Position of Organization of Petroleum Exporting Countries and Its Effectiveness - Essay Example

Running Head: Position Of OPEC & Its Effectiveness Position of OPEC Academia Academia Research The Organization of Petroleum Exporting Countries has merely become the most popular name related to oil, overnight. Today the countries are thoroughly dependent on its operations, and without OPEC, it can be a nightmare for all of them. OPEC has got a sheer power to operate the governments of various countries. Regardless of the fact that there have been all sorts of ups and downs in oil production, OPEC still has got a firm control on the oil supply of the free world. The weaker nations are all lucky to have a support of OPEC as well as stronger, the weaker nations get the support from the stronger ones all because of an operating body like OPEC. OPEC has found its geopolitical strength and has realized its power suddenly and has become an important force playing an important part in regions like Asia and Africa. It has brought the huge multinational oil companies under control who could have done so many wrong acts otherwise, but now they all are on their knees, OPEC has made them merely impotent in the decision-making process, which is a good sign as there aim of profitability can disturb many other economies. It has forced the Western nations to have its favor on numerous occasions. There is a growing recognition in the Western world that the industrialized countries cannot solve the problems of chronic inflation and economic stagnation permanently unless they force OPEC to abandon its stand of raising oil prices ever higher and disrupt supplies to the oil consuming nations, but imagine what they could have done if OPEC was not there. The dependence on OPEC increased considerably in the United States during the last decade and a half. According to a study by the Federal Energy Administration (FEA), U.S. oil imports raised 150 percent between 1968 and 1973, from about 2.5 million barrels a day in 1968 to 6.3 mb/d in 1973. Imports from the Arab oil producing countries were raised to 31.9 percent in 1976 from a negligible 2 percent of total U.S. oil imports in 1970. On the whole, the reliance of the United States on foreign oil had increased disturbingly. In 1970, the United States depended on foreign oil for 23 percent of its total oil consumption, which was quite clearly showing what could have happened in no oil situation. In 1974, the figure was raised to 37 percent, and in 1976, oil imports were about 44 percent of total U.S. consumption. In 1977, the oil imports reached the pinnacle at an average of 8.7 mb/d. That represented approximately 48 percent of the total domestic supply, which averaged 18.4 mb/d in that year. The FEA's figures also showed that the consumption of oil in United States was raised by 3.7 percent in 1976 as compared to 1975, with gasoline use advancing at 6.7 percent and distillate by 7.9 percent. At the same time, the domestic production during 1975 and 1976 had decreased from 8.24 mb/d of crude oil to 7.93 mb/d. The nation's refineries ran at 86 percent of capacity in that period compared to 87.1 percent in 1975, which is a considerable difference in the short run. It has also been identified that the Arab nations and Nigeria were increasing their share of the U.S. market while the nation's traditional suppliers such as, Venezuela and Canada were contributing a smaller share, fundamentally because of the high price of Canadian oil and the restricted output of Venezuela. It was for the first time in 1976 that Saudi Arabia had overtaken Venezuela as the United State's chief overseas supplier of crude oil. On the other hand countries like Algeria and the United Arab Emirates (UAE) have all increased their shipments, while Canada is pointing out its shipments to the United States. The conditions took a big change during 1979-1981. Suddenly, the oil crisis gave a rise to the oil surplus, it was perhaps due to the remarkable changes in the balance between demand and supply which is the base of economics and also famous for changing any country's fate. The oil consumption in the Western side of the world dropped more than 7 percent between 1979 and 1980, and declined another 3 percent in 1981 that gave birth to so many questions. In the United States, it decreased by 5.8 percent during 1980 and 1981. The country's oil import in 1980 was on average 5.3 mb/d, a much smaller figure as compared to that of previous years. Oil consumption in the United States fell an estimated 5 percent in 1980 to its lowest level in four years. Where as the world consumption of petroleum products also fell to 2.38 billion tons, or about 18.33 billion barrels, while gasoline consumption in industrial nations decreased merely by 30 million tons to 52.3 million, or about 231 million barrels. On the other hand the motor fuel consumption, accounting for nearly one third of total oil demand in industrial nations, also decreased by 5 percent in 1980, after a 2 percent fall in 1979. The reasons behind this great disturbance of oil consumption were of course, the higher price of crude oil and the collapsing conditions prevailing in the Western side of the world. The price of crude oil raised an average 74 percent in 1980, and in the first three months of 1981, it was 17 percent higher than the first three months of 1980. The price rose from $13 per barrel in 1978 and 1979 to $34 per barrel in