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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
they were able to plan their production of crude oil according to their requirements. Saudi Arabia and Venezuela.national oil companies through a system of oil concessions granted to the major oil-producing countries. 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. according to its market outlets in the countries to which crude oil is shipped “However. refining capacity.Mobil and Gulbenkian. Royal Dutch Shell. 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. Ecuador 1973). The founding members of the organization were Iran.e. The Organization of the Petroleum Exporting Countries (OPEC) was created at the Baghdad Conference in Iraq in September 1960. United Arab Emirates (1967).. Indonesia (1962). Nigeria (1971). refining. respectively. However.e. according to which these companies were interlinked in the “upstream” phase of the industry. Libya (1962). The oil industry has been plagued with falling prices ever since Colonel Drakes' discovery of oil at Titusville. Just as the major oil companies colluded from the 1920's to the1960’s The purpose of OPEC. and distribution networks. Prior to this event. the international oil industry had been characterised mainly by the dominant position of the major multi. by the second half of the 1950s.e. Any decisions made by OPEC countries to raise the prices or reduce production. transportation. about the time of World War II the oil exporting countries began seeking better terms in their oil contracts. oil products and distribution networks. development and production of crude oil. i. Kuwait. The rise of OPEC is tied to a shifting balance of power from the multinational oil companies to the oil producing countries. the amount of oil products needed by each. Through joint ownership of the holding companies that operated in various countries. immediately impacts the prices of crude oil in the global commodity markets. and until the late 1950s. as with any cartel. These were also known as the “seven sisters” Each of these “sisters” had its own “downstream” operations. Pennsylvania in 1859. production technology. and Gabon (1975). oil producing countries were unable to challenge the dominance of the oil companies prior to World War II. was able to find its way in investing beyond the control of the “Seven Sisters” by offering different and better financial . Iraq. i. the companies’ being interlinked in the upstream phase) was the Iraqi Petroleum Company (IPC).A large part of the world's crude oil share is produced by OPEC (Organisation of Petroleum Exporting Countries) nations. exploration. These five states were later joined by eight other countries: Qatar (1961). Compaigne Francaise Petrol. is to limit supplies in the hope of keeping prices high and to prevent prices (and profits) from falling. Standard oil (New Jersey). The state-owned Italian company. Lacking exploration skills. Ecuador and Gabon withdrew(from the organization in 1992 and 1994. which made them “vertically” integrated.e. The oldest example of this kind of “horizontal integration” (i. members of OPEC meet on a regular basis to set production levels in the hope of maintaining prices. ENI. The essential nature of oil (no substitutes) coupled with its limited number of suppliers make it the ideal product for cartelization. Algeria (1969). 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.
the expansion of cheaply produced oil from the middle east led to rising imports. In order to recapture profits.S. Similarly. commodity cartels collapse because there are many substitutes for the product or there are many potential producers of the product. 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. OPEC's objective is to co-ordinate and unify petroleum policies among Member Countries. responded with an import quota.30 and the domestic price of oil in the US was$3. dependence on foreign oil placed the country's national security in jeopardy. Moreover. the Eisenhower Administration concluded (as the Japanese had prior to World War II). but rather on the basis of a price realized in the free market. in reshaping the world energy scene and have such an impact on the world economy. in order to secure fair and stable prices for petroleum producers. A market price began to shape up in the form of discounts off the ‘posted’ price set by the major oil companies. By 1970. when the realized price falls. The downward push on prices led to a policy debate in Washington. and a fair return on capital to those investing in the industry . an efficient. 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. However. On the other hand. a new pattern of tax relationship emerged following the entry of newcomers investing in oil in new areas such as Libya. In 1959. The quota kept domestic prices artificially high and represented a net transfer of wealth from American oil consumers to American oil producers. A cartel inspired rise in prices not only creates .18 . In general. it was not able to raise prices as most members had hoped. No one could have foreseen at that time that this event would play such a crucial role. many independent oil companies began to invest outside the Sisters’ control by offering apparently better financial terms than the oil concession system. except perhaps by the specialised petroleum press. the host government’s per-barrel-share falls accordingly. which was always below the posted price.terms than the oil concessions. which was a fixed price. It instantly set off denunciation from the oil exporting countries. The event at the time passed almost unnoticed.During its first decade. OPEC was able to halt the free fall in prices. The U. In 1960. where the government’s per-barrel share was not calculated on the official posted price. some ten years or so later. economic and regular supply of petroleum to consuming nations. the multinational oil companies tried to cut the "posted" price from 1958onward. British Petroleum unilaterally cut oil prices by about 10 percent. domestic producers simply could not compete. the world price of oil was $1. and in this way. Although the United States had been a net exporter of oil until 1948. As prices fell. 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 .
