Carbon Taxes and OPEC

Are worries about climate change destroying OPEC?

Source: Photoeverywhere.uk

Last week OPEC died. Nigerian oil minister Ibe Kachikwu announced that OPEC would abandon its nominal target of 30 million barrels per day. Instead, every country would set its own target. Saudi Arabia will continue to pump around 10 ½ MMBD—close to a record. Iran won’t accept any curbs until after they restore their oil shipments. A cartel is supposed to limit supply in order to raise prices. If the members can’t agree on production cuts, it’s not a cartel any more.

Why is this happening? Part of the reason has to do with fracking and the rise of domestic US oil production. North Dakota and Texas now produce more oil than every OPEC country save Saudi Arabia. When the Saudis began to ramp up last year, they indicated concern that they were losing global market share to the frackers. For decades Saudi Arabia has been the world’s swing producer, cutting and expanding marginal production to meet marginal demand. That gave them enormous leverage over oil prices. By pumping flat-out, they effectively abandoned this role—hoping that North Dakota and Texas would fill it.

Source: EIA

But part of the reason also has to do with concerns about climate change, CO2 emissions, and the prospects for a carbon tax. Negotiators are meeting now in Paris to hammer out an agreement on greenhouse gasses. Any limitation on fossil fuel means that the market—and therefore value—of future oil production is uncertain. So oil is potentially worth a lot more today—even at currently depressed prices—than in the future. There is every incentive to get as much out the ground as possible as soon as possible.

For now, this means cheaper heating oil, gasoline, and petro-chemicals for consumers around the world. In the long run, this will help the global economy, as more money is allocated towards other goods—goods that can make people a lot better off. In the short run, however, there will be some economic dislocation, as oil prices find a new clearing level, and companies adjust exploration and production levels. A petroleum engineering degree from South Dakota School of Mines might not be so lucrative any more.

J. Paul Getty once described his formula for success as rise early, work hard, and strike oil. But in the energy business now, you’ll have to get your product to the market before new regulations and taxes are put in place. Or else strike a different kind of oil.

Douglas R. Tengdin, CFA

Chief Investment Officer

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