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Oil Prices and Opec

Oil Prices and Opec

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OIL PRICES AND OPEC: THE ORGANIZATION OF PETROLEUM EXPORTING COUNRIES

Petroleum has been know of and exploited by humans for more than 4,000 years. For example, asphalt was used for construction in the Fertile Crescent, oil wells were drilled in China in 347 A.D. and Baghdad's streets were covered in tar in the 8th century. In the early 20th century, oil fields were established worldwide in countries such as Canada, Mexico and the U.S. By the 1950s, oil overtook coal as the world's primary fuel source. Crude oil is one of the most basic global commodities . Fluctuation in the crude oil prices have both direct and indirect impacts on the global economy . Therefore, the prices crude oil are tracked very closely by investors the world over. Crude oil prices have gone up to record levels of USD 125 per bbl (rise of around 70 percent from previous year's levels) in the year 2008 and have also reached a record low of 50$ a bbl in the same year ,highlighting the fluctuations that oil prices are subject to.

The price variation in crude oil impacts the sentiments and hence the volatility in stock markets all over the world. The rise in crude oil prices is not good for the global economy. Price rise in crude oil virtually impacts industries and businesses across the board. Higher crude oil prices mean higher energy prices, which can cause a ripple effect on virtually all business aspects that are dependent on energy (directly or indirectly).specially industries related to the transport and energy sector. There are many factors that influence the global crude oil prices including technology to increase production , storage of crude oil by richer nations (one major indicator that is tracked closely is the US crude oil inventory data), changes in tax policy, political issues etc. In the recent past, we have seen many factors influencing the prices of global crude oil. Some of the most important factors affecting the price of crude oil are factors such as demand for crude oil, in the global economy in general, production of crude oil and its availability ,natural factors such as a natural calamity in oil producing areas and so on. However in today’s times one of the mast important factors controlling crude oil prices is OPEC . With the establishment of the U.S. Mandatory Oil Import Quota Program in 1959, the amount of imported oil into the U.S. was severely limited, with preferences to imports from Canada and Mexico. By excluding oil from the Persian Gulf, prices dropped, causing concern among some of the world's top oil-producing states. The Venezuelan Energy and Mines Minister Juan Pablo Pérez Alfonzo and Saudi Arabian Energy and Mines Minister Abdullah al-Tariki urged government representatives from Iran, Iraq, Kuwait, Saudi Arabia and Venezuela to hold the Baghdad Conference Sept. 10-14, 1960. The meeting's main objective was to discuss crude oil production and to work on better communication among the invited countries

Mobil and Gulbenkian. transportation. Ecuador 1973). by the second half of the 1950s. i. was able to find its way in investing beyond the control of the “Seven Sisters” by offering different and better financial . respectively. Any decisions made by OPEC countries to raise the prices or reduce production. the international oil industry had been characterised mainly by the dominant position of the major multi..e.e. Indonesia (1962). Saudi Arabia and Venezuela. and distribution networks. The state-owned Italian company. Libya (1962). Kuwait. Through joint ownership of the holding companies that operated in various countries. which made them “vertically” integrated. exploration. according to which these companies were interlinked in the “upstream” phase of the industry.national oil companies through a system of oil concessions granted to the major oil-producing countries. Ecuador and Gabon withdrew(from the organization in 1992 and 1994. The Organization of the Petroleum Exporting Countries (OPEC) was created at the Baghdad Conference in Iraq in September 1960. Iraq. according to its market outlets in the countries to which crude oil is shipped “However. Lacking exploration skills. The essential nature of oil (no substitutes) coupled with its limited number of suppliers make it the ideal product for cartelization. These were also known as the “seven sisters” Each of these “sisters” had its own “downstream” operations. Algeria (1969). However. development and production of crude oil. the companies’ being interlinked in the upstream phase) was the Iraqi Petroleum Company (IPC). the amount of oil products needed by each. The oldest example of this kind of “horizontal integration” (i. is to limit supplies in the hope of keeping prices high and to prevent prices (and profits) from falling. about the time of World War II the oil exporting countries began seeking better terms in their oil contracts. Nigeria (1971).e. refining capacity. refining. Royal Dutch Shell. Just as the major oil companies colluded from the 1920's to the1960’s The purpose of OPEC. This new development led to the creation – albeit on a limited scale – of a free market for buying and selling crude oil outside the control of the major companies.A large part of the world's crude oil share is produced by OPEC (Organisation of Petroleum Exporting Countries) nations. The oil industry has been plagued with falling prices ever since Colonel Drakes' discovery of oil at Titusville. this compact system of complete control of production and inter-company exchanges began to weaken with the appearance of independent oil companies searching for an access to cheaper crude oil. they were able to plan their production of crude oil according to their requirements. immediately impacts the prices of crude oil in the global commodity markets. Prior to this event. oil producing countries were unable to challenge the dominance of the oil companies prior to World War II. and until the late 1950s. production technology. Standard oil (New Jersey). ENI. These five states were later joined by eight other countries: Qatar (1961). and Gabon (1975). oil products and distribution networks. This compact system of horizontal and vertical integration allowed the companies to plan for their future crude oil requirements in line with their downstream requirements – i.e. as with any cartel. members of OPEC meet on a regular basis to set production levels in the hope of maintaining prices. Compaigne Francaise Petrol. The founding members of the organization were Iran. i. United Arab Emirates (1967). Pennsylvania in 1859. The rise of OPEC is tied to a shifting balance of power from the multinational oil companies to the oil producing countries.