November 1981. Also, the economies of the Western world grew at just over 1 percent in 1980, as compared to a 3.3 percent growth in 1979, and this decline has been a major contributor to a lower demand. Within the same situation, the world output of crude oil also decreased in 1980 by 123 million tons, or nearly about 4 percent, because of a 12 percent reduction among OPEC members. OPEC production had almost declined by 1 mb/d, from 31.1 to 30.2 from 1973 to 1978. Meanwhile, the non-OPEC production raised by nearly about 6 mb/d, from 27 million in 1973 to 32.8 million in 1978, which was showing the change in roles. The output of the Communist trading area such as China, extended sharply by about 45 percent, and the developing countries production rose by approximately 88 percent in 1980, according to the General Agreement on Tariffs and Trade (GATT) annual report. As a consequence of each and every act, the demand for oil lessened considerably in the Western world mainly because of the downturn, preservation and because of the higher oil prices, resulting in the surplus of excess oil supplies, which damaged the OPEC association vitally. "Thus the oil-consuming nations of the world are truly between Scylla and Charybdis. If their economies recover, OPEC gets stronger. If their economies decline, OPEC weakens. Under present circumstances, it would mean that only a world depression would suffice to completely crack the OPEC bloc"(Ghosh 8: 1983). Oil Demand and Supply Situation in the United States, 1980-1981 Demand (1,000 b/d, 4 week average) April 7, 1981 Change from a year ago %Change Motor gasolines 6,209 493 -7.4 Middle distillates 2,795 120 -4.1 Jet fuel 991 117 -10.6 Residual 2,178 310 -12.5 Other products 3,639 70 +2.0 Total demand 15,812 970 -5.8 Supply (1,000 b/d, 4 week average) Crude production 8,544 150 -1.7 Crude imports 4,252 1,361 -24.3. Product imports 1,212 292 -19.4 Stocks, 1000 b/d 396,622 21,672 +5.8 Drilling (4-week average) 3,696 1,036 +39.0 SOURCE: Oil and Gas Journal, April 27, 1981 (Ghosh 5: 1983). So far we have discussed the background of OPEC, which is potentially showing you all the ups and downs of OPEC, particularly its operations in relation to the countries that are supporting its regime and also those because of which it has paid a heavy price for. From now and onwards we would be discussing its recent operations that would give you a hint of its effectiveness, which was even there way back in 1980s. As a modern organization, OPEC is an organization of oil producing governments that assist to manage oil supply and prices in order to maximize the revenues of the member states and promote stability in the oil market, it is playing a role which is no different than the role of WTO or any other organization which is working for the equitable distribution of wealth. There are ten producer governments that have made OPEC, most of them are being operated in the Middle East, they are economies that are highly dependent on oil revenues, they are also having quotas but Iraq, which is the eleventh member, currently is having no quota because it is trying to re-establish its former oil production after the Iraq war in 2003. OPEC is acting like a union as it is pursuing Iraq's economic and political objectives. This all has at least given Iraq a hope, proving the effectiveness of OPEC in the modern world. The role played by OPEC and its importance can be visualized from the point that OPEC has about 75 percent of the world's oil reserves and it is currently comprising of only about 35 percent of world oil production, which is not in comparison to the 60-65 percent it controlled at the time of the oil shocks in the 1970s. There goes a chance for non-OPEC producers, which are playing an important role, led by Russia, whose production is growing day by day, and the United States, whose production is surprisingly turning down. OPEC has although got success in most phases in controlling the oil markets but it has also made mistakes, at various occasions it has been facing challenges that are perhaps beyond its control, as in 2004. "This rise in forward prices was matched by increases in prices bid for high-quality equity units offering investors a return directly linked to oil prices. Share prices offered for the BP Prudhoe Bay Royalty Trust, a trust issued by British Petroleum for production from Prudhoe Bay in Alaska, rose from $14 per share in May 2004 to almost $40 per share. The increase in the BP share price corresponds to a change in investor expectations regarding the rate of increase in future oil prices"(Verleger 22, Vol 18: 2004). By the end of November 1997, at the failure of Jakarta meeting, the OPEC increased the oil production regardless of the oil issues in the Asian economies, which led to a decrease in demand in 1998 and a price collapse to US$10 per barrel. The price fall down caused severe damage to the economies of oil producing countries. The union was able to regroup and cut production in March 1999 with the assistance of non-OPEC producers, which was a joint step to solve the situation, specifically Mexico, Russia, Norway, and Oman. Oil prices recovered and increased above US$30 per barrel by early 2000, determined partially by Asian recovery and low Organization of Economic Cooperation and Development (OECD) oil stocks. OPEC exceeded its goal of restoring prices to the US$20 range. In the year 2000, the OPEC increased its output by merely