OPEC survived the recent Middle East crisis, but the road ahead is still tortuous
With the outbreak of hostilities between Iraq and Kuwait in August 1990, some 4.5 million barrels a day (mb/d) of crude oil were withdrawn from the market, and the world’s fragile oil balance was threatened for the third time in less than two decades. Coming on the heels of a tenuous ceasefire between Iran and Iraq, the new turmoil threatened the survival of the Organization of Petroleum Exporting Countries (OPEC) and raised questions about the organization’s ability to function in the aftermath of a crisis involving four of its five founding members. Suggestions were made by OPEC’s opponents to put the organization once and for all out of business. Strategies included trying to convince Saudi Arabia to leave the cartel, encouraging non-Mideast members to withdraw from the organization, and asking the US Congress to impose a tariff on imported oil.
As it turned out, OPEC managed to survive the internecine war and rebuff the new threats to its existence. But it must still contend with some of the internal frictions and many of the external challenges that the group faced before August 1990. It must also deal with the problems that continue to unsettle the global oil market—supply security for the oil importers, fair incomes for the producers, and price stability for all—under the so-called “new oil order.” This article looks at the characteristics of this new order against the background of the latest oil crisis and examines the role that OPEC can be expected to play.
The third oil crisis
The turn of events began in the first quarter of 1990, when OPEC was producing an eight-year high of about 24 mb/d against its own self-imposed ceiling of 22 mb/d. The excess supply put strong downward pressure on world oil prices and threatened postwar reconstruction efforts in the area. By June, the price of OPEC crude had fallen to $14 a barrel from around $18-$20 a barrel at the beginning of the year, with two small members of the Gulf Cooperation Council taking most of the blame. To deal with quota violations and to ward off the threat of a possible military conflict, a new accord was reached in late July 1990 among all 13 OPEC members. It called for an output ceiling of 22.5 mb/d and a target price of $21 a barrel (up from $18). Although the new target was much higher than the $14-$15.5 a barrel prevailing in the world market, it was, in real terms, still the lowest since 1972.
Nevertheless, war erupted for reasons that had very little to do with quotas or prices, as oil prices were already on the way to recovery. Suddenly, OPEC was faced with a different dilemma: how to avoid a repetition of the 1973-74 and 1979-80 experiences, when an oil price explosion was followed by falling demand and plummeting prices. After a few days of intense consultations, the group decided in late August to suspend output quotas and authorize members to pump all the crude they could. Even so, the benchmark oil price in New York shot up to more than $41 a barrel in early October, largely reflecting a fear of potential supply disruptions rather than an actual crunch. OPEC itself (without Kuwait and Iraq) had 3-3.5 mb/d of excess capacity, which was tapped almost immediately. Moreover, total stockpiles of major consuming countries were at an eight-year high, equal to nearly 100 days of consumption.
Early in 1991, the oil market did another dramatic turnaround. With increased OPEC production and the psychologically effective decision by the International Energy Agency to release as much as 2.5 mb/d from strategic reserves if necessary, a new glut developed. Crude prices collapsed to the pre-crisis level for the OPEC basket in early February 1991. For the third time in 18 years, a less than 9 percent drop in world oil supply had resulted in a more than 200 percent rise in the oil price within 60 days, followed by a drop of 52 percent in half a year. Oil price volatility thus remained a fact of life, prompting a new chorus of demand for price stabilization.
The “new oil order”
The oil market that OPEC has faced since the war is shaped by five major developments: (1) a new set of relationships among OPEC members, and between them and non-OPEC producers; (2) a trend toward convergence on oil price strategy within the cartel; (3) the search for new ways to ensure production discipline; (4) a tendency toward fresh accommodations between national oil companies and the multinational oil concerns—the “oil majors;” and (5) renewed calls for a producer/consumer “dialogue.”
