Monopoly Round-Up: Did Texas Join OPEC?

Gas prices are going up. A new lawsuit says the reason is American shale producers have illegally cut capacity in league with the global oil cartel. In other words, Texas joined OPEC.

Today’s monopoly round-up is chock full of news. The most important macro-economic data of the week is that inflation readings were unexpectedly hot, and consumer sentiment fell slightly. And consistent with that theme, many of us have noticed gas prices are up. Why?

Before the good and bad news of the week, I want to start by discussing a new lawsuit alleging a conspiracy to hike global petroleum product prices. The claim is that the spike from 2021 onward of oil prices is a result not just of changes in demand, but intentional price-fixing arrangements by U.S. corporations. And that is one key reason gas prices aren’t resetting back to normal levels.

Let’s dive in.

In 2021, gas prices exploded upward, and have been fairly high ever since. America has traditionally been an oil importer that buys from a cartel known as OPEC, or the Organization of the Petroleum Exporting Countries. OPEC is a collection of countries who happen to have big oil reserves, and they cooperate to control the oil market, agreeing to a specific amount each will drill and sell in world markets, in order to ensure the price matches what they need for their budgets. Typically, when demand for oil drops, those foreign drillers don’t compete, but collectively cut production, keeping the experience at the pump quite painful even though in a competitive system the cost to consumers would drop. Oil prices, in other words, are managed, artificially boosting prices by controlling supply.

We are used to this arrangement, or have been for fifty years. It’s the basis for our close alliance with Saudi Arabia, and much of our policy in the oil-rich Middle East. With the largest reserves and thus the ‘swing producer’ that can turn on oil on tap, Saudi Arabia is the price leader of OPEC. The Saudis enforce discipline in the cartel; if a nation is cheating by drilling more than its share, the Saudis flood the market, driving down prices and costing everyone money. Investors watch OPEC meetings intensely; while changes in oil flows happen on a lag, because oil drilling takes time to ramp up, market prices adjust quickly in anticipation after announced shifts.

Such a cartel, in the American context, would ordinarily be illegal. The existence of OPEC is especially weird considering this group of nations has power over oil, the most important commodity in the world. Saudi state power since the 1970s has been based on the ‘oil weapon,’ which structures war and peace, banking and money flows, and which belief systems get funded, from Muslim schools to Elon Musk’s acquisition of Twitter. So why is this chokepoint legal? Well OPEC Is composed of governments and not private firms, so participants can’t be prosecuted under a doctrine known as ‘sovereign immunity.’ Periodically, Congress tries to pass a bill called NOPEC that would make states liable, but it never seems to go anywhere. OPEC remains dominant.

The Shale Revolution

But in the mid-2000s, something highly disruptive happened to these markets. Americans figured out how to get a bunch of oil from the ground in Texas and North Dakota through a new process called hydraulic fracking, in which drillers inject pressurized liquid into a shale rock formation to crack it and release oil and gas. America became an oil exporter.

Shale operates differently than traditional oil exploration, which requires long lead times and huge investment. Think about how difficult it is to put a new giant rig in the Gulf of Mexico. This new method, by contrast, means a firm can start drilling in as little as two weeks and the oil brought online shortly thereafter. Fracking is “as close to inventory-on-demand as oil ever comes.”

In the early 2010s, Wall Street investment flooded into fracking, creating an ecosystem of firms that could produce oil on tap. Some of them are quite big, such as Permian Resources., Chesapeake Energy, Continental Resources, Diamondback Energy, EOG Resources, Hess., Occidental, and Pioneer Natural Resources.

There’s one other reason - a very important one - why the shale revolution mattered. While OPEC producers can legally collude, these new American shale producers cannot, subject as they are to antitrust laws against price-fixing. By law, these firms can’t withhold production collectively. They had to take share in oil markets, disrupting the market allocation agreements at the heart of OPEC. The net effect was that American shale firms, as swing producers, broke Saudi leadership of oil prices.

This change was a very big deal. Dubbed ‘Cowboyistan’ in the industry, the new American shale producers, led by (among others) Continental Resources’s Harold Hamm, had by the mid-2010s ‘turned the world upside down.’ The era of ‘Saudi America’ was here. From 2014-2016, there was a price war, as OPEC flooded the market with oil to crush U.S. shale producers and regain price leadership.

The result was consolidation in the domestic industry, but not what OPEC sought. Shale drillers got more efficient and managed to continue producing.

