An Inconvenient Truth about OPEC

DALLAS – The three major organizations that forecast long-term oil demand and supply – the International Energy Agency (IEA), the Organization of Petroleum Exporting Countries (OPEC), and the United States Energy Information Administration (EIA) – along with oil companies and consulting firms, believe that OPEC will reconcile predicted global demand and non-OPEC supply. But they are wrong: OPEC output will not meet such projections, because they are based on flawed and outdated forecasting models.

In forecasts that carry forward to the 2030’s, the three organizations share the view that world energy demand will increase, that developing countries will account for most of the increase, and that fossil fuel will remain dominant. They also agree that dependence on oil from OPEC members will increase as non-OPEC oil resources dwindle and become more expensive to extract. But a major flaw in modeling world oil markets makes these forecasts as unrealistic as a projection that humans will land on Mars tomorrow.

Current forecasting models project world oil demand based on variables such as economic growth (or income), oil prices, the price of oil substitutes, and past demand. They also project non-OPEC output using variables such as oil prices, production costs, and past supply. But, after forecasting world demand and non-OPEC supply, these models simply assume that OPEC will supply the rest – without taking into account OPEC behavior or considering that OPEC members might not be willing or able to meet the “residual” demand. For this reason, these models estimate what is known as the “call on OPEC,” the difference between estimated world demand and estimated non-OPEC supply.

The idea to model the “call on OPEC” gained ground after the October oil embargo of 1973, a time when few economists were familiar with the oil market. The magnitude of the energy crisis attracted economists from a wide array of specialties. To diagnose the problem, they opened their tool kit and used what was available: if the supply-and-demand model did not work, then the monopoly model would.