Introduction
The price of oil is debatably the most influential single price on the global economy as a whole, and the Middle Eastern region tends to have an astonishing amount of influence on the price of oil compared to its influence on just about anything else. Realizing the impact that these countries share, several oil–exporting countries convened in September of 1960 in Baghdad and formed OPEC: the Organization of the Petroleum Exporting Countries. At its inception, the countries of OPEC made up eighty percent of all oil exports in the world (McNally), and ever since, the organization has been a dominant player on the global stage in terms of managing the price and supply of oil. It has used its collective influence several times over the past fifty-seven years to exert political pressure on foreign countries as well as economic pressure on the markets, leading some to describe it as a cartel and others as an oligopoly. However, despite OPEC’s colossal market share, questions have always existed as to whether or not the group is cohesive enough to control the price of oil in the long term. And as the group began to lose its dominant market position in the 1980s, a host of other factors With the sudden loss of the organization’s spare capacity, the rise of the speculative futures and derivatives markets at the turn of the century, and the recent shale oil revolution, even more doubt has been cast on OPEC’s ability to control the world’s most important resource. Going ahead, we may see the organization’s influence dwindle to a fraction of what it once was.
OPEC’s Inception
In the 1960s, the world oil supply was mostly controlled by a group of seven major, private companies, known as the Seven Sisters. The oil business was a highly profitable one: with low costs of production and high prices in oil–importing countries, the profit margin was gigantic. These private companies had a simple arrangement with their host countries: this profit margin, known as the “rent,” was split evenly between the companies and the countries’ governments. In the years leading up to the 1960s, though, the Seven Sisters were being forced to sell their oil at prices lower than market conditions would have set them at in oil–importing countries, while at the same time being forced to pay profit taxes as if they were selling at higher prices. Because they were making a lower total profit, the private companies decided to share lower revenues with their host countries, a move that angered many, as the host countries had no say in other countries’ administrative moves (McNally).
In 1959, Egypt’s president Gamal Al-Abdul Nasser organized The First Arab Petroleum Conference in response. It was here that the father of OPEC made his entrance. Pérez Alfonzo, head of a national oil company in Venezuela, was convinced that the oil–producing nations of the world needed to band together in order to prevent their manipulation. At the conference, he managed to recruit Saudi Arabian oil minister Abdullah Tariki to his cause. Together, the two courted Iraqi, Egyptian, Syrian and Kuwaiti delegates, convincing them to sign a document known as the Maadi Pact. This pact, although insignificant in its purposes, as it only called for annual meetings, is the origination of the world’s greatest oil oligopoly. Soon after, the Seven Sisters cut oil prices drastically, further angering host countries. A meeting of the Maadi Pact delegates was arranged in Baghdad, and it was there that OPEC was officially formed, with the primary intention of simply lobbying against further price cuts (McNally).
OPEC’s Early Successes
For thirteen years, OPEC lay dormant on the world stage, a formidable volcano waiting for the right moment to erupt. October of 1973 turned out to be the right moment. On October 6th, Egypt invaded Israel in a surprise attack which later came to be known as the Yom Kippur War. Ten days later, to exercise its unforeseen political power, OPEC chose to increase oil prices by seventy percent to punish Israel’s supporters. Additionally, the organization threatened to decrease oil production by five percent every extra month that Israeli troops occupied territories that were captured in the 1967 war. When America responded by announcing an aid program for Israel, OPEC began a complete ban on exports to America as well as a twenty-five percent cut in total oil production. In December, the organization raised prices again, to $11.65 per barrel, or $60 in real prices (McNally). This series of power moves by OPEC signified a shift in the group’s mission: originally, its intentions were simply to resist manipulation by the Seven Sisters, but now, the group itself was doing the manipulating. OPEC was now the sole body in charge of setting oil prices and supply levels, acting very much like a cartel (McNally).
OPEC’s second windfall was not completely of their own making; rather, it was triggered by the revolution in Iran in 1979, which completely stopped up its oil production. Deciding to simply “go with the flow,” Saudia Arabia and Libya both cut their own production as well. The result was a severe dip in oil exports, worsened even further when Iraq attacked Iran in 1980. This decrease in supply, in turn, caused a 163% increase in the price of oil between 1978 and 1980 (McNally). By 1980, OPEC found itself sitting on an annual revenue of $280 billion, over ten times what it had made eight years before, and the price of oil was up to a monstrous $34 per barrel (Chalabi).
