The OPEC's Influence

Introduction

This chapter introduces the research topic and provides a discussion of the historical background of the proposed study. This will be followed by the research aims, research questions, as well as the significance and the organization of the study.

Research Topic

The topic of this study is the impact of OPEC’s Policies on the Economies of Industrialized Nations.

Historical Background

OPEC was performed as a direct response to the sudden fluctuation of the oil production and price cut announced by several international companies in the industrialized nations (Adelman 1995). OPEC became the first in many efforts by oil producing nations to have a greater control over the production and pricing of oil. Initially, OPEC member countries included the UAE, Algeria, Ecuador, Indonesia, Qatar, Nigeria, and Libya (Adelman 1993). Initially, OPEC faced limited effectiveness due to abundance of oil in the global market and challenges in maintaining discipline within the ranks of the member states. According to Amano and Norden (1998), after its formations, OPEC’s influence in the world oil market was enhanced by the market conditions more than the organizational and the political prowess.

An increase in the global demand for oil increased significantly the ability of the organization to influence the price of oil. For instance, an oil embargo by the cartel against the U.S and major industrialized nations of Western European in response to support by the U.S and Israel, during the war between Israel and the Arab world in 1973, boosted the organization’s influence in the global oil market; hence, it emerged to a common name throughout the industrialized world (Auty 2001). According to the common myth, the oil embargo of 1973 and the conditions experienced in the global oil market provoked a wave of speculative purchase of oil future contrasts that influenced the price of oil at certain levels. This demonstrated that a significant part of OPEC’s influence depends on the perception of the public of the forecast future circumstances in countries with major oil reserves, particularly in the Middle East (Becker 2007). The increased costs in the oil prices made the industrialized nations suffer from recessions driven in part by the increased fuel costs. In response, the industrialized world made improvements that influence energy demands.

OPEC significantly influenced the increases in the oil prices and motivated a global demand for petroleum and oil products beyond the control of OPEC. However, the increases in the price of oil led to costly oil exploration and encouraged increased of oil production in other non-OPEC countries. Consequently, the increase in oil supply as well as efficiencies led to changes in oil price (Bradley 1996). Therefore, this demonstrated that oil is a commodity that influences the economy of the industrialized nations in many ways; hence, it is beyond the control of OPEC. However, the cartel remains highly influential in the world oil market and recognizes that the long-term health and the financial benefit to the member states rely on two key factors (Bradley 1996). According to Bradley (1996), first, OPEC seeks to work together with the global oil competitors beyond its rank, such as the Russian oil industry. Second, OPEC has recognized that the success of the industrialized nations economically depends on its products; hence, it works to control and maintain the stability of the global oil price.

OPEC has been fully integrated in the global economy with the main objective of determining and exercising influence through the control of oil prices in order to exercise, determine and generate high revenues. The OPEC statute, which was formed in 1960, declares that OPEC is dedicated to form a stable petroleum market, which helps supply petroleum regularly to customers at reasonable prices (Adelman 2002). OPEC as an economic organization has been one of the major influences on global energy markets (Horsnell et al. 1993). It also promotes cleaner fossil fuel technology to the rest of the country (OPEC). The organization also sees that it gives satisfactory returns to the investor in the oil industry, but the presence and policies of non-OPEC organizations around the world pose a serious threat to the long term sustainability of OPEC and its interests.

The OPEC member countries consider the prevailing state of the oil market and forecasts of economic growth rates, different petroleum supply, and demand situations. The member states then consider what changes in oil policies are necessary to control oil pricing. Previously, the member states have made decisions to increase or reduce their collective oil production rates to stabilize oil prices to consumers in the short-term, medium-term, and long term. However, OPEC has no mandate to control the oil market, but the member countries produce almost 50% of the world’s crude oil, as well as a considerable amount of natural gas. In addition, the oil exports from the member countries represent over 60% of oil traded in the global market. Therefore, OPEC has a very strong influence on the global oil market, particularly if it decides to increase or reduce oil supply. The cartel seeks to be stable in the oil market and aims at delivering steady supply of oil to meet the global energy demands at fair and reasonable prices. OPEC has been able to achieve this by voluntarily producing more or less oil in response to the demand and supply of oil changes.

