U.S. Frackers, Iran’s Oil Men Threaten Energy Cartel

Iran’s potential rehabilitation comes at an awkward time for OPEC, the elite club of petroleum-producing states that controls the flow of oil to the world market. The cartel’s dominance is already threatened by a boom in oil extracted from shale in the United States, and now the potential return of millions of barrels of Iranian oil to the market looms over Saudi Arabia and other OPEC countries as they meet in Vienna this week.

While the global power shift brought on by the U.S. shale boom threatens OPEC from the outside, member countries are threatening it from the inside. Iraq, and now Iran, both want to increase production at a time when global supply is already high, raising the specter that OPEC won’t be able to marshal its members into line to control prices. The end result could be lower oil prices next year, according to many analysts.

"OPEC’s relevance is waning in our view," said Eric Lee, an oil analyst with Citigroup. Lee said the increased supply from non-OPEC countries has created a disruptive shift in the oil markets that reduces the cartel’s control of the market.

That includes the United States, where a boom in oil and gas extracted from shale rock has changed the dynamics of the international energy market. The innovations in extraction methods that led to the boom, including horizontal drilling and hydraulic fracturing, are still under scrutiny for their effects on the environment, while U.S. domestic production continues to grow. The United States produced more crude oil than it imported in November for the first time since 1995. The shift means the United States is less reliant on oil from the Middle East, which could have wide-ranging effects on global politics and markets.  

This week in Vienna, Iran is laying the groundwork for a potential increase in oil production, pushing other countries to make room for Iranian oil to come back to the market in the event that a long-term deal to lift U.S. sanctions can be negotiated.

"Other OPEC countries would have to cut to make room for Iran," said Trevor Houser, partner at Rhodium Group, an economic research firm.

But it’s unclear whether other countries will want to reduce production in order to make way for Iran.

"This could be a difficult moment for OPEC, a difficult year," said Patrick Clawson, director of research at the Washington Institute for Near East Policy. "Iran is going to be very resentful of anyone saying they should hold back their increase," Clawson said.

That’s the way a cartel works. When global oil production is up, the cartel imposes quotas so that an increase in supply doesn’t cause the price of oil to drop. The 12 OPEC countries get together and decide to hold back some oil from the market. Each country takes the short-term setback in order to keep the price of oil up, which ultimately benefits all the countries in the club.

Though OPEC is not expected to change its policy this week in Vienna, the prospect of more Iranian oil coming into the market could mean that the cartel might have to move sooner than expected to lower quotas.

"There are two problems: Can you get agreement to reduce the quotas, and can you get countries to abide by the reduced quotas," said Houser. "I think both are going to be pretty challenging."

The struggle will be keeping everybody in line.

"The history of OPEC has been frustrated by sometimes formal agreements that never materialize in practice; many countries accept reducing their own production, but then continue to sell oil under the table," said Leonardo Maugeri, an associate of the Harvard Kennedy School and former executive of Italian oil company Eni. Maugeri said that he expects OPEC to meet again in early 2014 to settle on a new policy. If it can’t, oil prices could collapse.

While some analysts have heralded the end of OPEC, others have warned that it could lead to greater volatility.

"Volatile oil prices are especially damaging because people have less ability to make decisions about what kind of car to buy and where to live based on how much oil will take up in their budget," said Jason Bordoff, director of Columbia University’s Center on Global Energy Policy and a former senior advisor in the Obama administration.

OPEC helps dampen volatility. In addition to intervening when oil prices are falling, it also ramps up production when supply is suddenly cut, in an effort to keep prices from spiking.

"Over the last couple years the Gulf states have increased their production when there have been disruptions in, say, Libya," Richard Mallinson, a geopolitical analyst with energy markets consultancy Energy Aspects, said. Mallinson said OPEC has weathered many challenges and will likely survive this one as well.

And while Iran is warning OPEC countries this week that they may have to make room for Iranian oil, some experts think that is still wishful thinking on Iran’s part.

"The Iranians have an interest in actually creating this kind of perception, and that is to lure oil companies, the big international companies, to see the potential in coming back to the Iranian market," said Ali Vaez, senior Iran analyst for International Crisis Group. Since Iran doesn’t have lobbyists in Washington, Vaez added, Tehran is hoping to convince international oil companies to argue that sanctions should be rolled back.