OPEC; Consequences of Oil Price Fall
By Shuaib Bahman
The Organization of the Petroleum Exporting Countries (OPEC) was established on September 12, 1960. It is an influential organization in oil markets. Its current members are Iran, Algeria, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, Ecuador, Angola and Venezuela. One of the major objectives pursued by this organization is to coordinate and integrate oil policies of member states and find the best way for serving their interests and work out new mechanisms for guaranteeing oil price stability in international oil market in a bid to check challenging fluctuations.
Following such an objective, OPEC has been looking for a solution to stabilize the oil market since 1980s. In recent years, the oil producer group has sometimes followed price shoring up strategies and has tried to manage production. But in some other cases, it has preferred to support the market and it has followed the policy of price band. A review of the activity of OPEC indicates that neither of these two aforesaid strategies has proven successful on the long-term. The reason is that the strategy of price support and production control has resulted in the loss of share in oil markets while pro-market strategy has caused a price decline. In other words, both strategies have caused a significant decline in OPEC revenues.
Oil prices started falling in summer 2014 and this trend has since been continuing. This price slump has once more pushed OPEC, as the main oil producer group, to bold relief. Like in the past, OPEC is facing serious challenges and problems for stabilizing prices and curbing price fall.
In this analysis, we first review OPEC oil production and then we will examine challenges OPEC is facing with regard to oil price decline. In the end, we will analyze the consequences of oil price decline for OPEC.
Further Sale for Higher Revenues
OPEC member states’ oil revenues totaled nearly $1,000 billion in 2014, the lowest since 2010 when the 12-member body earned only $745 billion from selling oil. OPEC oil revenues reached $1,112 billion in 2013, but it fell to $993.3 billion in 2014 due to market crash. Therefore, OPEC oil revenues in 2014 were 11% lower than in 2013, which means that OPEC’s financial share of world oil market dropped from 43.5% in 2013 to 42.6% in 2014.
OPEC oil basket price was varying around $115 in summer 2014 before sharply falling to below $60.
An annual report by OPEC shows that the group’s oil production was a bit more than 30 mb/d in 2014, which reached 31 mb/d a year later. Despite an oversupplied oil market, OPEC member states decided in their last ministerial meeting to roll over the output at 30 mb/d for another six months. This decision was made by OPEC at a time official data released by the International Energy Agency (IEA) shows that the world has been grappling with the longest ever market oversupply at least in the past three decades.
Surveys show that supply glut, increased production of shale oil in the US and Canada, sluggish demand in consumer countries and low economic growth rate in China and India- major oil consumers- are the major causes of price slump.
However, some analysts lay the blame on Saudi Arabia’s policy of oil price discount in a bid to inflict losses on Iran and Russia for the current oil market instability.
Market Regulation
OPEC member states hold 814 billion barrels of oil reserves, or around 78% of the world’s total reserves. But these countries supply only 6.5% of the world’s crude oil needs. In case of lack of cooperation and understanding on the part of OPEC member states, energy supply security will face problem in the future. OPEC’s contribution to crude oil supply security for future consumption is key to supply security for industrialized countries.
At a time OPEC member states play an instrumental role in pricing and while the key condition for these countries to see their oil revenues rise is higher oil price, and OPEC member states need more hard currency for economic growth and development, in most cases they stir up the continuation of oil price fall. A number of factors are important in this trend:
First, OPEC member states often move to increase supply on the grounds that they should prevent a decline in the group’s share of world oil market. Such an increase in oil supply further drives oil prices down. In their view, increased prices give a strong impetus for the growth of investment in unconventional oil production; therefore, OPEC’s share of global oil market would decline. Moreover, since OPEC top producers are willing to maintain the level of their revenues from crude oil exports, every time prices are weakened, they increase supply. In other words, the impetus in these countries for maintaining or increasing crude oil revenues is so strong that they often go beyond their quota and increase their output to reach their desired level.
The second reason could be explained as follows: Given the fact that OPEC claims to be the main regulator of oil market in the world is seeking a fair price for crude oil. A fair price is one that would pursue the interests of both producers and consumers of crude oil at the same time. But, in a capitalist economy, no fair price could be defined because top crude oil producers are among developing countries and advanced industrialized countries are the major consumers of oil. That means that these two groups of countries have different economic structures; therefore, no price could be set for crude oil to serve the interests of both groups at the same time.
Citing OPEC Charter, member states assert that they are tasked with regulating oil market in the world. In other words, the task assigned to OPEC at this sensitive juncture is to manage the price crisis in the world markets. But the outcome of this management would be mainly to avoid any loss to leading consumers of crude oil in industrialized countries and their affiliated oil firms.
Third, there is incongruousness and lack of coordination between OPEC member states.
OPEC member states are classified under three categories in terms of oil reserves and the possibility of future oil supply.
- Big countries (Saudi Arabia, Iraq, United Arab Emirates, Kuwait, Iran and Venezuela): These countries hold a total of 70.2% of the world oil reserves.