Statement of the Problem

According to the OPEC statute, the organization is required to pursue stability and harmony in the global oil for the advantage for both oil producers and consumers. Therefore, OPEC member states respond to the fundamentals in the global oil market and to anticipate the developments through coordinating oil policies. In order to maintain the oil market stability, the member states meet to coordinate oil production policies. Hence, there may be alterations in the production levels depending on the prevailing market fundamentals. Thus, production agreements are one of the possible responses in the member state meetings. Thus, if demand grows, or some oil producers provide less supply of oil, the OPEC can have a say to increase the overall production and supply of oil to curb the sudden price increases or undersupply of oil. Moreover, OPEC might also decide to reduce its oil supply based on the prevailing conditions of other markets as a way of responding to the price reductions, or in a response to a sudden fluctuation in the oil price. OPEC achieves this through setting a new production ceiling for the member states or making adjustments to the existing ones.

When OPEC makes the production agreements, it does so through the expectation that the non-OPEC nations will support the measures taken by the organization, since it will ensure that the decisions become more effective, and the production agreement is beneficial to all (Bradley 1988). Since the OPEC member countries produce most the world's crude oil and over 60 per cent of crude oil traded in the global market, any attempt to change the production levels may have an effect on the price of crude oil. However, the influence of OPEC’s decision on crude oil can be considered separately from the debates of changes in the final pricing of oil petroleum products.

Many factors influence the price of the final product paid by the end customers for the oil products (Cooper 2003). Cooper claimed that, in some industrialized nations, taxes represent a larger percentage of the final gasoline price paid by consumers. This is often influenced by changes in the price of crude oil (Cooper 2003).

Currently, the Organization of Petroleum Exporting Countries seems to lose its control over the determination of crude prices, a position that it enjoyed over the previous years. The control of crude oil pricing may have been achieved by OPEC’s policies as well as the output regulation from the member countries. These included the output cuts that were aimed at raising oil prices or market flooding to reduce the prices. Economists have been supporting the argument that this may influence the production capacity to enable OPEC to achieve successfully relative member cohesion to cut output, hence raising oil prices and the global demand for crude oil. Recently, the rise in the crude oil prices as administered by OPEC has been linked to the global economic recession as the main contributing factor.

Research Aims

This study provides an analysis of current strength and capability of OPEC and how its behavior affects the economics of the industrialized nations. This research also tries to identify the positive and negative impacts of OPEC over the industrialized world’s sustainability. Finally, it aims to analyze the influence of oil-importing industrialized nation’s policies in relation with the OPEC current mode of operations.

Research questions

  1. What is the future of OPEC in the present industrialized world?

  2. Is there an adequate basis for action against the suspected influence of the OPEC in controlling oil price?

  3. What would be the impact of OPEC policies on the economy of industrialized nations?

  4. Will the policies of industrialized nations pose a challenge to the sustainability of the OPEC?

  5. Is there an appropriate legal ground for taking action against OPEC’s for the suspected influence in the fluctuations of oil prices?

Significance of the study

The global price of crude oil is an important issue of discussion and to the health of the world economy. The higher prices of oil has been observed to occur to some level due to the impact of OPEC’s supply management policies, which contributed to the global economic downturn in the previous years, and dampens the current recurring upturn in the global oil market (Dahl & Yucel 1991). However, OPEC does set crude oil prices. Fox (1997) claimed that, in the early years, the organization was responsible for setting the crude oil prices.

Currently, the OPEC may choose to influence the production of crude oil with an aim of stabilizing the oil market and preventing dangerous price fluctuations. Moreover, in the current complex global markets, the crude oil price is increasingly set by certain movements on the three main international oil exchanges. Various factors can lead to low crude oil prices, such as the imbalance between the supply and demand of crude oil. Therefore, the role of OPEC is to adjust the crude oil supplies in order to improve the imbalance between the supply and demand of crude oil. Thus, the cartel strives to ensure a steady supply of energy to consumers, while ensuring a reasonable return to the member countries (Gerber 2007). On the other hand, high crude oil prices are also caused by a number of factors. These include the fluctuations in the supply and demand and the falling rates of investment. For instance, if reasonable investments are not made in the short term, oil supplies could be limited in the long term, hence leading to price increases.

