FROM THE ECONOMIST INTELLIGENCE UNIT
OPEC marked its 50th anniversary on September 14th—an occasion that invites assessment of what the future holds for the organisation’s unique position in the global oil market. Often maligned in the Western press as a greedy cartel seeking to maximise oil prices at all costs, OPEC sees itself very differently. It claims that it matches global oil supply to demand, and that it therefore has a pivotal role in ensuring global economic stability. While the precise extent of its influence can be debated, the more pertinent question for OPEC is how its role may be challenged in the long term by efforts to raise fuel efficiency and cut emissions, and by geopolitical concerns in many countries about a reliance on imported oil.
OPEC’s history offers a chequered record of intervention in global affairs. The organisation’s original aim was to counter the power of the large international oil companies (IOCs)—the so-called “seven sisters”—that previously dominated the industry. Before OPEC’s inception in 1960, oil-producing nations received only a fraction of the value of their oil wealth. The organisation’s five founding members (Iraq, Iran, Venezuela, Saudi Arabia and Kuwait) sought to wrest control of their national oil industries from the IOCs. In securing national ownership of oil assets, OPEC not only succeeded in its initial aim but transformed the market. Global oil reserves are now predominantly in the hands of national oil companies, such as Saudi Aramco and Abu Dhabi National Oil Company.
However, OPEC’s subsequent efforts to use its influence politically or to manage the oil market backfired. The oil shocks of the 1970s—the first of which was the result of OPEC’s withholding of oil from the market in an effort to boost the Arab cause in the Arab-Israeli war, the second of which was the result of disruption to Iranian supply during the Islamic revolution—sparked massive exploration and production initiatives by non-OPEC countries. In particular, drilling began in earnest in the North Sea, the Soviet Union and Alaska. Arguably this was the point at which OPEC’s influence began to wane.
OPEC still moves markets
OPEC’s share of global oil output has fallen from 50% in 1970, but today its members still account for nearly 40% of daily production. According to OPEC, member states also hold 80% of the world’s conventional crude-oil reserves (though estimates from other sources vary) and account for 60% of global trade in oil. The high share of trade means that OPEC’s influence in the market is disproportionate to the amount of oil it produces. While the US is the world’s third-largest oil producer, it imports about 70% of its needs. In contrast Saudi Arabia exports 75% of its production (the percentage would be even higher were it were not for the current production ceiling). For this reason OPEC policy changes, statements and meetings are closely watched by the oil market—especially by the futures market, which trades on expectations rather than on the physical availability of oil.
At the same time, OPEC’s market influence has its limits. For example, oil prices surged in mid-2008 even as Saudi Arabia was actually announcing increased production. Indeed, at the time OPEC was as worried about the spike in prices—which was driven by speculative investment—as oil-consuming countries were. Excessively high prices can generate short-term windfalls but are potentially damaging to oil exporters in the medium term. They may hasten the development of alternative energies, prompt consumers to switch to cheaper hydrocarbon fuels (such as coal), encourage domestic exploration and deter oil consumption.
Furthermore, large producers such as Russia are arguably undermining OPEC’s control over the market. Saudi Arabia’s production restraint means that Russia is now the world’s largest oil producer. OPEC has warned Russia that if it continues to increase production, it will undermine price levels. But while there has been repeated talk about Russia joining OPEC, there is little incentive for the country to do so. Historically Russia has enjoyed the best of both worlds by staying outside the cartel. It has tended to benefit from OPEC’s efforts to support prices, while not being constrained by production quotas.
Is OPEC a coherent force?
OPEC’s internal dynamics may sometimes appear as a weakness. The group’s members are unlikely partners—with widely differing political systems, economies and cultures—and its machinations lack transparency. Meetings are conducted behind closed doors and there are only rare official statements, usually by OPEC’s secretary-general, currently Abdalla Salem El-Badri. Reportedly, there are always deep divisions amongst members, with the more maverick administrations in Venezuela and Iran chasing higher prices to finance their budgets, while the more financially secure states from the Gulf Co-operation Council typically take a more conservative stance.
OPEC member states often fail to adhere to OPEC policy. In August 2010 compliance with the group’s production ceiling stood at just 53%, and some OPEC members have a long history of “free riding”—increasing output when other members have agreed to a low ceiling—which undermines the group’s credibility. That said, when prices were at all-time lows in early 2009, compliance was estimated at over 80%. Moreover, OPEC’s survival over the years, despite the internal differences and even grave challenges such as wars between member states, suggests a cohesion of sorts.
Will OPEC cope with technological and environmental challenges?
Technological change and rising environmental awareness are arguably a greater threat. Certainly, OPEC’s biggest concern is lower growth in global oil demand in the future. Cognisant of this risk, the organisation in recent years has typically been cautious in its forecasts of global consumption. Transport currently accounts for about 50% of oil consumption. This has supported the oil market in recent years. Transport-related demand typically is relatively price-insensitive, and for the time being there is no credible alternative to petrol-fuelled transport. But the outlook for the future is mixed. At the margins, the incorporation of biofuels in the fuel mix is already constraining consumption. Natural-gas and electric cars can also be expected to become more mainstream in the next few years. Offsetting this, however, is growth in car sales and ownership in the developing world, which points to a rise in petrol consumption.
Where does this leave OPEC? The organisation undeniably remains a major force in the global oil market, supported by its particularly large share of traded oil. If anything, OPEC’s influence is likely to increase over the next ten years, given official estimates suggesting that OPEC output will grow more strongly than non-OPEC production. However, OPEC is mindful of global concerns about pollution and carbon emissions, which may generate persistent pressure to reduce oil consumption. Government-subsidised development of alternative sources of energy could alter the competitive landscape to the detriment of oil exporters, and research and development will focus on reducing demand for oil (particularly imported oil). All this could undermine OPEC in the very long term. With such uncertainty over future oil consumption, OPEC can be expected to take a conciliatory approach to its consumers and try to prevent high or volatile prices, which would only serve to accelerate efforts to replace oil with alternatives.