OPEC Welcomes Texas

In 2016, weary of the price war, OPEC brought Russia into the fold, taking a big competitor off the table. And American independents were also tired of the price war, and the loss of profits. In September of that year, Hamm stated it is "'high time' for Russia and the Organization of the Petroleum Exporting Countries [OPEC] to forge a pact that would put an end to slide in crude oil prices."

This comment from Hamm was a signal, and in March of 2017, at the major oil conference CERAWeek, where Arab princes and Texas oilmen rub shoulders, OPEC and shale producers began meeting to come to an arrangement. As Bloomberg put it, “OPEC Said to Break Bread With Shale in Rare Show of Detente.”

At an important dinner in 2017, the then-OPEC General Secretary Mohammed Barkindo “dined with about two dozen U.S. shale executives,” which had never happened before. Another OPEC official confirmed coordination, telling journalists that everyone had “compared notes on our experiences in this cycle [i.e., the recent price war] which everyone agreed was the most injurious.” From the U.S. side, Scott Sheffield of Defendant Pioneer stated, “I’m seeing a series of meetings where OPEC is reaching out and spending more time with US [I]ndependents than I have seen over my entire career.” OPEC and U.S. shale were now sharing “how much they [U.S. shale] are investing and their projections” as as to “avoid volatility.’” The U.S. private firms had started to work with the global cartel. Said one domestic shale CEO anonymously, "we now have a seat at the table on pricing."

The result is a decline in investment of shale producers, regardless of oil price.

Over the course of the next four years, OPEC and the shale producers came to an informal working arrangement. In November 2020, EOG Resources' CEO Bill Thomas confirmed shale producers had allowed OPEC to get back in control of pricing: "In the future, certainly we believe OPEC will be the swing producer – really, totally in control of oil prices. . . . We don't want to put OPEC in a situation where they feel threatened, like we're taking market share while they're propping up oil prices." In 2021, when oil prices spiked, the domestic oil industry didn’t invest to increase production, as they had traditionally done. Pioneer’s Scott Sheffield, for instance, said that “everybody's going to be disciplined, regardless whether it's $75 Brent, $80 Brent, or $100 Brent.”

“All the shareholders that I've talked to said that if anybody goes back to growth, they will punish those companies.” He added, “Whether it’s $150 oil, $200 oil, or $100 oil, we’re not going to change our growth plans.”

In other words, by 2021, the big independents had joined OPEC. And they had insight into the cartel’s inner workings. In January 2023, for instance, Pioneer CEO Scott Sheffield predicted a production cut by OPEC, stating "If [price] stays too low, it wouldn't surprise me if [OPEC] ha[s] another cut . . . [W]e'll see what happens in the next 90 days." As the plaintiffs pointed out, “OPEC then announced production cuts 87 days later.”

So that’s the argument. The plaintiffs, who are retail gasoline purchasers, argue they were harmed by having to pay higher prices at the pump as a result of the defendants' anticompetitive conduct. The suit comes from plaintiff lawyers who know the industry, and the claims are compelling enough that if a judge accepts the claim upfront and allows discovery, the process of litigating could showcase a very ugly geopolitical tie between Arab states and the American shale producers. That said, judges don’t love these kinds of cases, full of geopolitics and foreign policy, with massive sums on deck for damages.

The Urge to Merge

There’s one more element that makes this case interesting, and that is a merger wave among American independents that started in 2023, and that the Federal Trade Commission is examining.

In October of 2023, Exxon, one of the biggest integrated oil firms, announced it would buy Pioneer Natural Resources for $59 billion, which was quickly followed by tie-ups between Chevron and Hess ($53 billion), Occidental Petroleum and CrownRock ($12 billion), Diamondback and Endeavor ($50 billion), and Chesapeake-Southwest ($7.4 billion). Other notable deals included Exxon-Denbury ($6B), Ovintiv - Black Swan, PetroLegacy, Piedra Resources ($4B), Permian Resources-Earthstone ($4.5 billion), and Civitas buying $7 billion of assets in the Permian. That’s a little less than $200 billion in mergers.

This urge to merge was particularly pronounced among the big independents, who were the ones sitting at the table with OPEC. As I noted in February, the Dallas Federal Reserve asked exploration and production firms about their goal in 2024, and it’s split by size. The small ones want to produce, the big ones don’t.

One possibility is that merging will make it even easier to coordinate pricing. In the meantime, it’s been a very good ride for shale producers like Hamm. It turns out that the only thing more profitable than fracking, is not fracking.

And now comes the news of the week on the flip, only for paid subscribers.