The Organization of Petroleum Exporting Countries Review

The Organization of Petroleum Exporting Countries (OPEC) is a group consisting of 12 of the world’s major oil-exporting nations. OPEC was founded in 1960 to coordinate the petroleum policies of its members, and to provide member states with technical and economic aid. OPEC is a cartel that aims to manage the supply of oil in an effort to set the price of oil on the world market, in order to avoid fluctuations that might affect the economies of both producing and purchasing countries 5.

OPEC’s objective is to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the.

OPEC has been gaining steady power and influencing the global oil market since the 1970s when OPEC had ~50% of market share in global crude oil production. High market share has also given OPEC the bargaining power to price oil above what prices would be in a more competitive market. This means OPEC has the ability to sway crude oil prices by increasing or decreasing production. Because of the role the Organization of Petroleum Exporting Countries (OPEC) plays in oil production levels and the influence it has over pricing, OPEC affects industries of all sorts throughout the world. OPEC has a strong role in the economy of the world, and because money is deeply entwined with power, OPEC also has influence in the arenas of politics and public policy.

The conventional wisdom among scholars and policymakers is that OPEC is a powerful market actor and has the capability to significantly influence world oil prices, even if it cannot control them perfectly. Further, most people believe that OPEC does this by way of operating as a cartel does, by consciously producing less oil than it could to drive up its price.

The oil-growth nexus is studied in a panel of Organization of the Petroleum Exporting Countries (OPECs), for a long time span (1960-2011), controlling for the specific context of oil production. Their membership in the cartel put them under a common guidance, which originates phenomena of cross-section dependence/contemporaneous correlation in the panel. Jose Alberto Fuinhas, Antonio Cardoso Marques, Tânia Noélia Quaresma, (2015) “Does oil consumption promote economic growth in oil producers?: Evidence from OPEC countries”, International Journal of Energy Sector Management, Vol. 9 Issue: 3, pp.323-333

OPEC is a cartel, which is an association of manufacturers or suppliers with the purpose of maintaining prices at a high level and restricting competition. At the end of 2014, OPEC reported reserves of 1.206 trillion barrels of oil, which is 81% of total world reserves. Of those reserves, Saudi Arabia, Iran, Iraq, Kuwait, the United Arab Emirates, Qatar and Libya have 67.6% within their borders. Between the period of June 2014 and July 2015, crude oil was in a bear market the price of the energy commodity moved from over $100 per barrel to under $50 based on the active month NYMEX oil futures contract. OPEC’s mission is to “...ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to customers, a steady income to producers and a fair return on capital to those investing in the petroleum industry”.

As crude oil prices have moved lower, the oil cartel did not cut production even though it is in the cartel’s interest to maintain prices at a high level.

Instead, the cartel has let the price fall in order to allow higher cost production to become uneconomic. OPEC maintained their production ceiling at 30 million barrels per day. However, as prices moved lower many members of the cartel suffered economic hardship as they received less revenue for their oil production.When it comes to commodity or raw material markets, oil is one of the most political staple commodities that trade. This is because demand for crude oil is ubiquitous while supplies are concentrated in some of the most turbulent political regions in the world. At the end of 2014, OPEC reported reserves of 1.206 trillion barrels of oil, which is 81% of total world reserves. Of those reserves, Saudi Arabia, Iran, Iraq, Kuwait, the United Arab Emirates, Qatar and Libya have 67.6% within their borders. Between the period of June 2014 and July 2015, crude oil was in a bear market the price of the energy commodity moved from over $100 per barrel to under $50 based on the active month NYMEX oil futures contract.

As crude oil prices have moved lower, the oil cartel did not cut production even though it is in the cartel’s interest to maintain prices at a high level. Instead, the cartel has let the price fall in order to allow higher cost production to become uneconomic. OPEC maintained their production ceiling at 30 million barrels per day. However, as prices moved lower many members of the cartel suffered economic hardship as they received less revenue for their oil production.

Many have attempted to sell more oil to make up for the financial shortfall. In July 2015, OPEC was producing and selling around 32 million barrels of crude per day, which is above the stated ceiling level. The price of oil moved lower for a collection of reasons including a slowdown in the global economy, a strong U.S. dollar and increasing production from non-OPEC members.

OPEC and 11 other leading producers including Russia agreed in December to cut their combined output by almost 1.8 million barrels per day (bpd) in the first half of the year. The original deal was to last six months, with the possibility of a six-month extension.The International Energy Agency reports that oil production from Africa’s OPEC members Algeria, Angola, Libya and Nigeria has stagnated over the last five years at 7.12m barrels a day, posting virtually zero growth from 2012 to 2017. the Arab spring of 2011 looked like a blip as production recovered quickly from the war in Libya, but the losses for OPEC’s African members continued on the back of higher security risks in the wake of the Arab spring, uncompetitive fiscal terms, challenging local content requirements and contract sanctity concerns. On November 30, 2017, OPEC agreed to continue withholding 2 percent of global oil supply. That continues the policy it formed on November 30, 2016, when it agreed to cut production by 1.2 million barrels. Starting January 2017, it will produce 32.5 million barrels per day. That’s still above its average 2015 level of 32.32 mbpd. The agreement exempted Nigeria and Libya. It gave Iraq its first quotas since the 1990s. Russia, not an OPEC member, voluntarily agreed to cut production. The next joint committee meeting of OPEC and non-OPEC producers will be held in Vienna on Sept. 22. All options, including extending supply cuts beyond Q1 of 2018, are “left open to ensure that all efforts are made to rebalance the market”, according to an OPEC statement. The group also confirmed that its deal achieved a conformity level of 75 percent as of July.

There is reason to believe that, after the end of Q1 2018, OPEC will again be inclined to renew the agreement on limiting oil production. Global oil market trends indicate the low probability of a new wave of price cuts in the market until the end of the current year.

Lessons Learnt

Recently, the market has been questioning whether OPEC and non-OPEC would continue with their production cuts. Both of the main actors, Saudi Arabia and Russia, are heavily incentivized to continue with their strategic economic partnership.

Saudi Arabia’s recent visit to Russia further cemented that relationship, and the recent courting of other non-OPEC countries to joinmeans that the parties have every intention to continue the production cut partyU.S. shale production initially rose in response to high global crude oil prices in the last decade rather than an embargo by major producers.

And the initial reaction to a global supply glut by the Organization of the Petroleum Exporting Countries was to try to steal back market share from higher-cost producers in the U.S. shale plays and elsewhere by pumping furiously, contributing to a crash that took the U.S. crude benchmark from more than $100 a barrel in mid-2014 to a 13-year low below $27 a barrel in early 2016.

Recommendations

OPEC’s deal faces potential setbacks from Iraq’s call for it to be exempt and from countries including Iran, Libya and Nigeria whose output has been hit by sanctions or conflict and want to increase supply. The reality, especially if prices exceed the $70 mark, is that the fundamental supply-demand balance does not support Opec’s optimism. Even if it did, transitioning away from supply cuts is not going to be smooth, with growth in demand likely to weaken throughout 2018. Opec sees supply growth of 1 million barrels per day this year, of which 720,000 would be from the US. The International Energy Agency (IEA) is calling for 1.6 million, with the US contributing 870,000. But if prices remain elevated, the IEA’s forecast looks conservative. Consultancy Rystad Energy estimates as much as 1.9 million barrels per day of growth, with 1.6 million coming from the US. Higher oil prices today are allowing shale producers to hedge and lock in drilling programmes. Costs will inevitably rise as activity gears up, and there is much talk of a new capital discipline, but prices above $60 per barrel offer a win-win of profits and growth.