- Medium countries: Libya, Nigeria and Qatar
- Small countries: Algeria and Indonesia
Small and medium countries hold a 7.6% share in the world oil reserves. Libya, Nigeria, Qatar, Algeria and Indonesia together possess less oil than Iran.
The six big member states of OPEC hold oil reserves more than nine times higher the medium and small countries. Therefore, OPEC’s power is concentrated in Saudi Arabia, Iraq, UAE, Kuwait, Iran and Venezuela, respectively. These countries make up a 31.8% share in world oil production while other OPEC member states account for only 9.7% of the world’s total oil production. Therefore, in analyzing the OPEC status in world oil market and the structure of decision-making regime and OPEC’s policymaking, this incongruousness in the reserves held by OPEC member states should be taken into consideration.
In fact, any decision adopted by OPEC should take into consideration the interests of all member states. If not, it will face many challenges and some countries would refuse to abide by their production quota.
Some OPEC member states do not agree with the current production quota system and want changes. For these countries, the current production quota system is based on old statistical data about the production capacity of member states. Therefore, they say, it is unacceptable and it does not take into account changes to the production capacity of member states in recent years. Therefore, some OPEC member states demand changes to their quotas; therefore, they do not comply with their allocated quotas. Refusal to abide by quotas results in oil oversupply and subsequent oil price fall.
A drop in oil prices does not cut supply in the short and mid-term, but on the contrary, it would give impetus for more supply. Oversupply and the replenishment of consumer countries’ stocks would also facilitate serious oil price shock.
Another issue is that some OPEC member states work in coordination with consumer countries rather than with their fellow member states. For instance, while most OPEC members believe that supply should be cut due to oil price fall, Saudi Arabia refuses to be cooperative and it is raising its output in favor of consumers.
Apparently, OPEC is the only body capable of effectively managing crises stemming from oil supply and price in the world markets, but the structure of world oil market and relations between OPEC and non-OPEC member states are such that OPEC’s measures for crisis management often end in serving the interests of major oil consumers in industrialized countries and non-OPEC producers.
Consequences
Apart from the fact that what factors are behind the decline in oil prices, it should be noted that the continuation of this trend would bring about undesired consequences for oil producing countries.
In the first step, oil price decline would weaken the OPEC position because the immediate result of fall in the revenues of OPEC member states would be lower investment in the energy sector. Under such circumstances, producer countries would not be able to make investment. Nor will big companies be willing to contribute to these projects due to low prices and cost ineffectiveness.
Technically speaking, crude oil production requires very huge costs for exploration and recovery. In competitive markets, investment in this sector will be envisaged only if oil prices would be at a level to produce acceptable profits.
Therefore, oil price decline could result in insufficient investment in the energy sector of producing countries in the long-term and that would clear the way for weakening the position of OPEC member states. Undoubtedly, such a trend would pose a serious threat to the largest organization involved in oil supply in the world.
Meantime, continued oil price fall would add fuel to OPEC differences and this organization would risk dissolution or the withdrawal of some member states. Given the fact that there are serious differences between some OPEC member states regarding such issues as electing a secretary-general and pricing policy, oil price fall would further stir up differences. Such an issue will give rise to undesired consequences for OPEC and its member states. Lack of a common policy on the part of producing countries will finally end in the disadvantage of both and it could perpetuate the present conditions of oil price falls for years.
From another standpoint, oil price fall means a weaker role for OPEC member states in international policies. This means the falling influence of OPEC and it can turn the US into the major player in the world oil market.
Given its shale oil exploration and extraction, the US can grow into a key player in the oil market and orientate the trend of global petroleum industry. Such a change will by no means benefit the OPEC member states and could even destabilize this organization. Under the present circumstances, major industrialized countries will not be able to realize their main objective, which is diversifying sources for energy supply, without OPEC’s cooperation. If this organization is weakened and the US becomes the leader of world energy, OPEC will become an organization that would not be influential enough on the prices.
Given the consequences of oil price for OPEC member states, four possibilities are held out with regard to the future of this organization:
First, OPEC would maintain its current position in terms of members and policymaking and it would make no new structural changes.
Second, OPEC would move towards a weaker position and would see its cohesion being weakened. This possibility is ruled out for a variety of reasons.
Third, OPEC would be disbanded or would continue to work passively. Major oil cartels and companies in industrialized countries are the major opponents of this organization, but the presence of countries like Iran, Saudi Arabia and Venezuela – all member states of OPEC, weakens this possibility.
Fourth, OPEC would be downsized but would become stronger and more cohesive and countries like Norway and Russia – both top oil producers – would join it.
In conclusion, OPEC has no option but to change its membership structure and policies if it really intends to remain influential in supply-demand system and energy pricing in world markets.
A review of OPEC’s present conditions indicates that its member states have to reconsider their objectives and priorities in order to be able to adopt a comprehensive and unified policy in the future.
Therefore, making efforts for the realization of the fourth aforesaid possibility, i.e. more influence and cohesion, would turn OPEC into an influential organization in the future.