OPEC is not expected to change course at its meeting next month. Its de facto leader Saudi Arabia has not hinted at changing its current strategy of fighting for market share instead of cutting back production to lift prices. But while the likely outcome of the next meeting is fairly clear, what’s less certain is the cartel’s long-term strategy, and if any cohesion can be expected between members.
Members are split on the future of OPEC, and most discord exists within the cartel on what action to take in the oil market, both near and longer term.
Based on an internal OPEC report, Reuters has reported on the extent of the discord regarding both short and long term strategy. Certain members such as Iran, Iraq and Algeria see the maximization of revenue as a primary goal of the organization. For instance, Algeria commented that members should “establish and defend a price floor” and accept the trade-off of lower market share for higher revenues. Iran, meanwhile, wants to bring back a price band, which the group abandoned in the middle of last decade. “It is our recommendation to agree upon a fair and reasonable price (band) then try to support it as long as this price seems a fair and reasonable price,” reads one of Iran’s comments.
This indicates that the upcoming meeting will be contentious even with no change in policy, and the group’s divisions may sharpen through 2016 as certain states continue pushing for a new strategy if low prices persist. In the past year, since their monumental decision to hold output steady despite a weakening market, the Saudis, or OPEC as a group, have not given any indication under what circumstances they would cut again. The Fuse, in an article last month, speculated that a number of factors could motivate the cartel to throttle back in 2016, but the course it takes next year and beyond is far from certain: OPEC is in uncharted waters with shale’s success, Iran returning to the market, the worries of another economic slowdown, and a number of large projects getting shelved.
But while now is a time of unique challenges and the future of the organization is up in the air, this is not the first time OPEC has faced external threats, and it’s worth looking back on how successful the cartel has been in managing the market in the past. Although OPEC has long been a heavyweight in the global oil market, and used its heft for both political and economic reasons, it has also failed in certain attempts and has been at times completely powerless at times in the face of both rising and sinking prices.
Embargo of 1967
What many gloss over is the fact that OPEC’s first attempt to flex its muscles was an abject failure.
What many gloss over is the fact that OPEC’s first attempt to flex its muscles was an abject failure. In 1967, seven years after the group was formed, OPEC, led by Saudi Arabia, sought to use oil as a weapon to embargo Western countries that supported Israel in the Arab-Israeli War. Although Great Britain and West Germany relied heavily on crude imports and volumes sent to the U.S. were on the rise, a disaster was averted. The U.S., with the lifting of regulations on the Texas Railroad Commission, increased oil production sharply at the time, and also received cooperation from oil companies and non-Arab oil producers. Collectively, these actions successfully thwarted OPEC’s threat.
Energy Crises of 1973 and 1979
Much of today’s perceptions of the cartel are based upon the oil shocks of the 1970s.
Much of today’s perceptions of the cartel are based upon the oil shocks of the 1970s. The global fundamental outlook had changed considerably since 1967, with rising demand in Western countries and U.S. output on the decline. OPEC’s 1973-74 embargo, in response to another Arab-Israeli war, was largely successful for the group in that it showed it could indeed use oil as a geopolitical weapon and boost revenues while producing less. Arab OPEC members cut off supplies to the U.S. and other supporters of Israel, wreaking economic havoc across the United States and causing the price of oil to skyrocket. The energy crisis brought on by the embargo reflected the rising clout of OPEC producers while demonstrating the growing vulnerabilities of U.S. and European economies. Western countries’ dependence on oil, and supplies from Arab OPEC members, was on full display. As a result, lost supply during the 1979 Iranian Revolution was enough to instigate widespread panic and push prices toward $40 per barrel even though only about 4 percent of world supply was taken offline. Other OPEC members were able to profit well from the rise in prices drive by geopolitical volatility. Even though this drop in output did not stem from a coordinated cut, it showed the power that oil producers had over the global economy and oil-importing nations.
Although the cartel gained significant revenue immediately from these crises, the results turned out to be mixed for the longer term. To be sure, it exercised its muscle and let it be known that it was powerful global institution, and that curtailing output could ultimately impact prices and in turn boost revenues while also helping members achieve geopolitical goals. At the same time, however, consuming countries reacted swiftly to lessen their vulnerability to oil shocks by building strategic stockpiles, beginning a consumer country watchdog organization (the IEA), slicing demand for oil in the power sector, getting rid of price controls, implementing fuel-efficiency standards, and establishing transparent futures exchanges where crude could be traded. Moreover, the high oil price stimulated investment in the upstream sector, with the North Sea a big success story around this time.
Failed production cuts in the 1980s
Saudi Arabia cut output dramatically in the 1980s in an attempt to boost prices, but this time, it didn’t work.
