ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES (OPEC) (Social Science)

Throughout its history, the Organization of Petroleum Exporting Countries (OPEC) has indirectly influenced oil prices in response to sharp volume fluctuations resulting from geopolitical tensions. However, as of 2006 OPEC’s effect on the market, which affords member states political leverage, has changed dramatically relative to the late twentieth century, because member states now have far less excess production capacity (see Figure 1).

OPEC had more excess oil capacity in the 1980s, when crude oil prices reached close to $80 a barrel, than it did by 2006, during which prices reached as high as $75 a barrel (Figure 2). Minimal surplus capacity limits OPEC’s ability to soften the blow of the high price of oil via increasing supply to meet the immense demand.

The Organization consists of eleven developing nations whose economies rely heavily on oil export revenues. OPEC seeks to maintain stable international oil prices via quotas on oil production and pursue petroleum policies that serve the national and collective interests of its members. In 2002 OPEC agreed that a fair price on crude oil should be set between $22 and $28 a barrel. Three years later, member states agreed to cap their crude oil production at 28 million barrels per day (MBPD). By 2006 Qatari Energy Minister Abdullah Attiyah maintained that a fair market price for crude oil should be in the range of $50 to $55 a barrel. However, during the same year, crude oil prices reached over $70 a barrel, and some OPEC countries often surpassed their production quotas by 2 MBPD.


Figure 1

Figure 1

Figure 2

Figure 2

Prior to OPEC, the so-called Seven Sister Companies dominated the crude oil market. Those seven companies included Esso (which later became Exxon, and is now known as Exxon Mobil), the Anglo-Iranian (previously Anglo-Persian) Oil Company (later British Petroleum, and currently known as BP), Royal Dutch Shell, Gulf Oil (most of which became a part of what is today known as Chevron), Standard Oil of New York (which became Mobil, and later merged with Exxon), Texaco, and Standard Oil of California (now part of Chevron) (see Table 1). Crude oil prices remained stable, with a range from $2.50 to $3.00 a barrel during the late 1940s through the 1960s, or $21 to $22 a barrel when adjusted to 2006 dollars.

The Seven Sister Companies remained dominant by restricting oil output and minimizing internal conflict. But competition from other world suppliers would eventually break up their control over the international oil market.

OPEC was created at the Baghdad Conference on September 10-14, 1960, by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Eight more countries later joined the Organization—Qatar (1961), Indonesia (1962), Libya (1962), United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973), and Gabon (1975). OPEC set up a secretariat in Geneva, Switzerland, which moved to Vienna in 1965. The OPEC Statute states that countries that apply for membership must maintain "a substantial net export of crude petroleum" and "have fundamentally similar interests to those of Member Countries" (OPEC Statute, p. 3). The formation of OPEC resulted in a shift in influence over the oil market away from the Seven Sister Companies toward OPEC.

OPEC’s dominance became fully evident during the 1970s as its Arab member states limited oil shipments and cut production at a time when demand was high, which resulted in a spike in oil prices. The Arab countries imposed an embargo on oil shipments to the United States and any other country that condemned Egypt and Syria’s attack on Israel in 1973, which was significant considering that OPEC exports accounted for 85 percent of world oil trade at the time (Mikdashi 1974, p. 4). According to data from the Middle East Quarterly and WTRG Economics, the nominal price of oil escalated by more than 300 percent at the end of 1974 compared to prices a decade earlier. OPEC validated its authority and gained political leverage by reducing oil supply to the world market.

Shares in the international market of major oil companies (1946)

Seven Sister Companies

Production (%

Esso

28

Anglo-Iranian Oil Company

22

Royal Dutch Shell

21

Gulf Oil

9

Standard Oil of New York

5

Texaco

3

Standard Oil of California

2

Total

90

Table 1

Figure 3

Figure 3

During this same period, Libya became a more prominent member of OPEC. Libya had undergone a regime change a few years earlier as the result of a military coup led by Colonel Muammar al Qadhafi, and had officially become known as the Great Socialist People’s Libyan Arab Jamahiriya. Qadhafi encouraged Arab-nationalist and socialist policies. Many analysts have credited the new Libyan regime with shaping OPEC’s measures to increase oil prices, enforce embargoes, and gain control of oil production (Anderson 1999, p. 4). For example, according to a 1973 Time Magazine article, Qadhafi took advantage of the high global demand for oil by forcing oil companies to increase Libya’s oil royalties over 100 percent from $1.1 billion in 1969 to $2.07 billion in 1971 ("The Arab World," p. 2). Libya’s influence played a partial role in OPEC’s enhanced political strength on the world stage.