A cartel inspired rise in prices not only creates . when the realized price falls.30 and the domestic price of oil in the US was$3. an efficient. Similarly. However. No one could have foreseen at that time that this event would play such a crucial role. By 1970. A market price began to shape up in the form of discounts off the ‘posted’ price set by the major oil companies. many independent oil companies began to invest outside the Sisters’ control by offering apparently better financial terms than the oil concession system. in order to secure fair and stable prices for petroleum producers. domestic producers simply could not compete. except perhaps by the specialised petroleum press. On the other hand. which was a fixed price. economic and regular supply of petroleum to consuming nations. the multinational oil companies tried to cut the "posted" price from 1958onward. The event at the time passed almost unnoticed. In general. and the tax cost for the new producer would correspondingly fall lower thus providing a good margin of profit from the new investor with which to re=invest in the production of crude oil.During its first decade. In 1960. the host government’s per-barrel-share falls accordingly. The quota kept domestic prices artificially high and represented a net transfer of wealth from American oil consumers to American oil producers. British Petroleum unilaterally cut oil prices by about 10 percent. but rather on the basis of a price realized in the free market. OPEC's objective is to co-ordinate and unify petroleum policies among Member Countries. dependence on foreign oil placed the country's national security in jeopardy.18 . after a second cut in the posted price in August The five major oil producing countries responded by forming the Organization of Petroleum Exporting Countries cartel in September 1960 . Moreover. In order to recapture profits. which was always below the posted price. a new pattern of tax relationship emerged following the entry of newcomers investing in oil in new areas such as Libya. responded with an import quota. As prices fell. and a fair return on capital to those investing in the industry . the Eisenhower Administration concluded (as the Japanese had prior to World War II). The U. where the government’s per-barrel share was not calculated on the official posted price.terms than the oil concessions. The downward push on prices led to a policy debate in Washington. In 1959. It instantly set off denunciation from the oil exporting countries. OPEC was able to halt the free fall in prices. commodity cartels collapse because there are many substitutes for the product or there are many potential producers of the product. in reshaping the world energy scene and have such an impact on the world economy. and in this way. the expansion of cheaply produced oil from the middle east led to rising imports. Although the United States had been a net exporter of oil until 1948.S. it was not able to raise prices as most members had hoped. some ten years or so later. the world price of oil was $1. This deprived many independent American oil companies that had access to foreign crude oil from entering the US market – a situation that led to their having to sell surplus crude outside the major oil companies’ system.

