OPEC at 50

While not the force it once was, OPEC still wields considerable clout in a world that remains dependent on the steady flow of oil.

By Michael J. Economides

OPEC turned 50 this year, an event that went virtually unnoticed by the mainstream media. An oil cartel formed in September 1960 by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela was supposed, as its mission still states 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 did not, and certainly not equally for all members of a disparate and often ragtag group of countries with a huge spectrum of needs and an even bigger void of management skills and economic development. But one thing has worked: With the exception of small inconsequential disruptions, oil has kept flowing – providing a steady stream of 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 whom went in and out of membership. Others are relatively new while Indonesia, formerly a member, no longer is since it is now a net importer of oil. OPEC can never be ignored for the simple reason that it houses 1,064 billion barrels of proven oil reserves, about 80 percent of the world total of just over 1,300 billion barrels, and produces 27 million barrels per day, almost 32 percent of the world total.

The Golden Age

One cannot think of OPEC apart from the emancipation of former colonies and the emergence of assertive new national governments. Commodities and especially oil were the reason European powers became colonists in the first place. OPEC, once it was established, provided one of the most powerful vestiges of independence for these emerging countries. The need for 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 reached a crescendo with the Arab Oil Embargo of 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 it continued its lopsided support of Israel against its Arab neighbors. It was the first time in history that a cartel used oil as a weapon to effect a political aim.

The embargo never reached its threatened level 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 embargo made “energy crisis” part of the Western lexicon and introduced for the first time the rhetoric of “alternative” energy sources and the even more potent (but still silly) notion 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 redistribution of wealth in its history – 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 members, 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 the longevity of 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 included Nigeria, Indonesia, Iran, Iraq and Venezuela. Absorbers had an obvious interest in maintaining prices as high as possible and were also the most militant when it came to protecting prices. Interestingly, Iran and Venezuela were the most militant oil price hawks at a time when presumably their governments were friendly to the West. Of course they became even more militant when their governments became unfriendly. Militant members were the ones pushing for production quotas and a lid on production levels, which led to frequent and often transparent cheating among members. The non-absorber countries, on the other hand, included Saudi Arabia with its enormous oil resources and other smaller Mideast nations, who wanted a far milder stance, especially since they were closely aligned with the oil-consuming countries and mainly the U.S.

Fall From Grace

It was in 1984 that OPEC frayed at the hem. Then-President Ronald Reagan “encouraged” Saudi Arabia to over-produce unilaterally, and that 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 U.S. The collapse of oil prices at the height of the Cold War 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 today is not what it used to be. It does not have the power it once had to manipulate the market. Others have muddied the scene: Mexico and Brazil with their 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 of Vladimir Putin exactly for his desire to become powerful enough that he could challenge OPEC. He is now rotting in a Siberian prison. Russia did not want overproduction to collapse oil prices and thereby shoot itself in the foot. But Russian oilmen showed there was life beyond OPEC.
OPEC also does not have the excess capacity it once had. A demonstrable excess of over 10 million barrels per day in 1995, outside of Saudi Arabia, 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,” meaning oil it can turn off and on at will. The reason for the decline is simple: It takes huge reinvestment to maintain production capacity. 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 might claim. As for Iraq, it is hard to produce oil when people are shooting at you and, when the U.S. military gets out, I am not at all optimistic about future production. All of these countries are producing only about one-third of their geological potential.

OPEC had, moreover, little to do with the run-up in oil prices from 2004 to 2008, when they almost topped $150 per barrel. Geopolitical headlines ruled those days. Consumption gone berserk in China and sustained growth in the U.S. dominated the market. I am surprised that oil has yet to surpass $100, a testament to how much weaker the U.S. economy really is, even compared to some of the most pessimistic forecasts a couple of years ago.

Not Dead Yet

One should not write OPEC off by any means, for at least two reasons. First, “green” energy rhetoric notwithstanding, the world will continue to be 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 nearly close; and with all due respect to 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, that country can at least double its current production capacity and, along with its fellow cartel members, remain a potent geopolitical force for years to come. – MarEx

Dr. Michael J. Economides is a Professor at the Cullen College of Engineering at the University of Houston and Editor-in-Chief of the Energy Tribune.