OPEC’s reaction to the scarcity of oil supply resulting from the Iranian Revolution in 1979 and the Iraqi invasion of Iran in 1980 further illustrated its strength. The new regime in Iran, which was the second largest OPEC oil exporter following Saudi Arabia, curbed oil exports to the world market driving prices upward. By 1979 Iran produced less than 1 MBPD, which was down from over 6 MBPD a year earlier ("Iran and Oil Prices," Washington Times, January 17, 2006; Phillips 1979, pp. 1-2). Iraq’s invasion of Iran in 1980 sparked a reduction in the combined production of both countries to only 1 MBPD and a jump in prices from about $14 per barrel by early 1979 ($43.48 in 2006 dollars), to $35 per barrel by 1981 ($77.97 in 2006 dollars), according to WTRG Economics. Other countries within OPEC were able to offset Iran and Iraq’s lower oil production by increasing their output while also maintaining a substantial amount of excess capacity. Saudi Arabia alone utilized three-quarters of its production capacity in order to make up for reduced output. Additional output from the other OPEC members helped crude oil prices to fall.

However, increased OPEC crude oil supply resulted in an oil price collapse by the mid-1980s. A Brookings Institution report entitled "Lessons from the 1986 Oil Collapse" (1986) notes that Saudi Arabia increased its market share after many of its OPEC partners failed to abide by their production quotas, thus oversupplying the market. Consequently, in 1986 crude oil prices declined from over $20 to as low as $12 a barrel ($22.17 in 2006 dollars).

Lack of cohesion among member states presented a challenge to the effectiveness of OPEC during this period.

By the early 1990s, the price of oil began to creep upward with the Iraqi invasion of Kuwait and the resultant threat of a Persian Gulf war. Saudi Arabia possessed the most oil reserves regionally and internationally (see Figure 3).

Saudi Arabia increased production by more than 3 MBPD during the Gulf War of 1991 (Lieber 1992, p. 155). This increased output to offset shortages created by the Gulf War of1991 resulted in the stabilization of prices shortly after.

As the twenty-first century began, many geopolitical tensions further limited OPEC’s oil supply and raised prices. The 2002 strike by state-owned Petroleos de Venezuela caused Venezuelan oil production to plunge so low that Venezuela still has not been able to regain its peak output capacity of 3.5 MBPD. In addition, the international military action in Iraq in 2003 caused Iraqi output to plummet to less than 1.5 MBPD. In 2006 Iran’s threat to slash oil exports during its dispute with the United Nations over its nuclear missile program kept oil prices high at over $70 a barrel.

OPEC’s ability to offset price increases in the early part of the twenty-first century pales in comparison to its clout during political conflicts thirty years earlier because there is far less additional oil supply in OPEC countries, including Saudi Arabia. The U.S. Energy Information Administration reported Saudi Arabia’s excess capacity as being around 1.3 to 1.8 MBPD in May of 2006. Other OPEC members have zero surplus capacity in a world that consumes around 80 MBPD (see Figure 4). By the first half of 2006, oil prices jumped from $50 a barrel to a little more than $70 a barrel. Although the price per barrel is a few dollars shy of that in 1981 ($77.97 in 2006 dollars), the peak production capacity of OPEC is far less than that of the early 1980s, thus reducing OPEC’s ability to manipulate the market.

OPEC’s impact on the international crude oil market will continue to wane with such a tight supply. High crude oil prices have led to discussions about the possibility of tapping new oil reserves in non-OPEC countries and expanding alternative sources of energy, such as ethanol, in order to meet high demand at a much lower cost.

Figure 4

Figure 4

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