The incentive to cheat implies that cartels are traditionally short-lived enterprises. As the world oil market tightened. However. Iraq threatened to invade its neighbor Kuwait (it was deterred by the deployment of British forces). This was most acutely realized in the oil embargo during the 1973 Yom Kippur between Egypt and Israel The gulf states bent on destroying the newly created state of Israel which according to them had taken away land which rightfully belonged to the Palestinian Muslims wanted to use control over oil as a method to reign in the so called “westernized” nations. Production would be cut by 5 percent per month until the West backed down. all members have a similar incentive to increase production -. most of the oil reserves in the ground belonged to multinational corporations (except in Iran) also severely limited the power of OPEC countries Thirdly the oil glut of the 1960’s made the problem more severe. For example. Arab oil ministers than agreed to an embargo to further their political objectives. OPEC's fortunes began to shift in the early 1970's as rising demand for oil began to outstrip production. an individual country such as Iran can increase its oil revenues by expanding production as long as all other members stick to their quotas.2 billion military aid package for Israel. the oil exporting countries were desperate for revenue to fuel economic development . Secondly. Also . every member has an incentive to cheat on the the cartel by increasing its production. OPEC’S share of world production was only 28% in 1960. backed the Arab position. drove the world economy into deep recession. If there was any doubt that the ability to control crude oil prices had passed from the United States to OPEC it was removed during the Arab Oil Embargo. Although the essential nature of oil and the limited number of suppliers worked in the OPEC's favor.. By 1970. which did not end until the Syrian-Israeli disengagement was secured.i. South Africa. States adopting a "friendly" position (from the Arab perspective) would be unaffected. Fourthly. this figure would rise to 41%. Gross national product in the U. The embargo.e.: Firstly. of world production. Iran and Saudi Arabia vied for leadership of the Middle East. When Nixon publicly proposed a $2. they all want to free ride on the collective oil revenues by expanding production as long as all other members stick to their quotas. Arab states began an oil embargo against the United States (later expanded to the Netherlands. The jump in prices was unprecedented. Portugal. declined by 6 percent in the following two years. Cartels also suffer from a "collective action problem.encouragement for firms to enter the market but also promotes the consumption of substitutes which may be close or remote. the Arab world became more vocal in calling for use of the oil weapon to achieve their economic and political objectives. Oil prices increased from about $3. and Rhodesia)..S.65. the oil producing states began demanding further concessions. the power of the organization remained limited during the first decade for five reasons. The Japanese economy shrinks for the first time .S. good. Saudi Arabia refused to increase production in order to halt rising prices unless the U. The extreme sensitivity of prices to supply shortages became all too apparent when prices increased by approximately400 percent in six short months. The revolutionary government of Nasser repeatedly clashed with the Saudi monarchy." That is.and important political divisions existed in the Arab world.it made any attempt to raise prices unfeasible.00 a barrel before the war to $11.

the OPEC countries did not want to reduce prices.since the Second World War and the power and the hold of OPEC over oil prices made its presence felt From 1974 to 1978 world crude oil prices were relatively flat ranging from $12. Iran counterattacked by prohibiting the exporting of Iranian oil to any American firm. The two oil price shocks triggered enormous investments in scientific research to improve the efficiency of technology in finding. thus adding for the oil companies an even higher margin of profit with which to reinvest in high-cost areas The influence of OPEC appeared to be diminishing as the production by Mexico. However. developing and producing oil and thus reducing the high cost of upstream operations in these new areas.55 per barrel. Because of . Anxious to increase market share. However demand had peaked in 1979 and it became clear that the only way to for OPEC to maintain prices was by reducing OPEC production. OPEC reduced its total production by a third during the first half of the 1980s. having been less than 200 tbpd. they were making significant cuts in their official prices. coupled with the fall in demand as a result of high prices. As a result OPEC's share in world oil production dropped below 30 percent. the Iran-Iraq war abruptly removed almost 4 million daily barrels of oil from the world market—15 percent of total OPEC output and 8 percent of free world demand. The reason behind this was that OPEC’s high prices provided such a wide profit margin for oil investors that high-cost areas such as the North Sea became not only feasible but highly lucrative areas for continued reinvestment. Moreover. For example. OPEC saw its own market share fall from 62% in the mid-1970s to 37% in 1985. The Iranian revolution resulted in the loss of 2 to 2. 1979. and so diminish their political influence. Britain. and other non-OPEC countries and Alaska was continuing to increase. 1978 and June. all as a result of increasing supplies from outside OPEC. At one point production almost halted.5 mbpd in 1985. As a result. When the Carter administration placed an embargo on the importing of Iranian oil into the United States and froze Iranian assets in response to the hostage taking.5 million barrels per day of oil production between November. In 1980 OPEC representatives (with the exception of Saudi Arabia) agreed to set prices at thirty-six dollar a barrel causing another unprecedented increase in oil prices. lose their great economic and political gains. OPEC's share of world output quickly fell by 25 percent. and continued to rise thereafter. With this continued decline in the call on its oil. The Second Oil Shock began when the Iranian Revolution and ensuing halt of Iranian petroleum exports had caused panic and speculations in the world oil market. or 2mbpd in 1975. the outbreak of the war between Iran and Iraq in 1980 shook the oil market as well. for fear that they would undermine their whole pricing structure. The petroleum market confronted the OPEC with an unpalatable choice: cut prices in order to regain markets or cut production to maintain price. In its initial stage. When adjusted for inflation the price over that period of time world oil prices were in a period of moderate decline.21 per barrel to $13. Norway. North Sea production (both British and Norwegian) leapt to 3.