The Decline of OPEC and Underlying Factors
OPEC’s decline arguably began in the 1980s, when foreign countries began to impose on its dominant market share. For example, Norway resolved to increase its own domestic production by forty percent, and the United Kingdom began to expand its production in its North Sea fields (McNally). By 1997, non–OPEC countries held sixty percent of the world’s oil production, a stark contrast from the time of OPEC’s inception (Chalabi). The organization also began to lose its influence due to a variety of other factors, including its loss of spare capacity, the rise of the futures and derivatives markets, the shale oil revolution, and general lack of cooperation between its members.
The first factor which caused a significant drop in OPEC’s deliberate influence on the price of oil was the loss of its spare capacity in the 1990s. In the decade before the turn of the century, OPEC relied on global energy agencies for predictions on global trends of oil supply and demand. However, these agencies consistently forecasted said trends inaccurately, claiming that world oil supply was increasing far more than it was and that world oil demand was decreasing. The result was OPEC’s failure to ramp up production in response, forcing it to exhaust its “back storage” of oil in order to meet higher-than-expected demand. This spare capacity, in the past, had provided an effective buffer against relatively minor fluctuations in world oil supply and demand. Without this buffer, OPEC effectively paved the way for increasingly volatile oil prices due to random supply and demand fluctuations, decreasing the amount of control the organization has on the global price of oil (Bandyopadhyay).
Aiding OPEC’s decline in influence was the rise of the futures and derivatives markets. The stock markets are, essentially, places where people make (or lose) money off of unpredictable prices. The increased volatility of the oil market due to OPEC’s weakening grip on prices therefore made oil an attractive commodity to gamble on as stock options such as futures and derivatives became widespread on the market in the 1990s (Chalabi). The most likely result of speculation over a certain commodity is often increased volatility in the price of that commodity, which is precisely what happened. The effect of this increased volatility due to speculation was OPEC’s realization that rather than being able to manipulate the price of oil simply by manipulating its supply, it now had to “influence the expectation of the participants in the futures market” (Bandyopadhyay), demonstrating OPEC’s diminishing influence on the price of oil.
Another factor which has infringed on OPEC’s price–determining power was the recent shale oil revolution. George Mitchell, an American, developed a method of fracking in 1997 which allowed American producers to access oil under layers of shale rock in deep wells which were previously unaccessible. This method of production caused a boom in the American oil industry, with its most notable production increase being a four million barrels per day increase in 2015. This increase in American production forced OPEC to forfeit some of its own market share in order to keep oil prices high, regarded as a last–resort move. However, oil prices began to fall. OPEC refused to budge any further in its production decreases––it hoped that American producers would, in effect, force themselves out of the market; as prices continued to fall, shale oil would become unprofitable, causing production to cease. The price of oil reached its low point at $26.68 per barrel, and shale oil producers continued to soldier on, defying OPEC’s expectations and demonstrating yet again OPEC’s softening lack of control over the oil industry as a whole (McNally).
Lastly, the fatal flaw of OPEC is one that it has been haunted by since its beginnings: lack of cohesion between its members. Even while executing its relatively humble preliminary mission of simply resisting the Seven Sisters’ manipulations, the member countries fought over issues large and small, often making it difficult to come to unified decisions (Bandyopadhyay). Additionally, soon after OPEC’s first windfall victory in 1973, OPEC had its first instance of many of non–cooperation among members: certain members decided to limit production even more than agreed upon for fear of “premature depletion of reserves.” Some feared volatile pricing due to these members’ actions. Other countries also refused to reduce their prices along with others when demand for oil weakened, further demonstrating an early lack of cohesion (McNally). Furthermore, armed conflicts between member nations make it even more difficult for the group to work as a unit. Ultimately, OPEC’s inability to work together has not helped it in the past, and does not bode well for the future of the group.
Conclusion and the Future of OPEC
In conclusion, OPEC’s influence depended mostly on the staggering edge it possessed over the rest of the world on market share of oil exports. With the loss of that edge in the 1980s, OPEC’s influence soon began to dwindle due to a host of other factors: the loss of its “buffer” spare capacity, the rise of the futures and derivatives markets, the shale oil revolution, and the member countries’ general lack of cohesion. These factors together have caused the group’s recent lack of influence, and if this trend continues, OPEC’s influence on the global stage may soon be near negligible.
Originally published 15.10.2019