four times in a try to reduce the high oil prices that endangered to lessen the oil demand. In its Vienna meeting in March of year 2000, OPEC turned its 1999 decision, down and increased production, again got some assistance by the many of the non-OPEC producers. It also announced a price band mechanism designed to keep oil prices in a target range of US$22 to US$28 per barrel for the OPEC basket of crudes, in relation to its goal of maintaining it with in the range of US$20. "The OPEC basket is a weighted average of Saudi light and six other OPEC crude oils. It includes an automatic production adjustment mechanism that is implemented if the price goes above or below the band, though the mechanism has not always been implemented. Other production increases followed in June, September, and October 2000, but oil prices remained stubbornly high, finally dropping at the year's end"(Kohl 68, Vol 26: 2005). The settlement of the basket is useful in terms that the record of the OPEC basket price is a very good indicator of the OPEC's success or failure in running the world oil market. The OPEC basket price tends to run about US$2 below the US benchmark oil price for West Texas Intermediate crude (WTI), which is the price quoted on the New York Mercantile Exchange, which is showing a complete planning done by OPEC to overestimate the expenses and underestimate the outcome. In the year 2001, OPEC faced an economic collapse in the United States that gradually widened away in the world and reduced oil demand. Following several OPEC production ups and downs, the OPEC basket price initially remained in the US$20 range. However, the 9/11 attacks were followed by a decrease in air travel and a decline in the stock market that even extended the downturn. Eventually the oil demand chopped off, and oil prices sooner fell even below US$20 per barrel. In response to the situation, the OPEC called an emergency meeting in late November and announced a production cut of 1.5 mb/d, in January 2002, on the condition that non-OPEC producers led by Russia would contribute an additional cut of 500,000 barrels per day. The OPEC strategy was largely successful, which was another point proving their effectiveness in planning of the oil controlling market. Lets discuss the year 2002, with some more details. Right in the start of 2002, the OPEC was confronted by a global economic slowdown and a slump in oil demand. But OPEC was determined to avoid a further fall down of prices and restrained production. At the same point of time, political tensions also raised in the Middle East side with new Israeli attacks against the Palestinians and US threats against Iraq that was also determined to keep the practice alive, they continued their practice of interrupting oil exports. One of the good things which was supporting the OPEC was its quotas that were lowest since 1991, assisted in keeping the oil stocks as low as possible and also helped in bringing oil prices back into the US$20 to US$25 range by spring 2003. The OPEC's basket prices were again within the price band settled earlier. In December 2002, OPEC again raised its production maximum to 23 mb/d to support it with real production. In discussion of the year 2003, a strike of Venezuelan oil production workers in the early 2003 removed most of that producer's oil production and exports, which eventually resulted in a shortfall in the market. At the same time, turbulence in Nigeria decreased that country's production, as a result, at its January 2003 meeting, OPEC determined to raise its production by 1.5 mb/d to 24.5 mb/. It was mainly to compensate the Venezuelan shortfall. Later on in march, the WTI drove up the prices to US$40 per barrel as a result of the war threat in Iraq. OPEC stood up and gave a hope by indicating that it would keep the oil market well supplied in crisis and the International Energy Agency (IEA) agreed to let OPEC challenge this before responding with any release of strategic oil supplies. When the war broke out in Iraq, the oil prices again declined to US$30, as WTI was in expectation of a short war, which was not really a case. OPEC tackled the situation of lost production in Iraq by increasing the production in Saudi Arabia, Kuwait and Algeria. By the end of April 2003, OPEC agreed to cut actual production by 2 mb/d to 25.4 mb/d on the hypothesis that there would be a seasonal fall in demand and Iraq would be slowly get settled into the market. Saudi oil Minister, Ali al-Naimi made a good effort to keep the price as close to US$25 per barrel as possible. Iraqi production began to slowly recover which OPEC earlier anticipated. Now oil prices were at the top of the price band. But then in August when the Iraq export pipeline was damaged and UN headquarters were bombed in Baghdad, the oil prices were facing a pressure to get raised again. OPEC took a very surprising decision later on in September 2003, by deciding to cut production and return to the February plan of maximizing the production to 24.5 mb/d to obstruct stock build in the fourth quarter and maintain prices in the upper part of the price band. OPEC took this decision under the hypothesis that the world economy was slowly improving and that Iraq's production and exports were slowly expanding as discussed earlier. Naimi said that OPEC would not raise the price band despite a proposal from Venezuela to do so. Oil prices rose to between US$28 and US$29 per barrel in September and