Crude oil prices plummeted below $10 per barrel by mid-1986. raise oil prices and revenue. However the OPEC did not always organize a united front against this pressure. saw its oil revenues plunge from $113. the oil producing states placed a significant portion of their revenue into commercial banks because they simply could not spend the money as fast as it came in. the most serious long run impact of the second shock was in the developing world. the developed world responded to the Second Oil Shock by rapidly raising interest rates which deepened the on-going recessions. Higher prices also resulted in increased exploration and production outside of OPEC. and the greater the supplies of non-OPEC oil. the largest producer in OPEC. In August of 1985. A successful invasion. In 1991 the on-going territorial conflict was exacerbated by two oil issues: Firstly. During most of this period Saudi Arabia acted as the swing producer cutting its production in an attempt to stem the free fall in prices.0 billion in 1986.2 billion in 1981 to just $20. Saudi Arabia. and annul war debts to Kuwait. The developing countries saw exports fall. and secondly low oil revenues for Iraq which made paying off its war debts (to Kuwait and others) difficult. augment Iraqi power in OPEC. During the 1970s. the continued pumping of oil by Kuwait from a field located under both countries. A December 1986 OPEC price accord set to target $18 per barrel bit it was already breaking down by January of 1987and prices remained weak. These attempts met with repeated failure as various members of OPEC produced beyond their quotas. Oil revenues for OPEC members plunged after 1981. The result was the creation of a debt crisis which was felt all over the which was felt all over the developing world. any additional oil coming from outside OPEC would capture first its share in the market before buyers resorted to OPEC oil. the less OPEC oil on the market to meet world demand. Although the Second Oil Shock sent the developed world into recession. in 1961 it appeared Iraq was going to swallow its tiny neighbour until the dispatch of troops by the British. Saudi Arabia. They linked their oil price to the spot market for crude and by early 1986 increased production from 2 MMBPD to 5 MMBPD. whose oil production far surpassed other member countries. OPEC was faced with However. had championed decisions for low pricing for larger market-sharing and long-term gains The third major price hike in occurred in 1990-1 when Iraq invaded its fellow OPEC member Kuwait. from the point of view of Iraq would expand reserves. The commercial banks loaned this money to developing countries which hoped to repay the loans with revenue from their rapidly growing economies. For example. From 1980 to 1986 non-OPEC production increased 10 million barrels per day. the Saudis tired of this role. Despite the fall in prices Saudi revenue remained about the same with higher volumes compensating for lower prices.the fact that OPEC adhered to the system of fixed price and swing production. and interest payments skyrocket. oil import prices rise. OPEC attempted to set production quotas low enough to stabilize prices. Iraq had long claimed the territory of Kuwait. . From 1982 to 1985.