" That is. every member has an incentive to cheat on the the cartel by increasing its production. Iraq threatened to invade its neighbor Kuwait (it was deterred by the deployment of British forces). The Japanese economy shrinks for the first time . the power of the organization remained limited during the first decade for five reasons. Production would be cut by 5 percent per month until the West backed down. Arab states began an oil embargo against the United States (later expanded to the Netherlands. Iran and Saudi Arabia vied for leadership of the Middle East.encouragement for firms to enter the market but also promotes the consumption of substitutes which may be close or remote.65. South Africa. Saudi Arabia refused to increase production in order to halt rising prices unless the U. The incentive to cheat implies that cartels are traditionally short-lived enterprises. of world production.e. OPEC's fortunes began to shift in the early 1970's as rising demand for oil began to outstrip production. By 1970.. drove the world economy into deep recession.. Portugal. However. which did not end until the Syrian-Israeli disengagement was secured. As the world oil market tightened. Gross national product in the U. OPEC’S share of world production was only 28% in 1960. Arab oil ministers than agreed to an embargo to further their political objectives. and Rhodesia). all members have a similar incentive to increase production -.2 billion military aid package for Israel. 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. the Arab world became more vocal in calling for use of the oil weapon to achieve their economic and political objectives. the oil producing states began demanding further concessions. 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. Oil prices increased from about $3. Fourthly. The revolutionary government of Nasser repeatedly clashed with the Saudi monarchy.00 a barrel before the war to $11. backed the Arab position. an individual country such as Iran can increase its oil revenues by expanding production as long as all other members stick to their quotas.and important political divisions existed in the Arab world. this figure would rise to 41%. good.it made any attempt to raise prices unfeasible.S. the oil exporting countries were desperate for revenue to fuel economic development . The extreme sensitivity of prices to supply shortages became all too apparent when prices increased by approximately400 percent in six short months. The embargo. States adopting a "friendly" position (from the Arab perspective) would be unaffected. Although the essential nature of oil and the limited number of suppliers worked in the OPEC's favor. The jump in prices was unprecedented. they all want to free ride on the collective oil revenues by expanding production as long as all other members stick to their quotas. declined by 6 percent in the following two years. Secondly.i. Also . 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.: Firstly. For example.S. When Nixon publicly proposed a $2. Cartels also suffer from a "collective action problem.
1978 and June. OPEC's share of world output quickly fell by 25 percent. 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. developing and producing oil and thus reducing the high cost of upstream operations in these new areas.55 per barrel. When adjusted for inflation the price over that period of time world oil prices were in a period of moderate decline. OPEC saw its own market share fall from 62% in the mid-1970s to 37% in 1985.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. At one point production almost halted. 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. Moreover. 1979. As a result. lose their great economic and political gains. The Iranian revolution resulted in the loss of 2 to 2. coupled with the fall in demand as a result of high prices. With this continued decline in the call on its oil. they were making significant cuts in their official prices. and so diminish their political influence. The two oil price shocks triggered enormous investments in scientific research to improve the efficiency of technology in finding. North Sea production (both British and Norwegian) leapt to 3. 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. For example. However. the outbreak of the war between Iran and Iraq in 1980 shook the oil market as well.5 million barrels per day of oil production between November. or 2mbpd in 1975. 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. 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. Iran counterattacked by prohibiting the exporting of Iranian oil to any American firm.5 mbpd in 1985. having been less than 200 tbpd. the OPEC countries did not want to reduce prices. In its initial stage. 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. Norway. and other non-OPEC countries and Alaska was continuing to increase. OPEC reduced its total production by a third during the first half of the 1980s. and continued to rise thereafter. 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. Britain. Because of . all as a result of increasing supplies from outside OPEC. The petroleum market confronted the OPEC with an unpalatable choice: cut prices in order to regain markets or cut production to maintain price.21 per barrel to $13. for fear that they would undermine their whole pricing structure.