to between US$30 and US$32 per barrel by November. Both US President George W. Bush and IEA Executive Director Claude Mandil showed great disappointment at the September decision, as they perceived it harmful for the economic growth. In the last month of 2003, OPEC confirmed its September decision, keeping in mind the disorder in Iraq and the continuing weakness of the US dollar, which worsened OPEC purchasing power. Meanwhile, Iraq's production reached 2.35 mb/d and the OPEC basket price had exceeded US$28, But OPEC, in response resisted this action, fearing that demand would be dropped by the second quarter of 2004. Lets now discuss the year 2004, it was sooner that OPEC lost control of oil prices in 2004, In the first three quarters of that year, the OPEC basket price remained above US$40 per barrel which was far above from US$28 per barrel, however it fell slightly below US$40 per barrel later on in September. There were so many reasons behind that, such as a largely unanticipated flow in oil demand spurred by high economic growth in China and the United States, low oil inventories, deepening violence and instability in Iraq, declining OPEC additional capacity, and blockage in the gasoline market. OPEC, led by Saudi Arabia, began the year by misunderstanding the market when it announced its intention to decrease overproduction and stick to a 24.5 mb/d of maximum production. Naimi confirmed his belief in a US$25 per barrel price for the OPEC basket, mentioning concern about falling demand and a large stock build in the second quarter, and was determined not to repeat the previous mistakes of 1997 to 1999. In March, WTI prices reached a high of between US$36 and US$38 per barrel and the OPEC basket price ranged from between US$32 and US$33 per barrel was yet not according to the plan and willingness of many other associates. Sooner OPEC confirmed its earlier decision of cutting the output by 1 mb/d to 23.5 mb/d despite high oil prices. OPEC also tried to cut many of the supplies of market, however ministers insisted that the market was very well supplied with oil and thus OPEC should not allow any shortages in world oil markets, but they were all determined to keep inventories low and prices high. White House and US Department of Energy officials criticized OPEC's production cuts while prices were high. In the meantime, Venezuela, Nigeria, and Iran argued for the need to raise the price band, causing disagreement within OPEC. In the face of growing oil demand and attacks on oil facilities in Iraq and Saudi Arabia, oil prices rose above US$40 per barrel in May, which was because of a side never perceived by OPEC. Naimi finally began calling for a production increase. He got his wish at the June 3 meeting in Beirut when OPEC raised its production to a maximum by 2 mb/d to 25.5 mb/d from July 1, and by a further 500 kilo barrels per day from August 1. This was a negotiation between Saudi Arabia, which wanted an instant increase to 26 mb/d, and Iran, which would initially only accept 25.5 mb/d. The measures were taken only to ensure ample supply and give a clear signal of OPEC's commitment to market stability and to maintaining prices at acceptable levels to both producers and consumers, according to a June 7 OPEC statement. Actual OPEC output was reported as 26 mb/d in April increasing to about 27 mb/d in June, with Saudi Arabia increasing to 9.1 mb/d. As a result, remaining OPEC extra capacity was significantly reduced to about 1 mb/d in Saudi Arabia, then again conditions turned very tight in the summer of 2004, in July, the IEA enlarged its oil demand projection for the year by an additional 2.5 mb/d. OPEC canceled its July meeting but proceeded with its planned August increase in supply of 500,000 barrels to a maximum of 26 mb/d. Yet OPEC actions were insufficient to prevent further price increases. The WTI oil prices again moved above US$40 per barrel in July and hit record highs of US$44.73 on August 5 and US$48.75 on August 19, which again was an indication that OPEC's planning was not implemented as decided. Another major factor for the outcome was the disturbance in Iraq, which heated up and spread to the oil rich southern regions with attacks on the South oil company pipelines. The U.S. oil inventories were still low compared with demand, refineries continued at peak production, and there was continuing concern about the small OPEC additional capacity to meet any supply disruption, which was originally about 1 to 1.5 mb/d. Saudi Arabia continued to secure the price band, but other countries, including Iran, Nigeria, and Venezuela, were satisfied with oil prices in the US$30 to US$40 range. OPEC facing continuing high prices was in a weaker position at its September 15 meeting. With additional capacity reduced to about 1 mb/d in Saudi Arabia, OPEC required to cure high prices by announcing an increase in its production with a maximum from 26 to 27 mb/d in November. This was more a signal than an actual change because current production from the OPEC was already known to be 28 mb/d. Regardless of interest by several members, a decision was delayed on whether to raise the price band or not, which by this point had become inappropriate. Naimi clearly opposed the raise, saying it should only be raised if there was a structural change in the market. Saudi Arabia, now producing 9.5 mb/d, also announced just before the meeting that it would add 800,000 barrels per day of