Oil prices collapsed in the mid-1980s as demand contracted due to recessionary conditions and improvements in efficiency, while non-OPEC supply grew thanks to the prolonged high oil prices of the 1970s. Saudi Arabia cut output dramatically in an attempt to boost prices, but this time, it didn’t work. From 1980 to 1985, the Kingdom’s production fell from around 10 million barrels per day to 3.6 mbd in 1985, which brought about a dramatic loss of market share. From 1983 to 1986, the price of West Texas Intermediate (WTI) was cut in half, falling from $30 per barrel to $15. This 1980s debacle for Saudi Arabia undoubtedly influenced its 2014 decision to hold production steady instead of cutting back alone in an attempt to elevate prices.
Price collapse and output cuts in 1998-99
Market fluctuations at the end of the 1990s reflect both mismanagement and success on the part of OPEC. Failing to anticipate the Asian economic collapse of 1998, which significantly dampened demand, OPEC countries upped production which caused prices to plummet to $10 per barrel. The price collapse was so bad for producers that OPEC was able to coordinate cuts with non-OPEC countries such as Mexico and Norway. In 1999, the cartel made another round of cuts, successfully pushing the market to the $30 level the next year and setting the stage for elevated prices throughout the decade.
Powerless in the price spike of 2004-08
During the price rise in the 2000s, many analysts, and even some OPEC ministers, said the group had lost control of the market and speculated that its days were numbered.
In 2004, prices began a prolonged rally amid rising demand in emerging markets and the influx of speculative money into oil futures. OPEC was mostly powerless in halting the price surge, which culminated in WTI reaching $147 in July 2008. The group was virtually pumping all out and calling emergency meetings, but it quickly ran out of space capacity and couldn’t keep up with rising demand. Many analysts, and even some OPEC ministers, said the group had lost control of the market and speculated that its days were numbered. “There is not much we can do [about rising prices],” Algerian Oil Minister Chakib Khelil said in 2005, while Qatar Oil Minister Abdullah al-Attiyah stated, “This is out of the control of OPEC.”
During this period, there was a noticeable split in the philosophy of the group’s members. The doves, led by Saudi Arabia, were worried that higher prices would spur alternative fuel sources, curtail demand growth, and undermine the global economy. The hawks, chiefly Iran and Venezuela, reveled in the higher-price environment and wanted to milk the situation as long as they could.
Output cuts in 2009
After prices peaked in July of 2008, they collapsed in spectacular fashion, falling all the way the $30 range, prompting OPEC to take swift action to rebalance the market and lift prices. The group agreed altogether to a massive 4.2 mbd reduction in late 2008. Although each country was expected to cut, many members cheated and overproduced, meaning the Saudis bore the brunt of the production pullback. The Kingdom alone reduced output by as much as 1.8 mbd. Oil prices rebounded over the next couple of years and consistently traded above $100 from 2011-14. While OPEC can surely take credit for supporting the market, extraordinary monetary and fiscal measures taken after the 2008 financial crisis boosted economic growth, global oil demand and speculative activity in oil futures, all of which also helped lift the price of oil.
Libya’s outages in 2011, Iran sanctions in 2012, and Saudis’ use of spare capacity
The Arab Spring destabilized the Middle East and North Africa, spurring chaos in many major oil producing states. Libya was hit the hardest, losing all of its 1.6 mbd of production in 2011, which caused oil prices to skyrocket above $120 per barrel that year. In response, Saudi Arabia upped production by roughly 1.5 mbd in a relatively short period of time, helping calm the market—although the coordinated release of strategic stockpiles by consuming countries also contributed. The chaotic oil market of 2011 was highlighted by OPEC’s meeting in June of that year, when total disorder erupted as members couldn’t agree on a production strategy. “It was one of the worst meetings we’ve ever had,” said Saudi Oil Minister Ali al-Naimi. Despite the internal dissent, the Saudis boosted output on its own terms that year. It did so again in 2012, as the global market had to deal with the loss of Iranian volumes from sanctions for Tehran’s nuclear program.
The surprise 2014 decision
The Saudi-led decision in November 2014 not to cut production amid the ongoing price rout caught the market off-guard—even though it seems like the obvious choice in hindsight.
The Saudi-led decision in November 2014 not to cut production amid the ongoing price rout caught the market off-guard—even though it seems like the obvious choice in hindsight. The Kingdom was clearly influenced by the event of the 1980s, when it ceded so much market share, as well as the 2008-09 cut, when it shouldered most of the burden alone. The group was and still is in a conundrum. Its strategy has yielded mixed results. All oil producers are competing fiercely for market share, and U.S. production has fallen at a surprisingly slow pace. Lower prices have hurt each country’s revenues, some more than others, but it’s generally understood that changing course with an output cut would spur growth in non-OPEC supplies, particularly U.S. shale. After all, sustained high oil prices enabling new production was the main reason oil prices fell in the first place.
As the group moves forward, there are numerous challenges besides unconventional oil, such as the durability of demand growth in emerging markets, rising demand in members’ own economies, the direction of subsidized fuel, social unrest, and fiscal deficits as the new oil market “paradigm” continues.