. the continued pumping of oil by Kuwait from a field located under both countries.0 billion in 1986. 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. and annul war debts to Kuwait. and interest payments skyrocket. the Saudis tired of this role. From 1980 to 1986 non-OPEC production increased 10 million barrels per day. For example. OPEC attempted to set production quotas low enough to stabilize prices. 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. and the greater the supplies of non-OPEC oil. 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 developed world responded to the Second Oil Shock by rapidly raising interest rates which deepened the on-going recessions. However the OPEC did not always organize a united front against this pressure. Oil revenues for OPEC members plunged after 1981. 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. saw its oil revenues plunge from $113.the fact that OPEC adhered to the system of fixed price and swing production. They linked their oil price to the spot market for crude and by early 1986 increased production from 2 MMBPD to 5 MMBPD. The commercial banks loaned this money to developing countries which hoped to repay the loans with revenue from their rapidly growing economies. Although the Second Oil Shock sent the developed world into recession. the less OPEC oil on the market to meet world demand. Saudi Arabia. raise oil prices and revenue. whose oil production far surpassed other member countries. In August of 1985. from the point of view of Iraq would expand reserves. the largest producer in OPEC. Crude oil prices plummeted below $10 per barrel by mid-1986. OPEC was faced with However. 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. A successful invasion. These attempts met with repeated failure as various members of OPEC produced beyond their quotas. In 1991 the on-going territorial conflict was exacerbated by two oil issues: Firstly. During the 1970s. Higher prices also resulted in increased exploration and production outside of OPEC. Saudi Arabia. in 1961 it appeared Iraq was going to swallow its tiny neighbour until the dispatch of troops by the British. Iraq had long claimed the territory of Kuwait. The result was the creation of a debt crisis which was felt all over the which was felt all over the developing world. the most serious long run impact of the second shock was in the developing world. oil import prices rise. From 1982 to 1985. any additional oil coming from outside OPEC would capture first its share in the market before buyers resorted to OPEC oil.2 billion in 1981 to just $20. Despite the fall in prices Saudi revenue remained about the same with higher volumes compensating for lower prices.
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. Asian consumption accounted for all but 300. 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 MMBPD effective January 1. The United States economy was strong and the Asian Pacific region was booming. The proximity to the world's largest oil producer helped to shape the reaction. 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. In 1998 Asian Pacific oil consumption declined for the first time since 1982. In response. Declining Russian production contributed to the price recovery. Price continued down through December 1998. Saudi Arabia expanded production by literally millions of barrels per day to keep prices from rising a great deal. the Iraqi invasion triggered a military response which was supported by an unlikely coalition of western. Since the war. 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. 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. Iraq's refusal to comply with United Nations resolutions had resulted in the continuation of an oil embargo.335 million in July.000 barrels per day of that gain and contributed to a price recovery that extended into 1997.25 million b/d in April and another 1. OPEC cut quotas by 1. 1997 OPEC increased its quota by 2.S. In December. 1998.Iraq had gambled that the U. 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. OPEC continued to have mixed success in controlling prices. Prices began to recover in early 1999 and OPEC reduced production another 1.2 million barrels per day were not able to stem the price increases. There were mistakes in timing of quota changes as well as the usual problems in maintaining production discipline among its member countries.719 million barrels in April. developing. The price cycle then turned up. .2 million barrels per day. response would be political and economic.000 effective November 1. The rapid growth in Asian economies had come to a halt. Between 1990 and 1996 Russian production declined over 5 million barrels per day. The combination of lower consumption and higher OPEC production sent prices into a downward spiral. From 1990 to 1997 world oil consumption increased 6.5 million barrels per day (10 percent) to 27. However. . The war had sent oil prices skyrocketing through the ceiling. Prices finally started down following another quota increase of 500. The world and particularly the Middle East had a much harsher view of Saddam Hussein invading Arab Kuwait than they did Persian Iran. 2000 three successive OPEC quota increases totaling 3.
