Revision on OPEC and oil prices
What is OPEC? • • • • • • A producer cartel founded in 1960 – now has thirteen members although several other countries are considering becoming members (and Indonesia’s place in under threat) Controls around 45% of world crude oil output (compared to 55% in the mid 1970s) and just over half of world oil exports But has a larger share of world crude oil reserves (long run importance?) Controls it’s own supply through a system of output quotas Many of the OPEC nations have accumulated huge FX reserves as the world price of oil has soared – contributing to the growing power of sovereign welfare funds UK is a net importer of oil, along with Norway and the USA it is not part of OPEC Nigeria Qatar Saudi Arabia United Arab Emirates Venezuela
Current members of OPEC are: Algeria Iran Angola Iraq Ecuador Kuwait Indonesia Libya
OPEC's mission is to coordinate and unify the petroleum policies of 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 to those investing in the petroleum industry.
OPEC's Oil Production and Share of World Total
Percentage share of world output (top pane), output (million barrels per day) bottom pane
60 55 50 Percent 45 40 35 30 25 80 70 Barrels/Day (millions) 60 50 40 30 20 10 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 OPEC Output World Output 60 55 50 45 40 35 30 25 80 70 60 millions 50 40 30 20 10
These aims are worth focusing on – in particular the aim of providing a steady income to producers and a fair return on capital – what is a fair return? This raises questions of equity. OPEC acts as a swing producer – meaning that it can change supply to bring about a change in the balance between global oil demand and supply. To have any control over global prices it needs to act together – as a producer cartel – and, as with many other examples of price fixing, there are frequent tensions within the cartel about how best to impact on the market.
OPEC's percentage
OPEC countries
Total World Source: Reuters EcoWin
Too high a price risks accelerating research and investment from oil-importing nations to find alternatives to oil (damaging in the long run for OPEC). But high prices in the short run gives many of OPEC’s members much needed foreign exchange reserves which are needed to fund infrastructure projects in their domestic economies. Importance of the dollar For the moment, OPEC continues to use the US dollar as its reference price for a barrel of crude. Oil producing countries can of course convert dollars into any currency that they want, but when the dollar is falling (as it has been recently) this has the effect of reducing the value of each barrel
of oil exported from OPEC countries. This can have a damaging effect on a country’s trade and budget (fiscal) position especially if oil exports are a high percentage of total exports. OPEC’s production relative to capacity
OPEC Crude Oil Production against Capacity
Million barrels per day, source: International Energy Agency
35 Total OPEC Crude 34 33 32 Barrels/Day (millions) 31 30 OPEC Production Capacity 29 28 27 26 25 24 OPEC Oil Production 29 28 27 26 25 24
31.56M OPEC Sustainable Production Capacity 34.73M
35 34 33 32 31 millions 30
The chart on the left shows OPEC’s current production set against estimates of their production capacity: Capacity is influenced by: 1. Capital investment in by each of the oil exporting countries e.g. in drilling equipment and other plant 2. Investment in finding new reserves of oil that might be economically viable
Worth noting that OPEC has been raising output in recent years – the assertion that they have “cut supply to increase oil prices” is simply wrong – as a whole OPEC is producing at around 90 per cent of its capacity – think about what that might mean for the price elasticity of supply of crude oil from OPEC producers?
Q1 Q3 02 Q1 Q3 03 Q1 Q3 04 Q1 Q3 05 Q1 Q3 06 Q1 Q3 07 Source: Reuters EcoWin
Although OPEC production has been increasing – so too has global demand for oil (especially from the USA and emerging market countries) - and it is this will has been the main factor putting upward pressure on crude oil prices. Oil is priced at over $100 a barrel and has been for some time – but this is NOT due to a shortage of oil in world markets Instead
World Oil Demand
Million barrels per day, source: International Energy Agency
90 90 85 80 millions millions 75 70 65 60 55 50 30.0 25.0 20.0 15.0 10.0 5.0 0.0 74 76 78 80 82 84 China 86 88 90 92 94 96 98 00 02 04 06 08 85 Barrels/Day (millions) Barrels/Day (millions) 80 75 70 65 60 55 50 30.0 25.0 20.0 15.0 10.0 5.0 0.0 72
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Shortages of oil refining capacity has been a factor Oil as a commodity has attracted speculative buying as oil consumers have bought forward to hedge against price volatility The price of crude carries a high risk premium because of geopolitical tensions - situation in Iraq and US-Iranian tensions The falling value of the US dollar has attracted speculative buyers of oil because other currencies can now buy more barrels of oil as a result
Total Demand
Europe
North America Source: Reuters EcoWin
Ultimately the world price of oil is determined mainly by demand rather than supply. As the swing producer in the global oil market, OPEC can influence the direction of prices but fundamentally it is all about how much oil we need and the price we are willing to pay. OPEC cartel in profile (BBC) Oil markets explained (BBC)