which is basically opening the cartel to other nations to participate without being full members. And even American oil producers will be happy to take advantage of high prices, so they will not pump to full capacity even if the price is high. Note that I'm using the word capacity, well, capaciously here. It doesn't matter that much.
The real constraint on OPEC is other energy sources. U isn't only competing with other oil producers. It competes with the decision not to use oil. And if they keep prices high too long, they risk undermining their market. Look at what happened after the oil shocks of the 1970s. Cars started getting more fuel efficient. Demand fell, which is not what U wants to see.
4. OPEC's solution? Price bouncing. So all through the 1980s and 1990s, OPEC pursued an expand and restrict strategy. They would limit production to raise prices, to get that average selling price up and reap the benefits. But then after a year or so, they would pull the price back down. Their goal? To prevent Americans from developing alternate technologies. They want Americans thinking that every spike in oil prices is temporary and thus there is no need to try other tech. And they were successful in that for a very long time.
5. But price bouncing doesn't work if countries are motivated to get away from oil for reasons that have nothing to do with price. This is why climate policy was/is such a threat to them. It's why they love Trump -- they can manipulate him into stifling all renewable energy endeavors. Trump hates wind farms. So does OPEC. OPEC bribes Trump and get what they want.
But it's not just climate policy, right? Renewable energy is becoming cheaper in its own right than fossil fuels. On the economics alone, they are losing market share. They know there is little they can do about that in the long term, which is why the Arab nations have been trying -- in fits and starts that are difficult because of political structure -- to diversify into high tech. AI is perfect for them. It allows them to exchange oil for cash without selling the oil. They use it.
But renewables have been limited and while there is momentum behind them, renewable capacity is still globally tiny compared to oil-driven capacity.
6. Enter the war with Iran. This is an existential threat to the OPEC model, because it is encouraging countries all over the world to make big renewables pushes. Remember: renewables are cheaper, but they have higher installation costs. Countries that maybe didn't want to spend money on installation now realize they have no choice: their dependence on oil makes them economically insecure. It makes their economies hinge on the whims of American presidents.
And once countries go through that process of expanding renewables, the renewables remain cheaper. The whole price bouncing strategy simply fails. Countries will be expanding their renewables as fast as they can, especially in Asia. It won't matter if oil is cheap. Because they know it could get very, very expensive.
7. THIS is why the UAE is exiting now. It would never do something that consequential based on a short-term conflict in the Strait. This is a profound break with their policy over the past 50 years. And while the news reporting suggests that the UAE has long been frustrated with OPEC -- yeah, they have. Guess what. Nobody likes the cartel. Everyone thinks the cartel screws them relative to other cartel members. They've lived with it for fifty years. Why now?
The UAE is exiting because they see the writing on the wall: the world is now going to move irreversibly to a renewable energy basis, or at least irreversibly in that direction. It has been moving but the closing of the Strait is accelerating that.
Why does exit help UAE? Go back to that revenue figure: R = X*P. If the UAE expects P to steadily decrease in the future, then holding oil is a bad idea. It is thinking, "we have to get all of our oil out of the ground now, when we can still sell it for good money." And that's not what the cartel will allow them to do. So they exit the cartel.
I hope everyone is with me so far. I will post the conclusions in the next post down