Recently, high crude prices were caused by non-fundamental factors like the speculative activities and fluctuations in the exchange rates (Abdallah 2005). In the industrialized nations, taxation has been noted to create a greater influence on the price of oil products. The actual price of crude oil presents less than 25% of the price of oil products in many regions (Granger 1969). Hoekman and Holmes (1999) stated that the founding nations decided to form the organization with the main aim of controlling and stabilizing the oil market without the sudden fluctuations in prices.

Oil is very fundamental to the economy of the industrialized nations. It is the foundations of many industries in the world. The industrialized world would greatly suffer without a steady supply of oil at stable and reasonable prices. The price of oil influences the cost and the availability of many vital products. When there are fluctuations in the price of oil, goods and services become expensive, and the economies of industrialized counties experience inflation. On the other hand, when the prices of oil are too low, the petroleum resources are used unsustainably, and the investors become no longer attracted to the oil industry, this lowers the investment levels in the industry, causing increased levels of unemployment as well as a possible decline in production. Consequently, this may result into an eventual fall in the supply of oil. Therefore, the fluctuations in the oil prices are very detrimental both to producers and consumers in the industrialized nations and the world at large (Hoekman & Mavroidis, 2002).

OPEC aims at maintaining the balance so that the oil market faces neither the problem of undersupply nor oversupply. Moreover, the cartel also collaborates with other oil producers to encourage them to do the same by adopting fair and equitable policies that are non-discriminatory against oil. The global GDP growth may increase to some percentage higher in fears of OPEC’s policies, supply cuts, as well as tensions in various nations. The prevailing marker conditions have become more unstable than normal ones due to escalating political uncertainties, tight crude cost, and other tight product markets such as gasoline. For instance, in the United States, OPEC is reinforcing upward pressures on crude oil prices. This has yielded high unemployment rates and exacerbated budget deficits in most OECD and other oil importing nations (Horsnell and Mabro 1993).

The economic impact of higher oil prices and oil importing developing nations are very severe than the OECD nations. The impact of OPEC is felt on the economic stimulus provided by higher oil export earnings that would be more outweighed by the depressive effects of the higher oil prices on the economy of oil importing nations. In addition, the impact of the crude oil prices on the economic growth in OPEC member countries depends on many factors, particularly on the manner the revenues are spent (Jacquemin and Lloyd 1998).

Organization of the Study

The organization of the study follows the following structure: chapter two will begin with providing a description of relevant literature concerning the impact of OPEC’s policies on the economy of industrialized nations; the section of data analysis will take two major steps. It will comprise the very detailed data on the nature of OPEC’s policies and then the impact on the economy of the industrialized world. The findings are described in chapter four, while chapter five will providea discussion of the findings and relevant issues covered in the reviewed literature and finally, the conclusions, recommendations, and the directions of further research are explained in chapter six.

Literature Review

Introduction

This chapter provides a review of previous literature that captures the influence of OPEC on the selected industrialized countries that have been previously investigated in the field of global crude oil pricing.

The Impact of OPEC’s Policies on the Economies of Industrialized Nations

OPEC plays a crucial role in promoting and sustaining the global economic growth by maintaining steady supplies of oil at fixed and reasonable prices, which do not pose a detrimental threat to the economic expansion of the industrialized world. The organization has been aware of the need for improvements in the global trade. For instance, in 1975, OPEC backed calls for the establishment for a new international economic order based on justice, mutual understanding, as well as a genuine concern for the wellbeing of the current and the future generation. In the same year, the organization called on the industrialized and the developing nations to join hands to solve the problems that were faced by the third world countries and to seek for better ways of increasing trade and the exchange of knowledge. In addition, OPEC recognized that crude oil is a finite resource; therefore, through a better management of its production, the organization aims at improving the benefits from its utilizations.

According to Adams (2003) during the 20th century, petroleum resources substantially transformed the world for the industrialized nations. Consequently, exploration of oil is doing the same for the developing nations. Thus, OPEC’s mission is to support technological improvements that make the transportation of oil cleaner, safer and more efficient in order to make many people enjoy the benefits of oil in an environmentally and sustainable manner (Johany 1978). This is aimed at meeting the energy demands for the current and future generation, improving the economy of the nations, preventing inflations, and bettering the living standards by meeting the global energy demands. Among the most fundamental policies of OPEC is to ensure the safety of the environment in order to enhance sustainability for the sake of the current and future generations. Environmental protection is very crucial in achieving sustainable development in the oil industry (BP 2007). Therefore, the organization promotes the use of environmentally friendly fossil-fuel technologies and also recognizes that more of the global emissions originate from non-oil resources.

