The Organization of the Petroleum Exporting Countries (OPEC) was formed in 1960 to co-ordinate economic policies related to oil among member nations, which spend billions of dollars investing in drilling platforms, pipelines, storage terminals, shipping, and refineries in order to extract and export crude petroleum.
Because oil is the primary revenue generator for these countries, they have a collective interest in ensuring that prices are stable and that global energy demands are steady. However, supply and demand trends have provided both opportunities and challenges for OPEC, new resources add competing production outputs and ever-increasing demand places limits on the division of those resources. Additionally, concerns over oil prices and global warming are spurring investments and development of alternative fuel sources.
In this article, we'll take a look at OPEC, its role in the world economy and how it affects consumers and investors. (Don't believe the water-cooler talk - big oil companies aren't to blame for high prices. Read more in Why You Can't Influence Gas Prices.)
History of OPEC
OPEC was formed on September 14, 1960, by five founding members: Iraq, Iran, Kuwait, Saudi Arabia and Venezuela. As of 2009, eight additional members have been added, including Algeria, Angola, Ecuador, Gabon, Indonesia, Libya, Nigeria, Qatar and United Arab Emirates. Gabon and Ecuador have both at some point suspended their memberships, but both have later rejoined. Indonesia announced a temporary suspension of its membership at the end of 2016.
The organization typically meets twice a year, and maintains its headquarters in Vienna, Austria. Its stated objectives are:
— to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers;
— an efficient, economic and regular supply of petroleum to consuming nations;
—and a fair return on capital to those investing in the industry
OPEC was formed to manage and stabilize the economic and geopolitical landscape in the Middle East as well as the vast global energy markets. By far, oil is the main marketable commodity and revenue generator for member nations. With most of the members' income tied to a single commodity - in other words, all eggs in one basket - their citizens are largely dependent on government programs funded by these petrodollars; programs such as education, healthcare, economic initiatives, infrastructure, employment and defense. Thus, members assess energy market fundamentals and supply and demand scenarios. Such analysis then contribute to the raising or lowering of oil production quotas. If members deem price to be too low, they cut back on production in order to raise the price of oil. Alternatively, if they consider the price of oil to be too high (which can reduce both the short-term and long-term demand for oil, and also ripen conditions for alternative sources of fuel), then they can increase production. (For related reading, see A Guide To Investing In Oil Markets.)
The oil producers of OPEC invest billions of dollars in exploration and production activities - in drilling activities, pipelines, storage and transportation, refining and staffing. These investments take place up front, and successfully harvesting a new oil field can typically take between three to 10 years. Thus, member countries want to ensure that they receive sufficient returns on their capital. They are most comfortable with stable demand for oil without big fluctuations in prices. (To learn about investing here, see Unearth Profits In Oil Exploration And Production.)
Oil Embargo and Western Response
During the 1970s, criticism of OPEC became more widespread, and the organization came to be viewed as a monopolistic cartel in many circles. The organization triggered high inflation and low fuel supplies around the world by imposing oil embargoes in 1973.
Member countries ceased providing oil to the United States, Western Europe and Japan for their support of Israel in its military conflict with Egypt, Iraq and Syria. The embargo resulted in drastically higher oil prices in the West; nervous investors pulled capital out of the U.S. markets, resulting in big losses at the New York Stock Exchange. Inflation ensued and gasoline rationing practices were enforced. OPEC eventually restored oil production and exports to the West, however, the 1973 crisis had lingering negative effects on international relations. In response to the crisis, the West attempted to curtail its dependence on OPEC and stepped up efforts in offshore oil production, particularly in the Gulf of Mexico and the North Sea. In the 1980s, overproduction worldwide combined with reduced demand, resulting in a significant drop in oil prices. (For more about this period in economic history, see Stagflation, 1970s Style.)
Contemporary Role and Trends
Over the years, billions of dollars in new investments and new discoveries in locations such as the Gulf of Mexico, the North Sea and Russia have somewhat diminished OPEC's control over global oil prices. The continuing extraction of petroleum from offshore drilling, advances in drilling technology and the emergence of Russia as an oil exporter have brought fresh sources of crude oil, and the latter is continuing to mark its territory and power. Currently, the oil prices are notably low, hovering around $50 per barrel (about one third of the peak in June, 2008).
In recent years the price of crude oil — and the energy market — have been rather volatile. In 2016, there was a price crash due to uninhibited production by OPEC members when the quota system was abandoned. Later in the year the members agreed to cut production in order to regain control,the deal was recently extended to be valid through the end of 2018.
As many experts advocate the "peak oil" theory — that oil production has peaked worldwide — many investment groups, companies and governments are increasing funding and the development of various means of alternative fuel sources, including wind, solar, nuclear, hydrogen,and coal. While OPEC has raked in hundreds of billions of dollars in oil profits in the 2000s (when the price of oil skyrocketed), member countries are seeing a lot of long-term risk to their rainmaking commodity investment and cash cow.
OPEC's decisions over the years have had considerable influence on worldwide oil prices. However, it is also in OPEC's collective interest to ensure that prices remain "reasonable" to consumers. Otherwise, they merely provide massive incentives to the market to generate alternative products for energy-consuming masses. Oil is increasingly coming up against some heavy opposition, as the harmful effects that carbon dioxide is believed to have on the environment, particularly as a contributor to global warming, are providing added incentive for policymakers, institutions and citizens to rapidly deploy non-oil sources of energy.