OPEC decision on quotas could destroy the cartel

This week, the Organization of the Petroleum Exporting Countries, better known as OPEC, is meeting to discuss the direction of the oil markets. Just about a year ago, the cartel attacked the American fracking industry in order to protect their market share. They in essence said that they wanted to put the U.S. fracking business out of business. OPEC was concerned that America was moving rapidly toward energy independence and would no longer need to import OPEC crude oil.

{mosads}Last Thanksgiving, the price of crude oil dropped by just under $5 per barrel and today it is close to its bottom of $40. BBC news online reported in January that for every $1 decline in the price of oil, Russia loses $2 billion in income. At the time that article was written, crude oil was selling at $70 a barrel, so the $30 decline from the $70 level in January has been devastating for the Russian economy and other oil-exporting nations.

I do not think when OPEC made the decision to hold production that they expected prices would stay down as long as they have; some OPEC nations need a significantly higher price to break even. The International Monetary Fund (IMF) estimates the break-even price needed on crude oil. Below is a list of some nations and what they need in price for OPEC members to break even (the current price is around $41 a barrel):

• Iran: $131
• Venezuela: $118
• Russia: $105
• Saudi Arabia: $104
• Kuwait: $78

I recently reported that Venezuela has resorted to selling its gold position as it has spent all of its cash and oil revenue is vastly short. Trading Economics reported that the inflation rate in Venezuela is 68.5 percent.

Other OPEC nations are finding significant budget shortfalls. The IMF reports that Saudi Arabia has a deficit of $150 billion, while Russia has a deficit of $50 billion.

As I see it, the discussions can only have one of two outcomes. First, OPEC can leave production levels as they are currently and risk triggering a further decline in prices of crude oil to perhaps the high $20s or low $30s, as the glut will continue to grow on a global basis. The risk in this move is that OPEC nations that already find themselves strapped for income will see significant further declines in revenue from current levels. This stay-the-course choice may push many of its members to the verge of bankruptcy. The stock market would see this move as mostly positive for the economy and the American consumer, but the oil patch could see a decline in prices as the expectation for diminished revenue makes the oil stocks less attractive.

The second option is to cut the production levels so that the current demand will eat into the excess inventory crude oil, in turn reducing inventory. The stock market will see this as a positive for the future of oil prices and for oil stocks. The initial reaction would be that the oil sector would rally greater than the overall market. The risk to OPEC in this latter move is that the American fracking oil industry may begin to uncap their wells and in turn bring more American oil on the market, replacing what OPEC has reduced. OPEC nations may find that they will lose market share because they will not be able to compete with America on price.

A collapse to $20 to $30 a barrel for crude oil would have a significant impact on the OPEC nations’ ability to run their governments. A decline in the price of crude oil will mean lower energy costs in the United States, which is a positive. Dramatically reduced oil prices will make it difficult for alternative sources of energy to become competitive with cheap oil, so we may see as a result of lower prices bankruptcies in the alternative energy space.

My guess is that OPEC will side with some revenue as opposed to risking and waiting for increased revenue in the future. I think OPEC will choose to keep production at the current levels; if I’m right, we may see $1.50 a gallon for regular gas by next summer — perhaps even lower.

Perkins is a current events commentator and contributor to The Hill. He is the author of “The Brotherhood of the Red Nile” trilogy, a fictional account of radical Islamic nuclear terrorism against the United States.