Among the industrialized nations, the environmental policies are focused on limiting the utilization of oil products. Therefore, heavy taxation on petrochemical products has been a common, longstanding policy within the industrialized nations. The high level of taxation leads to instability in the oil industry, hence influencing the future of investments in the oil sector. OPEC has been in the forefront to ensure that the member countries improve their overall environmental impact by using sources of higher quality oil and gas, as well as developing cleaner fuels for the consumers (Krugman 1983). Moreover, it advocates for a reduction in the impacts of activities through safer, sustainable drilling, transportation, as well as refining process.

Most industrialized nations are implementing polices aimed at minimizing overreliance on oil and its products a way of reducing environmental pollution by reducing carbon dioxide emissions (Kaufmann 2004). However, previous studies have indicated that the industrialized nations of the OECD could reduce the carbon dioxide emissions by a greater extent in the future and still maintain the tax revenues with concentrating the taxes majorly on oil products. In order to achieve this, the industrialized nations should develop a pro rata tax system on all energy forms based on the differences on the carbon contents. The main policy of OPEC is to maintain stability in the global oil market (Klodt 2001). This has been achieved by the member countries through an increase or a reduction in the amount of oil produced. Only OPEC member countries have the potential to have significant spare oil production capacity that enables the organization to increase the output at a relatively short notice. However, since OPEC does not monopolize the global oil market, it has no mandate to guarantee the fluctuations in oil prices or the availability of oil supplies to all consumers at all times (Lloyd 1998). OPEC is concerned about the issues that undermine the prosperity of the oil industry; hence it will threaten the security of the world.

By the end of 2010, OPEC had proven oil reserves of 1,193,172 million barrels of crude oil (Appendix 1). Thus in 2010, OPEC’s member countries produced over 29 million barrels of crude oil on a daily basis. This is equivalent to 42% of the total world output, which stood at approximately 69.7 million barrels daily. According to economists, the rate of production recorded in 2010, indicated that OPEC’s crude oil reserves are sufficient to last for more than 113 years.

Even though, the price of crude oil may not be fixed, a small alteration in the volume can lead to price changes (Mead 1979). For instance, in 1987, a change of 4% of supplied quantity of crude oil caused a 50% change in price; this was also followed by a dramatic 7.5 % increase in the quantity produced that caused a 30% reduction in the crude price with supply elasticity of less that one in the cases (Klodt 2001). The impact of OPEC in industrialized countries could be felt since OPEC had a significant influence on the global oil prices. Understanding the sources of the previous oil prices can assist in understanding what may happen in the economy of the industrialized countries in the future. However, the current global oil market is free than in the previous years. Krugman 1983 claimed that the current global oil market has become like other international markets, with price changes responding to the supply and demand. Thus, crude oil availability is more likely that the cost of crude oil will increase as higher costs will be needed for more extraction in the future, to meet the increased energy demands in the oil-importing industrialized world. This will result into price increases that will result into problems for the producers and consumers in the industrialized world (Krugman 1983).

The uncertainties that are based on the future demand levels for oil end energy, and the economic situation in the major oil-importing industrialized world and the root causes of the challenges faced in the oil industry and the economy (OPEC 2006). As a result of the recent fall in oil prices, oil supply from the non-OPEC countries have significantly reduced, and the cartel is expected to increase the supply of crude oil. If this situation continues in the future, the sparse capacity of the crude oil resources will continue to diminish. This condition may be similar to a situation that occurred in 1999 when the reduction in oil prices led to a capacity shortage, which eventually causes a price the rise (Radler 2007).

