The Oil “Pipe Dream”

While it’s nice to have low oil prices, and thus low gas prices, the fact is that there is an oil price war going on between OPEC and everyone else in the world. OPEC is not happy that the United States, Canada and the Eurozone have become more energy independent, and have flooded the world with an overstock of oil.

Why would OPEC do this? Because they are an Oligopoly – a cartel. Most economists and market people know this. It hasn’t been a secret since OPEC was formed. An organization decides the supply and price of oil as produced by people in the organization.

The only problem is that Canada, the United States, and the Eurozone are not members of the cartel. So the cartel is losing its power over oil prices. The way to gain that power is to eliminate the competition. And OPEC is doing this through a manufactured “supply glut.”

Let’s use the Canadian Tar Sands as an example. Producing Tar Sand oil is very labor intensive, energy intensive, and expensive. High oil prices assures that Canada will get a return on their investment, which right now is about 10:1. For every dollar Canada spends to extract oil from the tar sands, they get a $10 return on its sale. This 10:1 ratio is pretty bad actually, considering that OPEC gets about 100:1 return on investment. It’s cheap to just let oil spew out of the ground in the middle east.

By over supplying the world, OPEC is driving down the price. This means that places like Canada run the risk of only getting a 5:1 return on investment. How much money would you spend to get $5 back? Eventually, it’s not going to be worth it for Canada.

And the Eurozone isn’t going to be much different. Their oil extraction is largely coming from offshore oil rigs, which while not as expensive as tar sands, is still more expensive then pulling a supertanker up to a middle eastern spigot.

So when CNBC reports that the market is hoping that OPEC cuts supply to keep prices from falling any further, that’s a pipe dream. Not only is it in OPEC’s best interest to NOT cut supply (in order to eliminate world competition), but it’s also scary to think that the market wants high prices in light of the absolute need for alternative energy. Right now, with tar sands and off-shore drilling, the return on investment for non-OPEC oil is approaching the same as for solar and wind. Yet the market is choosing oil over solar and wind.

Lastly, we have the CBOE VIX for Oil. This shows how volatile the oil market is with OPEC’s supply glut as an Oligopoly. OPEC is taking the pipe dream all the way to the world bank.

CBOE Oil VIX

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This entry was posted in Demand, Economics, Environment, Markets, Politics. Bookmark the permalink.

One Response to The Oil “Pipe Dream”

  1. Pingback: The Oil "Pipe Dream" | Gaia Gazette

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