OPEC at 50
This week, OPEC turns 50 years old. An oil cartel, formed in mid-September 1960 by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela, was supposed, as its mission states still today, “to coordinate and unify the petroleum policies of its Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry.”
Lofty pronouncements, which at times worked but often they did not, certainly not equitably well for all members, a disparate and often ragtag group of countries with a huge spectrum of needs and even bigger gap of management skills and economic development. But one thing has worked. With the exception of small inconsequential disruptions, oil has kept flowing providing the most vital and irreplaceable element of the world economy.
Seven other countries are now members, Algeria, Angola, Ecuador, Libya, Nigeria, Qatar and the United Arab Emirates. There is a huge difference between the five founding members and the rest, some of which went in and out of membership, others are relatively new, while Indonesia, which was a member, is no longer since it is now a net importer of oil.
OPEC can never be ignored. It houses 1,064 billion barrels of proven oil reserves, about 80% of the world total of a bit over 1,300 billion barrels and produces 27 million barrels per day, almost 32% of the world total. One cannot think of OPEC apart from the emancipation of former colonies and the emergence of assertive new national governments. Commodities and, especially oil, was the reason that European powers became colonists in the first place. OPEC, once it was established, in many ways provided one of the most powerful vestiges of independence for these emerging countries. The need of oil by the developed world brought not only money but also a sense that finally former colonists and “imperialists” were getting their just comeuppance.
OPEC’s assertion of power and the one that made it infamous in the developed world reached a crescendo with the Arab Oil Embargo in October 1973, following the second Arab-Israeli war, the Yom Kippur War. The Arab members of OPEC threatened to withhold oil shipments to the West if they were to continue their lopsided support for Israel, against its Arab neighbors. It was the first time in history when a cartel used oil as a weapon to affect a political aim.
The embargo never materialized to what was threatened but it brought panic in the West, which had come to rely on cheap oil from far away. Dirty oil was not to spoil the pristine beaches of California or Florida and it would not be enough anyway. The events made “energy crisis” part of the western lexicon, it brought up for the first time the rhetoric of “alternative” energy sources and the even more potent (but still silly) ambitions of “energy independence.” But more to the point, it shot oil prices up and the price shocks continued for a decade that included the fallout from the Iran-Iraq war. During that decade the world witnessed the largest ever re-distribution of wealth from the oil-consuming countries to the oil-producing countries.
That was OPEC’s golden era and that’s when stories of ostentatious wealth, solid silver cars, gold toilet fixtures and all sorts of outrageous playthings became the stuff of legend. Those were not just for the rulers. Even the middle classes could take weekend trips to Paris for shopping. The trouble was, and still is, that many of the OPEC countries suffer from endemic corruption and are grossly mismanaged. With the notable exception of a couple of tiny countries, virtually none of them have capitalized on their oil revenues to diversify their economies and wealth-producing capabilities. One is mystified at the persistent resistance to progress and modernity that still permeates Iran, Venezuela and Libya, along with notorious and buffoonish leaders who could never have come and stayed in power had it not been for oil.
OPEC might have been a cartel but it was far from monolithic. Member countries were divided into “absorbers” and non-absorbers. Absorbers were countries with large populations which could readily use all the revenues from oil. These certainly included Nigeria, Indonesia, Iran, Iraq and Venezuela. Absorbers had an obvious interest to maintain prices as high as possible and were also the ones that were the most militant when it came to protect prices. Interestingly, Iran and Venezuela were the most militant oil price hawks when presumably their governments were friendly to the West; of course they became even more militant when their governments became real political militants. Militant members were the ones pushing for production quotas and to keep a lid on production levels. Cheating among members was often transparent. Saudi Arabia, with enormous oil resources, and other smaller Middle Eastern countries, wanted a far milder stance, especially since they were too attached to the oil consuming countries, mainly the United States.
It was in 1984 that OPEC frayed at the hem. The President Ronald Reagan “encouraged” Saudi Arabia to over-produce unilaterally and then sent the oil price on a tailspin. From November 1985 to February 1986 oil prices collapsed from $32 per barrel to less than $10. Caracas, Jakarta and Lagos never really recovered, remaining the abject poverty-ridden eyesores that were created during the boom years, an era that would never return.
There was an ancillary benefit for the United States at the height of the Cold War. The collapse of the oil prices laid bare the internal fractures of the Soviet Union which depended on oil for almost all its “hard currency.” The fractures became gaping holes and the rest is history. I have recounted all of these events in my book The Color of Oil.
OPEC is not what it used to be. It does not have the power that it had to manipulate the market. Others have muddled the scene, Mexico, Brazil with is massive offshore developments, Canada with its tar sands and, especially, Russia with ambitious Communists-turned-capitalists such as Mikhail Khodorkofsky, the ex- Chairman of Yukos, who got afoul with Vladimir Putin, exactly for his desire to become powerful enough that could challenge OPEC. He is now rotting in a Siberian prison. Russia did not want overproduction to collapse oil prices, shooting itself in the foot. But Russian oilmen showed there was life beyond OPEC.
OPEC today does not have the excess capacity that it had. From a demonstrable excess capacity of over 10 million barrels per day in 1995, outside of Saudi Arabia, it has been reduced to near zero today. This is not what OPEC’s potential production capacity could be but what it is now “behind the valve”, i.e., oil they can turn off and on at will.
The reason is that it takes huge re-investment to maintain production capacity: massive exploration and production budgets. Nigeria, Venezuela and Libya are suffering from gross and chronic mismanagement and Iran is gasping under the sanctions, no matter what the bravado of the leaders of these countries. In Iraq, it is hard to produce oil when people are shooting at you and, when the US military gets out, I am not at all optimistic for the country’s petroleum future. All of the above countries are producing close to one third of their geological potential.
OPEC had little to do with the run-up in oil prices from 2004 to 2008, when in July 2008 they almost topped $150. Geopolitical headlines ruled those days. Consumption gone berserk in China and sustained growth in the United States dominated the market. I am surprised that oil has yet to surpass $100, a testament to how much weaker the United States economy really is, even compared to some of the most pessimistic economists a couple of years ago.
One should not write OPEC off by any means. First, “green” energy rhetoric notwithstanding, the world will be still dominated by oil (and gas and coal, i.e., fossil fuels) for at least another century. Second, peak oil, which will happen eventually, is not even nearly close yet and, for my recently departed friend Matt Simmons, we will not see, any time soon, a “twilight” in the Saudi Arabian “desert.” With proper management and investment they can double their production capacity, at least.