Low oil prices usually result into unsteady markets and price rises (OPEC 2009). It is predicted that, on a global scale, the oil trade will experience changes until the year 2015, when the industry experiences a decline in the crude oil exports. However, the oil trade is anticipated to commence in growth, and beyond 2030, millions of barrels of crude oil will be produced each day, in trade between regions (OPEC 2009). Following any increase in oil price, the GNP falls; while the unemployment and inflation, as well as changes in the inflation rates increase. But how do OPEC’s policies relate to these effects? Oil and gas prices are dictated not only by the market demand and supply, but also by national interests, political considerations, wars, and other strategic requirements of a country; hence, OPEC does have a crucial role in fixing the prices of oil and gas the world over (Adelman 2002). OPEC works out the total output required to maintain and control the prices of oil. It also decides to increase or decrease the output keeping in mind the requirement of the various countries of the world (Chalabi 1997). Wars, mismanagement, corruption, and political instability make the organization decide whether to increase or decrease the oil production (Horsnell et al. 1993). During the Gulf War in 1990, the whole nation was in turmoil as Iraq and Kuwait suddenly stopped the oil production, which led to increase in oil prices. Fortunately, the other member countries helped out in solving the problem by producing more oil so that the rest of the world could live comfortably (Horsnell et al. 1993). Ramcharran (2002) posit that the work of the organization is not easy as it has to put up with a lot of political pressure within the member states as well as other nations.

At times, the organization reduces the output of oil in order to create artificial scarcity so that the demand becomes more and the supply less. Thus, the high and rising price of oil imports from OPEC countries burdens the industrial countries (Schrijver 1995). This adversely influences the economy of these countries as the production and transportation cost will soar, and this will effect the economic growth of these countries. At times, it increases the output to bring down the soaring oil prices so that the demand for oil is not cut down by non-oil exporting countries (Smith et al. 2003).

To achieve stability in the Oil market is not easy especially when the financial market plays a significant role in the present day world (Adelman 2002). As an economic organization, OPEC has to play a very significant role in the Global energy markets. OPEC has the lowest average oil production cost, this is due to the large amount of oil reserves that some of the member countries have (Smith et al. 2003). Moreover, these locations are easily accessible to the public. Hence, decisions related to the supply of crude oil from OPEC plays a vital role in the cost determination of the global oil and gas price. The world oil and gas demand along with the policies of OPEC’s contributing nations regarding the adherence of production quota has a direct influence on the price determination factor of world oil and gas (Chalabi 1997). Usually OPEC controls the production to achieve the estimated target price. Even though every member nation has voluntary independent production quotas, it always adheres to the estimated production target of OPEC which in-turn controls the target price of oil and gas, globally. It is the economic factor. When the demand increases, but the production remains same, the price increases (Smith et al. 2003). As OPEC controls the world’s largest and low-cost conventional crude oil fields, any determining factors of production directly affects the demand and price of oil. At the same time, OPEC has the ability to increase production capacity if it observes an acute supply shortage of crude oil. These two factors mainly control the world oil and gas price (Zycher 2001).

OPEC’s oil price is presently denominated in US dollars. Thus, fluctuations in the US currency price in the world currency market also affect the world oil and gas price (Smith et al. 2003). OPEC’s production quota determination also takes this currency parameter to make a decision regarding the crude production to achieve the collective target price for its individual member nations (Adelman 2002). Even though OPEC is formulated to control the sudden sharp fluctuations in the oil and gas price in the global market, it is losing its stand as there are new players to dominate the following market. Advent of non-OPEC nations like OECD (the Organization for Economic Co-operation and Development), EIA (the Energy Information Administration), NYMEX (the New York Mercantile Exchange), DMX (Dubai Mercantile Exchange), etc., all are set to gain the global oil and gas market share, which decreased the market control of OPEC (Smith et al. 2003). Thus, the output regulation strategy normally adopted by the OPEC to control the target price for its production is less likely to work as expected in the present market scenario because non-OPEC organizations do not make policies control the demand and supply of crude oil along with the OPEC (Roeber 1993). Other vital parameters, which affect the world energy price, are the move towards the alternative energy source and increase in energy efficiency. Despite facts like these, OPEC still holds a major market share in the production and supply of crude oil in the world energy market, hence having a final say in the market price (Chalabi 1997). OPEC does not have full control over the global oil and gas price but still has the power to decide the control of production and supply according to the global demand, which definitely correlated to the price of oil and gas, worldwide.