2000 Russian production increases dominated non-OPEC production growth from 2000 forward and was responsible for most of the non-OPEC increase since the turn of the century. Between 1990 and 1996 Russian production declined over 5 million barrels per day. Price continued down through December 1998. 1997 OPEC increased its quota by 2.5 MMBPD effective January 1. Asian consumption accounted for all but 300. From 1990 to 1997 world oil consumption increased 6. The rapid growth in Asian economies had come to a halt.335 million in July. Since the war. The United States economy was strong and the Asian Pacific region was booming. The price cycle then turned up.S. developing.719 million barrels in April. In response. The war had sent oil prices skyrocketing through the ceiling.2 million barrels per day. he price of crude oil spiked in 1990 with the lower production and uncertainty associated with the Iraqi invasion of Kuwait and the ensuing Gulf War.5 million barrels per day (10 percent) to 27.Iraq had gambled that the U. In December. As usual not all of the quotas were observed but between early 1998 and the middle of 1999 OPEC production dropped by about 3 million barrels per day and was sufficient to move prices above $25 per barrel. In 1998 Asian Pacific oil consumption declined for the first time since 1982. the Iraqi invasion triggered a military response which was supported by an unlikely coalition of western.2 million barrels per day were not able to stem the price increases. The price increases came to a rapid end in 1997 and 1998 when the impact of the economic crisis in Asia was either ignored or severely underestimated by OPEC.25 million b/d in April and another 1. Prices finally started down following another quota increase of 500. 1998. OPEC cut quotas by 1. Iraq's refusal to comply with United Nations resolutions had resulted in the continuation of an oil embargo. With minimal problems in the beginning of 2000 and growing US and world economies the price continued to rise throughout 2000 to a post 1981 high Between April and October. However. following what became known as the Gulf War to liberate Kuwait crude oil prices entered a period of steady decline until in 1994 inflation adjusted prices attained their lowest level since 1973. . Declining Russian production contributed to the price recovery. However. .000 effective November 1. OPEC continued to have mixed success in controlling prices. The proximity to the world's largest oil producer helped to shape the reaction. 2000 three successive OPEC quota increases totaling 3.000 barrels per day of that gain and contributed to a price recovery that extended into 1997. response would be political and economic. There were mistakes in timing of quota changes as well as the usual problems in maintaining production discipline among its member countries. The combination of lower consumption and higher OPEC production sent prices into a downward spiral. The world and particularly the Middle East had a much harsher view of Saddam Hussein invading Arab Kuwait than they did Persian Iran. Prices began to recover in early 1999 and OPEC reduced production another 1. Saudi Arabia expanded production by literally millions of barrels per day to keep prices from rising a great deal.

In 2001. and other OECD countries. 2001.S. 2003. However the cartel has faced several problems since its inception in 1960. were down 35 percent by the middle of November. OPEC increased quotas by 2.S.000 barrels per day below its peak capacity of 3. 2001 terrorist attack this would have been sufficient to moderate or even reverse the trend .In the wake of the attack crude oil prices plummeted.5 million barrels per day and was joined by several non-OPEC producers including Russia who promised combined production cuts of an additional 462.S. There are 2 major problems that t OPEC or any other cartel faces two problems in their attempts to control prices. This increased to approximately 150$ a barrel by mid july 2008 before falling by 20$ in the course of a few days.9% over the same 15-year period up to end 2007. Economic slowdown and the global recession in general. . inventories remained low in the U. just as some Venezuelan production was beginning to return. With an improving economy U. In a world that consumes over 80 million barrels per day of petroleum products that added a significant risk premium to crude oil price and was largely responsible for prices in excess of $40-$50 per barrel. Prices in the U. military action commenced in Iraq. During much of 2004 and 2005 the spare capacity to produce oil was under a million barrels per day. In the absence of the September 11. On March 19.6% a year over the past 15 years. there was over 6 million barrels per day of excess production capacity and by mid-2003 the excess was below 2 million. a weakened US economy and increases in non-OPEC production put downward pressure on prices. demand was increasing and Asian demand for crude oil was growing at a rapid pace. 2002. while world Gross Domestic Product growth averaged 2. Meanwhile.Once again it appeared that OPEC overshot the mark. The world demand for oil has averaged growth of 1. By mid-year the non-OPEC members were restoring their production cuts but prices continued to rise and U. Problems in Venezuela led to a strike among workers in oilfields causing Venezuelan production to plummet. By year end oversupply was not a problem. In mid 2002.. currently oil prices are fluctuating to hover around the 50$ benchmark. inventories reached a 20-year low later in the year. 2003.S. In January 2008 the price of crude oil touched about 100$ a barrel. After the U. This had the desired effect with oil prices moving into the $25 range by March. In the wake of the strike Venezuela was never able to restore capacity to its previous level and is still about 900. It then reduced its quota by 1. Under normal circumstances a drop in price of this magnitude would have resulted an another round of quota reductions but given the political climate OPEC delayed additional cuts until January 2002.8 million barrels per day in January and February. In response OPEC once again entered into a series of reductions in member quotas cutting 3.5 million barrels by September 1.500 barrels. the world demand for energy has reduced and therefore production quotas for the OPEC are expected to fall further. The loss of production capacity in Iraq and Venezuela combined with increased OPEC production to meet growing international demand led to the erosion of excess oil production capacity.5 million barrels per day.S. The first problem is to determine the level of production which meets their collective goals. A million barrels per day is not enough spare capacity to cover an interruption of supply from most OPEC producers.