production capacity in two new fields by the end of September. Kuwait was also planning to have an expansion. The WTI crude price decreased slightly after the meeting to US$43.58. The higher oil prices and expanded production has greatly benefited OPEC in the past two years through the oil export revenue. In June 2004, the Energy Information Administration (EIA) estimated OPEC's net oil export revenues for 2004 at US$286 billion, up from US$240 billion in 2003 and US$195 billion in 2002. Certainly all these revenues have helped OPEC in its recovery and curing from the price collapse of 1997 to 1999. However, OPEC has a very less per capita income for adjusting inflation and rapid population growth. It should be noted that many countries are greatly thankful from the period of lower oil prices from the mid 1980s to the late 1990s, and many OPEC countries are moving slowly on required economic restructuring. Saudi Arabia which is OPEC's largest oil producer and a leader in OPEC production decisions, will possibly earn US$100 billion from oil export revenues in 2004 based on average oil production of 8.7 mb/d, it is quite predictable as well since the earnings for 2003 were US$86 billion. Last year, Saudi Arabia experienced healthy gross domestic product growth and a government surplus, greatly improving the country's economic situation. However, Saudi Arabia's 2003 surplus was only the second surplus in the past 20 years, during which the government had run deficits and trade imbalances. Total government debt has been nearly 100 percent of GDP, surpluses in 2003 and 2004 are likely to be used to increase foreign assets and pay off some government debt, which would stable the country's situation more importantly. In Saudi Arabia, oil exports put in over 90 percent of export earnings, 70 to 80 percent of state revenues, and about 40 percent of GDP, which gives a hint of its heavy dependence on oil sector. Oil export revenues per capita were about US$3,683 in 2003, which in real terms are much lower than the per capita figure for 1980 at the high point of oil prices, which was only about US$22. Saudi Arabia continues to face serious economic challenges of fast population growth, which is about 3 percent per year, which is not a healthy sign and relating them to other economies, which are not doing well because of similar population growth, such as Pakistan. Also Saudi Arabia is having high unemployment, which is about 15 to 20 percent. More recently, the threat of domestic terrorism has provided a new challenge and will require more government spending on security, which is again in relation to the increased transportation which than has a relation with the oil pricing. The large financial needs of the state have been estimated to require a stable oil price of US$30 per barrel, which helps explain recent Saudi unwillingness and disagreement at OPEC meetings to press for lower oil prices. Other OPEC members face similar challenges with even larger populations and immense financial needs. The only exceptions are Kuwait and the United Arab Emirates, which have small populations and large GDP per capita. The Stock traders in New York, London, and Singapore, which are all aware of both economic fundamentals and geopolitical risks, ultimately have set the price of oil. In recent months the risk premium on the oil price may have grown to US$10 to US$15 per barrel. However the OPEC actions to increase production have not been sufficient to reduce the upward price acceleration, which if left free, will slow economic growth and lessen the future oil demand. OPEC continues to be in a weak position by the fact that as a group of independent countries, it has no enforcement method. Therefore, exceeding quotas is a continuous problem, which weakens its efforts to manage the market. The financial needs of Saudi Arabia and other OPEC countries appear to require oil prices well above the price band as discussed earlier in relation to the population growth and unemployment, still the members have delayed making a decision about whether to admit this or not and this delay has damaged OPEC's market standing. It is difficult to trust Saudi statements that they would be happy with an oil price at US$25 per barrel for the OPEC basket when they clearly are not trying to achieve this and their financial needs are demanding a much higher price. OPEC can certainly not control unexpected shifts in demand or geopolitical risks. The oil market is difficult to manage and would remain this way as OPEC has limited tools and also at times inadequate information to take decisions. References & Bibliography Akacem M, "Middle East Policy: A New World Order For Oil", Vol 1, Issue 3: 1992. Alnasrawi A, "Arab Nationalism, Oil and the Political Economy Of Dependency", New York, Greenwood Press: 1991. Ford N, "The Middle East: Keeping OPEC Together", (n.p.), Issue 339: November 2003. Ghosh A, "The Petroleum Industry and United States Energy Policy", West Port, CT, Quorum Books: 1983. Kohl W.L, "Harvard International Review: The Perfect Storm", Vol 26, Issue 4: 2005. Lowry R, "National Review: Info AfricaAnd Out of OPEC", Vol 54, Issue 11: June 2002. Shojai S, Katz B.S, "The Oil Market in 1980s: A Decade of Decline", New York, Praeger Publisher, 1992. Siddiqi M.A, "The Middle East: OPEC Maintains Firm Resolve", (n.p.): May 2001. Verleger P.K, "The International Economy: Why Oil Could Go to $60", Vol 18, Issue 4: 2004. Read More