As non-OPEC organizations gain market share, which were once dominated by OPEC, other factors - both economic and political - have a wide impact on the oil and gas price decision mechanism. According to Udin (2001), the events that occurred in 1970 generated sudden and permanent changes in the petroleum industry, hence affecting global oil prices. Prior to the formation of OPEC, the major oil multinational companies that formed the ‘seven sisters’ controlled the international oil markets (Udin 2001). The multinationals determined the manner in which crude oil was traded and also controlled the oil prices. OPEC countries demanded more involvement and profit in the oil production from their nations. Since OPEC is the force behind these nations that has taken control of the global oil market for some time.

The impact of OPEC’s policies on the industrialized nations has been a controversial issue due to the political nature as well as the complexity of the commodity markets. Established several decades ago, OPEC’s interests of the national government oil producers have reduced but continued to exert more influence on the world crude oil production. Most of the time after the inception of OPEC, it was concerned about the power balance between the major western oil companies, and the impacts reflected the various experiences and contributions of some of the cartel’s countries (Verleger1982). In addition, Verleger observed that the challenges faced by OPEC in doing so were different from those presented in the previous years (Verleger 1982). The correct price of crude oil is influenced by the quality and the changing supply and demand for different grade, proximity to the market, global oil market conditions, competition with non-OPEC nations, as well as the OPEC nations. It is a great challenge that hampered OPEC’s effectiveness in delivering the supportable and sustainable high prices. The following fact will be observed.

The major challenge on a co-ordinated approach to increased oil prices and market stability is associated with the internal tensions that exist within the OPEC member countries. For instance, the energy crisis experienced in 1979 was a reflection of a consistent pattern since the foundation of OPEC’s influence on the oil market, focusing on the tension that occurred in the Middle East: the Yom Kippur War of 1973, the Iran-Iraq conflict in the year 1979 to early 1980’s, the Gulf War in the year 2003 to 2005, and in Libya in 2011, with the aim of having a united approach.

The Iranian Revolution of 1979 caused chaos that precipitated in the global market and resulted into the spiraling of crude proves. In 1980, the Iraq’s invasion of Iran led into a combined production of both nations falling (Watkins & Streifel 1998). In 1980, the global production of crude oil fell by 10%, followed by the sharp oil price increase, in the short-term, causing instability of oil sourcing. This was to minimize consumption of oil through improved energy efficiency. Moreover, there occurred an increased sourcing of oil from non-OPEC countries as well as a switch to other energy alternatives such as nuclear energy and coal (Gülen 1996).

In 1980 to 1986, there was a marked increase in the oil supply from non-OPEC nations, which posed a threat to erode the ability of OPEC to control market prices. However, from 1986 to 1988, the efforts never sought to thwart the efficient oil production in order to realize an increase in the oil prices. OPEC was not ready to adhere to the quotas that actually eroded its influence. Thus, it is very complex to assess the success of OPEC through statistical analysis that is a contradiction to the agreed assessments from the participants involved. A study by Gülen (1996) of OPEC’s attributes showed that the organization had been able to strengthen its influence in the global oil market after adopting the 1982 rationing framework. According to Gülen (1996), OPEC had achieved less success in the 1970’s than in the following decades of depression. In addition, OPEC enhanced stability in the oil prices by controlling the prices through maintaining the abrasive pricing quotas policy that assisted in the protection of its future market share as well as the demand (Weinstein & Charnovitz 2001). However, the main argument that results in failures in controlling the market price and fluctuations in the production is through jeopardizing the long-term market prosperity due to its own political fabric. For instance, the membership of the organization is composed predominantly of autocratic national governments. Thus, it has been found that this translated into policies that are determined by short-term gains, coupled with corruption and lack of transparency, hence, curtailing the incentives for the long-term planning and cooperation.

OPEC has made efforts to guide stability in the oil price through a new focus that targets petroleum inventories in the industrialized countries (Weinstein & Charnovitz 2001). According to Yergin (1992), the excess production of oil fell sharply in 2002 with consequent implications for the future supply shocks. The excess production fell sharply from over 6mbd in mid-2002 to 1mbd by 2004-5, with consequent implications for future supply shocks (Yergin 1992). The organization strives to control oil prices directly through production quotas. For instance, it has managed to impose a production quota of approximately 28 million barrels of crude oil on a daily basis. Thus, crude oil represents just 25% of oil products in most industrialized countries. Taxes mostly influence oil products in most countries than what is charged by OPEC for crude. When the oil taxes are increased, consumers often blame the producers, but the real problem emanates from the governments who are responsible for the increased oil prices. 

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