Politics & Policy

OPEC KO’d by the Three Rs

American oil and natural-gas production have shot ahead in the last decade.

Tomorrow in Vienna, the members of the Organization of Petroleum Exporting Countries will meet once again to jawbone about oil prices.

But here’s the reality: OPEC is no longer a price maker, it’s a price taker. The price of oil is no longer being set by the cartel, it’s being set by U.S. drilling companies producing oil from shale deposits. And those drillers are thriving largely because of three key advantages, ones that I call the three Rs: rigs, rednecks, and rights.

Before I explain how the three Rs have neutered OPEC, let me state the obvious: The oil produced by the organization’s members still matters. OPEC supplies about 30 million barrels of oil per day, or about one-third of global demand. But OPEC today consists of Saudi Arabia and the eleven dwarves.

Sure, the now-bankrupt Venezuela is agitating for production cuts. (It always is.) And Iran, which needs to have oil sell for about $140 barrel to balance its budget, wants higher-priced petroleum. But Saudi Arabia is the only OPEC member with significant spare production capacity. And the Saudis appear happy with a price of about $75 per barrel.

They can afford to be content. Saudi Arabia is flush with cash, with over $1 trillion in the bank, according to various estimates. Further, Saudi Arabia owns refineries with a total capacity of 2.5 million barrels of refined products per day, and it recently announced a major expansion. By owning refineries, the kingdom can exploit the crack spread — the difference between the price of crude and that of refined products, like gasoline, diesel fuel, and Jet A fuel — and in doing so, more easily monetize its own sour crude (which sells at a discount to the Brent and WTI markers).

The Saudis have already indicated that they will protect their market share rather than cut production (and allow Venezuela and the other OPEC members to profit from their cut). Thus, the hard reality is that OPEC cannot force oil prices up significantly because none of its members, save for Saudi Arabia, can cut production enough to make a significant difference in a 92-million-barrel-per-day global market that has too much crude and lackluster growth in demand.

So why is the world market suddenly awash in oil? The answer: Over the past few years — thanks to rigs, rednecks, and rights — the U.S. has added the equivalent of one Kuwait and one Iran to its domestic oil and gas production.

Since 2004, U.S. oil production is up 56 percent, or about 3.1 million barrels a day, about the same volume as Kuwait produced last year. The dimensions of the boom in natural gas can be seen by looking solely at the Marcellus Shale in Pennsylvania, where output has jumped eight-fold since 2010 and is now about 16 billion cubic feet per day, a volume roughly equal to Iran’s current natural-gas production.

U.S. oil and gas numbers are soaring because of an abundance of rigs. More than half of all the drilling rigs on the planet are operating in the United States. We have about 1,900 active rigs. The rest of the world combined has about 1,300.

OPEC is on its heels because of America’s rednecks, and I use that term respectfully. The men (and some women) who work on drill rigs and hydraulic-fracturing teams are highly skilled. Our oil-patch workforce has been trained over a period of decades and is unmatched anywhere else in the world. Sure, lots of other countries have large shale deposits, but they can’t effectively tap their shale because they don’t have the expert labor needed to operate the drilling rigs, maintain the mud pumps, or analyze the well logs.

Rights is the last of the three Rs, but it may be the single most important factor in the demise of OPEC. The U.S. is anomalous in that it allows the private ownership of mineral rights. People who own mineral rights have a huge financial incentive to exploit them, as they will get at least one-eighth of the value of the oil or gas produced, and perhaps significantly more.

It’s no doubt true that access to federal land is essential to the U.S. oil and gas sector, but the shale revolution has happened almost entirely on private land, and that drilling has occurred because we Americans count mineral rights among our enforceable property rights. That means billions of dollars per year in cash payments to individuals, not the state or the crown. In my fourth book, Power Hungry, I estimated that in 2007 alone, the value of the oil and gas mineral rights distributed to private individuals in the U.S. was about $21.5 billion. And recall, that estimate was made before the beginning of the shale gale.

Looking forward, some prominent commodity analysts are predicting that over the next few years, oil will trade in a range between $75 and $90. If those prices — or even lower ones — prevail, they will slow the growth of shale production in the United States, but lower prices will not kill it. They can’t. The three Rs — along with America’s vast pipeline network and its huge capital markets — assure that the energy-price and investment advantages accruing to the United States thanks to the shale revolution will last for decades.

As for OPEC, it will no doubt remain in business and continue garnering lots of media attention. But the energy story of the moment is happening right here in the United States. The combination of innovation, price, and mineral rights have allowed American drillers to unlock enormous quantities of oil and gas, and that, in turn, has allowed the U.S. to turn OPEC into an also-ran.

— Robert Bryce is a senior fellow at the Manhattan Institute. His latest book, Smaller Faster Lighter Denser Cheaper: How Innovation Keeps Proving the Catastrophists Wrong, was published in May by PublicAffairs.

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