OPEC's Freeze and the Petrodollar

After about 18 months of lower oil prices, the big oil-producing countries have had enough. Perhaps the only exception to this is the United States, where consumers enjoy the benefits of lower gas prices at the pump.

Recently, some members of OPEC, along with Russia, agreed to a plan to freeze their output at current levels. This is an attempt to limit supply, or at least create the perception of a more limited supply, so that prices start going up again.

Venezuela is a complete disaster with its socialist policies continuing from the days of Hugo Chávez. We talk about socialist politicians in the United States, but most of them really aren’t socialists. They may want big government and central planning, but they don’t want the government to own the means of production in most areas.

Venezuela really is socialist to a large degree. The government has been nationalizing industries. And where the government doesn’t outright own them, it almost fully controls them. It is a mix between socialism and fascism, with a huge amount of corruption.

The central planners of Venezuela will blame anyone and anything other than themselves and their own policies. Lower oil prices certainly haven’t helped, but I hope nobody is deluded enough to think that Venezuela’s main problem is lower oil prices.

For Russia, life goes on, although lower energy prices do have a significant impact. Targeted U.S. sanctions against Russia did not help the situation there, and the currency has had some problems because of it. Still, it is understandable why Russian officials want a higher oil price — the government relies so heavily on the revenue as a major part of its budget.

Then there is the Middle East, where crude oil that is easily extracted from the ground is the greatest blessing and biggest curse of the region. The wealth is evident, but so is the war and chaos. We can’t blame all of the problems in the Middle East on oil, but we have to believe that it would be a much different place without oil.

Perhaps there wouldn’t be as much wealth, although we don’t know that for sure. There probably wouldn’t be as much struggle for power in the region.

It is interesting that so many of these countries are coming together in an attempt to limit oil supplies, or at least make the appearance of such.

It tells us that all of the governments involved in this decision either outright own the oil in their respective countries, or else they fully control all of the energy companies under their jurisdiction.

This is why you don’t see the U.S. government agreeing to freeze oil supplies. If it tried, it would be faced with lawsuits from the likes of Exxon Mobil. While the U.S. government does own some oil and has some control over the energy sector, it is mostly a private sector industry in the U.S.

Consumer Choice, Meet Government Control

When it comes to the oil market, there is no question that it is not a free market. You have central governments controlling the oil in most places, and even then, they are colluding in an attempt to dictate prices. Imagine the outcry if a bunch of private sector companies got together and tried the same thing.

If the major grocery chains had a meeting and decided they would all limit how much food they put out for sale in their stores in an attempt to raise prices, there would be screaming coming from everywhere. We would instantly hear about needing the government to break up the cartel.

Such a plan by grocery stores wouldn’t work, though, even if they knew the government would leave them alone. Other businesses would quickly move in and not limit their supplies. They would charge less and still make a decent profit. The cartel of grocery stores wouldn’t survive with this strategy in an open market.

I don’t know who wants to break the news to OPEC, Russia, and any other countries that are attempting to freeze oil production. It isn’t going to work because they don’t control all of the oil in the world. There is this little guy called the United States of America that produces more oil than any other country in the world.

Some of the U.S. oil production is in shale oil, which is more expensive, but even many of these producers are managing to survive despite the low oil prices. Maybe more of them will go out of business given some time. But if oil prices spike back up, you can bet that more investment will follow.

The other problem for OPEC and its allies here is that oil isn’t the only choice in the world. So even if they did control all of the world’s oil, consumers would still have alternatives. Right now, oil is the best choice to meet many energy needs in terms of price. But if the price goes high enough, there are alternatives.

This is the great thing about technology. Governments can try to gain monopolies, but technology and innovation come up with ways to compete, even if indirectly. We have seen what Uber has done to taxicab monopolies all over. We don’t know if technology will find a cheap replacement for oil in the future, but we already know there are alternatives at some price.

Saudi Arabia, The Big Oil Player

Venezuela will be a mess with or without low oil prices. Russia will continue to have its problems but will survive either way. And for the United Arab Emirates, much of its wealth now comes from tourism and its position as a hub for international business and finance.

Qatar certainly heavily relies on oil sales for its wealth. Iran also relies on oil sales, but the people there are better off with lower oil prices than having trade sanctions against them.

Really, the one big player in all of this is Saudi Arabia. It is the Saudis who are calling the shots for OPEC anyway.

The House of Saud — the ruling family of Saudi Arabia — not only depends on oil revenue for its wealth; it also depends on oil revenue for its power. Without significant oil revenue, the House of Saud loses its influence with the U.S. government and with its people.

The House of Saud and the U.S. government have basically had a not-so-secret agreement over the decades. The House of Saud uses the U.S. dollar to trade its oil on international markets. This is why it is the petrodollar.

In return, the U.S. government implicitly backs the ruling family with military power and looks the other way when it comes to human rights abuses.

As oil coming out of Saudi Arabia becomes less important, so does the House of Saud. Its influence wanes. We can even talk about the possibility of its oppressive rule being broken.

When Saudi Arabia Goes, So Goes the Petrodollar

The U.S. does not need Saudi oil as much as it did in the past, especially with lower prices. It also helps that there has been a significant increase in production within the United States.

Still, the U.S. government does not want to see Saudi Arabia fail for the simple reason that it would wreck the petrodollar. This has been a massive subsidy to U.S. politicians, as it creates demand for the U.S. currency and for U.S. government debt.

Other countries have already figured out that they don’t always have to use the U.S. dollar as a middleman in international trade. At this point, Saudi Arabia doesn’t have to use it either, except that it is essential for U.S. backing.

If the House of Saud falls, it is hard to imagine the petrodollar surviving. If some country in the Middle East wants to sell oil to Japan, it can do so in yen. If it sells to China, it can do it in yuan and then convert it to the currency of its choice.

With the House of Saud in trouble with lower oil prices, and the rest of the world finding international trade in currencies other than the U.S. dollar, we have to believe that the petrodollar will likely decline and eventually go away.

This isn’t to say that the U.S. dollar is doomed. The dollar has been strong for the last several years because the other major world currencies have been so weak.

The latest plan by oil exporting countries to freeze production rates is not going to work because the consumers ultimately have the final say. The plan may or may not temporarily increase prices.

For American consumers who drive a lot, enjoy the benefit of lower gas prices while it lasts. For U.S. politicians, enjoy the subsidy of having the U.S. dollar used as a middleman in the world trade of oil. It may not last that much longer.

Until next time,

Geoffrey Pike for Wealth Daily