for OPEC this means maintaining production levels which insure the highest prices possible without encouraging competition outside of OPEC or significant conservation measures on the part of consumers. In fact OPEC has had troubles because of the non adherence of members to production quotas and therefore leading to internal weaknesses. we can conclude that the volatile nature of the oil prices has not reduced. By 1986 the Saudis tired of this role. Oil price shocks occurred during the Arab oil embargo. thereby creating an anomaly. OPEC has also been behest by problems due to internal divisions. This creates a situation where oil prices may not be determined by market forces but instead. most of the member states of the OPEC are dependent on oil revenues which accounts for the maximum proportions of their GDP’s. Prices also fluctuated during USA’s “war on terror” in Iraq. by the short term financial requirements of the country. Even though they have not been adjusted for inflation one can make out the changes in prices at the interval of a decade or so. In fact the figure given below documents the constant fluctuation in oil prices over the years. Saudi Arabia acted as swing producer for OPEC during the first half of the 1980s in an attempt to shore up declining prices. Other OPEC . The OPEC has actually been responsible for the creation of oil price fluctuations. squabbles and disagreements among member nations. In fact a major key to understanding why OPEC does not always do what seems obvious to the rest of us is the battle for market share within OPEC.Simply stated. After studying the fluctuation of oil prices after the formation of the OPEC cartel. And oil supplies being dictated by political motives. Apart from being driven by political considerations. as the OPEC had been founded with the objective of bringing about a stability in oil prices. It is important to note that we are now taking into consideration the OPEC member's share within OPEC and not their share of total world production. the Iranian revolution as well as the Iraqi invasion of Kuwait. In certain cases such as the embargoes placed on oil and the reduction of production quotas. One of the major limitations of the OPEC is its increased politicization.

opec.org/aboutus/history/history.cges.co/uk www. In response Saudi Arabia rapidly increased production causing a major price collapse. members of the OECD and the Post Soviet states produced only 23. www. FYBA Div A Roll no 12 References:www.chavezoil. as of March 2008.org www.. The use of oil – which is an essential commodity required for the development of any nation .8%. affording them considerable control over the global market. respectively. By the end of the decade of the 1980s OPEC and prices seemed to have stabilized.6% of the world's oil production. In fact the Arab leg of the OPEC (Arab members of the organization of petroleum exporting countries) was founded after internal squabbles among the OPEC Moreover oil price shocks have also led to an increased demand for research into and innovation of new sources of energy. The fact that oil prices are generally expressed in US $ has also created problems for the OPEC This means that as the prices are denominated in US dollars means that any depreciation of the value of the US dollar could lead to a loss in real value of oil revenues when used to pay OPEC countries’ imports from non-dollar countries.rouhani . increased oil efficiency may also have reduced its power to some extent. As a result the strength of the dollar has an impact on the domestic revenues of the member nations wealth.8% and 14. Although during its inception OPEC had somewhat been successful in stabilizing oil prices in the short term it failed to see that the very nature of the cartel might not be conducive to price stability in the long run. as a political weapon to rally support has been widely condemned. and.org OPEC-instrument of change –Seymour History of OPEC. It encouraged increased consumption and halted production increases in much of the rest of the world. Moreover the share of OPEC in the world market has also decline with the discovery and exploration of oil sources in other regions of the world Priya Bhatter. he lower prices did have a positive result for OPEC. The next largest group of producers.member countries were cheating on their quotas. In fact in Japan the total share of oil in energy consumption has decreased from 77% to 50% while that of nuclear power has increased from 1 % to 14% OPEC nations still account for two-thirds of the world's oil reserves.opec. 35. of the world's total oil production.

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