While many perceive the Organization for Petroleum Exporting Countries (OPEC) as a sinister Middle Eastern cartel with the sole purpose of bleeding the Western world's wealth by driving up oil prices, OPEC is not exclusively Middle Eastern or predatory in nature. OPEC constantly faces challenges from forces within the organization and abroad. OPEC has made severe blunders forecasting global oil demand and has had limited success controlling prices. OPEC's share in world crude oil production has steadily declined since the 1970's due to the rise of non-OPEC production, alternative energy use and conservation in rich countries. OPEC members struggle to reconcile differences among themselves while coping with their own internal domestic political and economic problems. OPEC members may have a lot of oil sitting beneath them; but controlling the oil prices, while maintaining a constructive relationship with each other, has proven to be very difficult.

For the first time in two years, in January 2001, OPEC announced a 1.5 million barrel a day (b/d) cut in crude oil production. The decline in oil prices in the late 1990s rattled OPEC members, and OPEC decided a cut was necessary to prevent a "significant fall or rise in the price of oil." Due to a slowdown in the US economy in late 2000, US officials worry that a production cut could raise prices sharply and accelerate the country towards recession, thus causing a global economic slowdown. Background OPEC was founded in 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Based in Vienna, Austria, OPEC accounts for 40% of global production and 75% of known reserves. The current 11 OPEC members are Algeria, Indonesia, Iran, Iraq (operating under UN restrictions), Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the UAE and Venezuela. Ecuador and Gabon suspended their memberships in 1992 and 1994, respectively. OPEC by its own definition is "an intergovernmental organization dedicated to the stability and prosperity of the petroleum market." While this is true, a more accurate statement of OPEC's objective is to maximize revenues of member countries from oil exports by increasing production to sell more or by decreasing production to raise the price of oil.

Controlling Prices and Production

In recent years, poor forecasting has put the cartel on the brink of collapse. In 1997, OPEC, influenced by Saudi Arabia, decided to raise oil production just as Southeast Asia was heading towards an economic crisis. As OPEC increased the supply of oil, much of Southeast Asia reduced manufacturing, thus decreasing its need for oil. OPEC was left with a big surplus and had to lower prices to sell excess supply. The price of oil plummeted to $10/(barrel)bbl.

To avoid future price collapses, OPEC has developed mechanisms designed to react to market factors. In March 2000, OPEC employed a price band mechanism (Automatic Crude Release Mechanism) as a tool to automatically raise or cut production to maintain a price range (or band) of $22-$28/bbl. If the price is above $28/bbl for more than 20 days, production is increased by 500,000 b/d (barrels per day). If the price is below $22/bbl for more than 10 days, production is cut by 500,000 b/d.

Pricing mechanisms have sparked controversy among OPEC members. The latest price band mechanism caused confusion over whether the 20-day upper trigger meant: an average price for an OPEC basket over 20 days, or a daily price for 20 consecutive days. In June 2000, OPEC members agreed to use a daily price for the upper and lower triggers. But upper triggers have been maintained on occasion for more than 20 days without implementation of the price band mechanism. As the daily price of oil remained well above $28/bbl for much of the second half of 2000, OPEC hesitated to increase production. OPEC finally agreed that the price band mechanism was to be used informally and only be implemented after approval at an official OPEC conference. As it stands, OPEC only uses the price band mechanism to boost low prices, not to cut high prices of oil.

The individual oil policies of OPEC members vary greatly and are often the source of debate. Small producers usually favor higher price control, while large producers can compensate for low prices with high volumes of production. Smaller producers who also have large deposits of natural gas like Algeria, Libya, and Qatar have historically been price hawks to protect gas demand. Other members exceed their production quotas to protect their country's interests. Sovereignty allows members to sell unilaterally to whomever they please. In the case of Saudi Arabia, with 25% of the world's known reserves, it produces twice as much oil as any other OPEC member (8.78 million b/d in 2000) and has the capacity to produce well beyond its quota. Saudi Arabia insists on "long-term sustainable and stable price levels" to keep prices reasonable so major consumers, like the US and Europe, do not pursue alternative energy sources. Saudi Arabia frequently releases oil beyond its quota to stabilize world oil prices. Nigeria and Qatar are notorious for exceeding their quotas, so much so that it has become commonly accepted in OPEC.

Infighting has plagued OPEC. Twenty years ago, OPEC members could not agree over details concerning a pricing mechanism that would be adjusted every quarter according to market factors like inflation and currency fluctuations. Saudi Arabia and smaller producing "price hawks" disagreed over what price on which to base their calculations. At the same time, energy conservation and non-OPEC production took off. The pricing mechanism failed and prices collapsed. Former Saudi oil minister, Sheikh Ahmed Zaki Yamini, known as "the architect of OPEC," has warned of its history of infighting. He stated at OPEC's 40th anniversary that the organization has a short memory; and if such fractious infighting continues, as it did in the late 1990s, prices would start to come down in 2001 and throw the cartel into disarray once again.

High oil prices are not always a result of OPEC's activities. The world's largest oil consumer, the US, and its policies and practices (e.g., stringent environmental standards and patterns of consumption) impact greatly on the price of oil. So do more basic factors, like the weather. Economists generally agreed that the US was the principal force behind high crude-oil prices in 2000.

The rise of Asian industrialization and manufacturing has increased that region's dependence on oil imports. Countries like Thailand and South Korea will feel the bite of high oil prices more than developed nations who are becoming increasingly active in industries that use far less oil (services and high-tech). Thus, high oil prices can impede the growth of developing economies far more than those of the developed world.

Political Issues

Political disruptions in the Middle East have affected oil prices and threatened OPEC unity in the past. Oil prices surged in the early 1970s when Arab oil producers embargoed nations friendly to Israel, and again in 1979 when oil workers went on strike to support Iran's Revolution. The Iran-Iraq War dominated OPEC politics during the 1980s. Arab members in the Persian Gulf sided with Iraq against Iran's extremism; then Gulf members sided with Iran when Iraq invaded Kuwait in 1991. Future events in Iran, Iraq, and Saudi Arabia will continue to play key roles in determining oil demand and maintaining regional stability. Saudi Arabia, arguably the world's most important oil producer, faces an imminent succession issue that will undoubtedly impact on OPEC operations. Iran and Iraq have their own volatile political issues to address.

Conclusion

Businesses should understand OPEC's motives and how its actions influence global oil supply and petroleum pricing. High oil prices may mean opportunities for oil and gas investment in more difficult operational environments. It may also point to opportunities in non-OPEC countries or in the field of alternative energy or conservation technologies. On the other hand, high prices may also stunt economic growth in emerging economies. If prices are stable, investment opportunities may arise in OPEC countries to develop downstream oil industries. OPEC's unity as an intergovernmental organization may improve stability in the Middle East. Businesses with international operations should pay close attention to OPEC's activities, its role in the petroleum industry and its influence on economic stability in the developing world. There may be a place for a competent, objective advisor to read the tealeaves on the future direction of OPEC.

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