The Organization of Petroleum Exporting Countries (OPEC) is an organization of 13 oil-producing countries. In 2019, 79.1% of the world's oil reserves were located in OPEC-member countries. OPEC's decisions have a significant impact on future oil prices, so it's important to learn how it works.
The Oil and Energy Ministers from the OPEC members meet at least twice a year to coordinate their oil production policies. Each member country abides by an honor system in which everyone agrees to produce a certain amount. If a nation winds up producing more, there is no sanction or penalty. Each country is responsible for reporting its own production. In this scenario, there is room for "cheating." A country won't go too far over its quota though unless it wants to risk being kicked out of OPEC.
Despite its power, OPEC cannot completely control the price of oil. Global supply and demand set its price. Supply is influenced by exploration, production, and geopolitical influencers that interrupt production and flow of oil from producers to consumers. Demand is dictated by consumers, businesses, and governments based on their needs for energy.
On December 7, 2018, OPEC agreed to cut 1.2 million barrels per day. Members would cut 800,000 bpd. Allies would cut 400,000 bpd. Analysts predicted the cut would return prices to $70 a barrel by early fall 2019. In November, average global prices for Brent crude oil had dropped to under $58 bpd. Commodities traders had bid prices down. They believed higher U.S. supplies would flood the market with supply at the same time slowing global growth would cut into demand.
On July 1, 2019, members agreed to maintain the cuts until the first quarter of 2020.
On November 30, 2017, OPEC agreed to continue withholding 2% of global oil supply. That continued the policy OPEC formed on November 30, 2016, when it agreed to cut production by 1.2 million barrels per day (mbpd). As of January 2017, it would produce 32.5 mbd. 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.
OPEC was struggling to maintain market share. Its share fell from 44.5% in 2012 to 41.8% in 2014. Its share fell because of a 16% increase in U.S. shale oil production. As the oil supply rose, prices fell from $119.75 in April 2012 to $38.01 in December 2015. That was one of the biggest drops in oil price history.
OPEC waited to cut oil production because it didn't want to see its market share drop further. It produces oil more cheaply than its U.S. competition. The cartel toughed it out until many of the shale companies went bankrupt. That created a boom and bust in shale oil.
OPEC's Three Goals
OPEC's first goal is to keep prices stable. It wants to make sure its members get a reasonable price for their oil. Since oil is a somewhat uniform commodity, most consumers base their buying decisions on nothing other than price. What's the right price? OPEC has traditionally said it was between $70 and $80 per barrel. If prices drop below that target, OPEC members agree to restrict supply to push prices higher.
Without OPEC, individual oil-exporting countries would pump as much as possible to maximize national revenue. By competing with each other, they would drive prices even lower. That would stimulate even more global demand. OPEC countries would run out of their most precious resource that much faster. Instead, OPEC members agree to produce only enough to keep the price high for all members.
When prices are higher than $80 a barrel, other countries have the incentive to drill more expensive oil fields. Sure enough, once oil prices got closer to $100 a barrel, it became cost-effective for Canada to explore its shale oil fields. U.S. companies used fracking to open up the Bakken oil fields for production. As a result, non-OPEC supply increased.
OPEC's second goal is to reduce oil price volatility. For maximum efficiency, oil extraction must run 24 hours a day, seven days a week. Closing facilities could physically damage oil installations and even the fields themselves. Ocean drilling is difficult and expensive to shut down. It is then in OPEC's best interests to keep world prices stable. A slight modification in production is often enough to restore price stability.
For example, in July 2008, oil prices hit an all-time high of $143 per barrel. OPEC responded by agreeing to produce a little more oil. This move brought prices down. But the global financial crisis sent oil prices plummeting to $33.73 per barrel in December. OPEC responded by reducing the supply. Its move helped prices to again stabilize.
OPEC's third goal is to become the world's oil supply swing producer. This would involve responding to shortages or surpluses by increasing or decreasing supply as needed—effectually achieving its first two goals of controlling price stability and volatility. For example, it replaced the oil lost during the Gulf Crisis in 1990. Several million barrels of oil per day were cut off when Saddam Hussein's armies destroyed refineries in Kuwait. OPEC also increased production in 2011 during the crisis in Libya.
OPEC has 13 active members. Saudi Arabia is by far the largest producer, contributing almost one-third of total OPEC oil production. It is the only member that produces enough on its own materially impact the world's supply. For this reason, it has more authority and influence than other countries.
|OPEC Country||Joined||Located||Oil Produced (mbpd) 2019||Comments|
|Ecuador||1973||Central America||0.53||Left in 1992. Rejoined in 2009.|
|Gabon||1975||Africa||0.22||Left in 1995. Rejoined in 2016.|
|Iran||1960||Middle East||2.37||Rose due to nuclear treaty.|
|Iraq||1960||Middle East||4.58||Increased output to fund Iraq War.|
|Libya||1962||Middle East||1.10||Returned to 2013 levels.|
|Saudi Arabia||1960||Middle East||9.81||Produces 30% of total.|
|Venezuela||1960||Central America||1.01||Funds the failing government.|
|TOTAL OPEC||29.38||Less than the record 33.44 in 2016.|
Qatar left in January 2019 to focus on natural gas instead of oil. Qatar's departure means the country is aligning itself more with the United States than with Saudi Arabia. U.S. officials stopped Saudi Arabia from invading Qatar in 2017, investigative website The Intercept reported. That same year the Saudis and the United Arab Emirates imposed an embargo on Qatar due to border disputes.
Indonesia joined in 1962 but left in 2009. It rejoined in January 2016 but left after the OPEC conference in November 2016. It did not want to cut oil production.
In 1960, five OPEC countries allied to regulate the supply and price of oil. These countries realized they had a nonrenewable resource. If they competed with each other, the price of oil would drop too far. They would run out of the finite commodity sooner than they would if oil prices were higher.
OPEC held its first meeting on September 10-14, 1960, in Baghdad, Iraq. The five founding members were Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. OPEC registered with the United Nations on November 6, 1962.
OPEC didn't flex its muscle until the 1973 oil embargo. It responded to a sudden drop in the U.S. dollar's value after President Nixon abandoned the gold standard. Since oil contracts are priced in dollars, the revenues of oil exporters fell when the dollar fell. In response to the embargo, the United States created the Strategic Petroleum Reserve.
Non-OPEC Oil-Producing Countries
Many non-OPEC members also voluntarily adjust their oil production in response to OPEC's decisions. In the 1990s, they increased production to take advantage of OPEC's restraints. That resulted in low oil prices and profits for everyone. These cooperating non-OPEC members are Mexico, Norway, Oman, and Russia.
Oil shale producers did not learn that lesson. They kept pumping oil, sending prices plummeting in 2014. As a result, many went below their break-even price of $65 a barrel. OPEC did not step in to lower its production. Instead, it allowed prices to fall to maintain its own market share. The break-even price is much lower for most of its members. But U.S. producers got more efficient.
OPEC-Russia Oil Alliance
OPEC is forming a partnership with a 10-country oil alliance led by Russia. Iran opposes the deal because then Saudi Arabia and Russia will dominate the organization. Russia is the world's second-largest oil exporter after Saudi Arabia.
On July 2, 2019, the participating countries endorsed a three-year charter of cooperation, an agreement to promote continued ministerial and technical dialogue. Together, they produce almost half the world's oil output.
OPEC would continue its regular meetings but the Russia-led group would also attend. Iran would prefer that the two groups only meet when there is a crisis.
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