000 barrels per day below its peak capacity of 3. There are 2 major problems that t OPEC or any other cartel faces two problems in their attempts to control prices.S. The world demand for oil has averaged growth of 1.S. inventories remained low in the U. military action commenced in Iraq. 2001 terrorist attack this would have been sufficient to moderate or even reverse the trend . demand was increasing and Asian demand for crude oil was growing at a rapid pace.S. 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. 2001. This had the desired effect with oil prices moving into the $25 range by March.5 million barrels per day. In response OPEC once again entered into a series of reductions in member quotas cutting 3. In mid 2002.5 million barrels per day and was joined by several non-OPEC producers including Russia who promised combined production cuts of an additional 462. Economic slowdown and the global recession in general. By mid-year the non-OPEC members were restoring their production cuts but prices continued to rise and U. By year end oversupply was not a problem. However the cartel has faced several problems since its inception in 1960.S.8 million barrels per day in January and February.9% over the same 15-year period up to end 2007. OPEC increased quotas by 2. A million barrels per day is not enough spare capacity to cover an interruption of supply from most OPEC producers. 2003. This increased to approximately 150$ a barrel by mid july 2008 before falling by 20$ in the course of a few days. In January 2008 the price of crude oil touched about 100$ a barrel. In the absence of the September 11. 2003. On March 19. currently oil prices are fluctuating to hover around the 50$ benchmark. while world Gross Domestic Product growth averaged 2. Prices in the U. In 2001. the world demand for energy has reduced and therefore production quotas for the OPEC are expected to fall further. Problems in Venezuela led to a strike among workers in oilfields causing Venezuelan production to plummet. 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. were down 35 percent by the middle of November. just as some Venezuelan production was beginning to return. 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. 2002. . It then reduced its quota by 1. In the wake of the strike Venezuela was never able to restore capacity to its previous level and is still about 900. Meanwhile.6% a year over the past 15 years.In the wake of the attack crude oil prices plummeted. The first problem is to determine the level of production which meets their collective goals. a weakened US economy and increases in non-OPEC production put downward pressure on prices. and other OECD countries..S. there was over 6 million barrels per day of excess production capacity and by mid-2003 the excess was below 2 million. After the U. With an improving economy U.5 million barrels by September 1.500 barrels.Once again it appeared that OPEC overshot the mark. inventories reached a 20-year low later in the year. During much of 2004 and 2005 the spare capacity to produce oil was under a million barrels per day.
The OPEC has actually been responsible for the creation of oil price fluctuations. Oil price shocks occurred during the Arab oil embargo. In fact OPEC has had troubles because of the non adherence of members to production quotas and therefore leading to internal weaknesses. One of the major limitations of the OPEC is its increased politicization. thereby creating an anomaly. Prices also fluctuated during USA’s “war on terror” in Iraq. Saudi Arabia acted as swing producer for OPEC during the first half of the 1980s in an attempt to shore up declining prices. squabbles and disagreements among member nations. This creates a situation where oil prices may not be determined by market forces but instead. Apart from being driven by political considerations. 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. most of the member states of the OPEC are dependent on oil revenues which accounts for the maximum proportions of their GDP’s. 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. by the short term financial requirements of the country. Other OPEC . 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. we can conclude that the volatile nature of the oil prices has not reduced.Simply stated. OPEC has also been behest by problems due to internal divisions. 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. After studying the fluctuation of oil prices after the formation of the OPEC cartel. And oil supplies being dictated by political motives. In fact the figure given below documents the constant fluctuation in oil prices over the years. as the OPEC had been founded with the objective of bringing about a stability in oil prices. 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. By 1986 the Saudis tired of this role.
The use of oil – which is an essential commodity required for the development of any nation . members of the OECD and the Post Soviet states produced only 23.org www.member countries were cheating on their quotas. affording them considerable control over the global market.org/aboutus/history/history. By the end of the decade of the 1980s OPEC and prices seemed to have stabilized. increased oil efficiency may also have reduced its power to some extent. of the world's total oil production. www. 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 of March 2008. 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.co/uk www.8% and 14.. he lower prices did have a positive result for OPEC.rouhani . and.cges.org OPEC-instrument of change –Seymour History of OPEC. 35. FYBA Div A Roll no 12 References:www. As a result the strength of the dollar has an impact on the domestic revenues of the member nations wealth. 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. In response Saudi Arabia rapidly increased production causing a major price collapse. The next largest group of producers.6% of the world's oil production. 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. It encouraged increased consumption and halted production increases in much of the rest of the world.chavezoil. as a political weapon to rally support has been widely condemned. 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.opec. respectively.opec.8%.
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