New internal and external coalitions. OPEC’s new relationships are reflected in its internal power balance, as well as its external arrangements. Internally, the nearly successful bid by Iraq to alter the organization’s leadership has now been decisively rebuffed. Saudi Arabia has once again become the most influential producer and exporter of crude within OPEC. After six years of renouncing its role as a swing producer, the kingdom may again be obliged to play that role to save the organization’s solidarity. Iraq and Kuwait have lost their previous market shares for the time being and face an uncertain future in terms of both output and sales. And Iran has once again become a strong power broker and an active team player. Externally, the Russian Federation and other oil-producing states of the former USSR, along with members of the Independent Petroleum Exporting Countries (China, Egypt, Malaysia, Mexico, Norway, Oman, and Yemen), have been in regular contact with OPEC members and have shown a growing interest in cooperating with them on matters of mutual concern.
At the same time, a greater resolve has emerged within OPEC to cooperate more, as evidenced by reactions to wartime demands. Faced with a United Nations embargo on Iraqi oil shipments and Kuwait’s almost total incapacitation—a situation that every OPEC member could have taken advantage of—the organization’s delicate cohesion was not breached. Both Venezuela and Saudi Arabia, which were urged by the international community to use their excess capacity to make up for the oil shortage, increased their offtake, but only within the framework of OPEC’s August 1990 resolution. Another example is Saudi Arabia’s uncharacteristic decision in mid-1992 not to propose or press for a higher OPEC output ceiling, despite rising demand for OPEC oil and new pressures on oil prices. This apparent shift from the kingdom’s traditionally restrained price stance is widely interpreted as a gesture of cooperation with other members.
A greater desire within OPEC for price moderation. Stung by the downward trend in real oil prices since 1973 and chastened by the wartime price seesaw, an overwhelming majority of OPEC members now seem to favor keeping the reference price at a reachable level. This means a price target high enough to attract investment in oil exploration and to give members needed revenues, but not high enough to cut oil’s share in the global energy supply or to reduce OPEC’s share in the world petroleum market. Even if one argues that OPEC emerged from the war no less fractious than before, the very fact that it is now dominated by a country with large reserves must ultimately favor more moderate and more stable prices. Also working in this direction is the producers’ growing interest in “downstream” operations (e.g., refining and marketing). The “integrationists” may no longer be interested in merely raising short-term crude prices at the expense of refiners and distributors, if they can gain more in the long run by maximizing profits at the gas pumps and other final outlets.
Stronger enforcement of production discipline. Strict observance of output quotas has nearly always eluded OPEC members and may continue to be a contentious issue in the future, although there are signs that greater efforts are being made to stick to what has been agreed. Mindful of the acrimony that preceded the war, members seem determined not to repeat the mistakes of the past, and indications are that they have so far observed their informal pledge not to raise output. Indeed, the firming up of oil prices in the second quarter of 1992 shows that members have been careful to keep total production not much beyond OPEC’s ceiling. Even so, it is too early to conclude that production discipline will no longer be a problem, as quotas were suspended after the outbreak of hostilities and not reinstated until mid-1992.
A greater willingness to accommodate the “majors.” With the average real price of world crude expected to remain at best in the $21-$27 a barrel range for the rest of this decade and the increasing need for larger revenues by all OPEC members, oil exporters have realized that the only way to enhance their incomes is to sell more oil. This will mean investing in new capacity to boost output by at least 7-8 mb/d, as current excess capacity will probably be wiped out in two to three years. OPEC’s “upstream” investment needs in the next five to seven years are estimated to cost up to $80 billion—not an easy sum to raise in these days of global capital shortages.
Prompted in large part by the desire for external capital and up-to-date technology, many OPEC members have begun to woo the same foreign oil companies that they ousted in the early 1970s—a move that some western analysts refer to as de facto denationalization. For example, Algeria has offered several oil and gas exploration blocks for international bids. Iran has signed an exploration and production agreement with a Japanese oil concern, Japex, for offshore drilling in the Persian Gulf. Venezuela, eager to increase capacity by 1 mb/d in five years, has awarded oil development contracts to a number of foreign companies and has signed a production-sharing agreement with Ashland Oil. Nigeria is allowing British Petroleum to resume its oil search.
But the new arrangements with the oil majors—which the oil exporting countries insist on calling mutually rewarding “joint ventures,” and which are fundamentally different from the old “concessions”—go beyond a mere access to capital. They involve secure export outlets, predictable buy-back prices, and regulated marketing. And although oil and nationalization are still closely linked in many of the countries, the stigma attached to foreign joint ventures is not as strongly felt as before. The majors also have something to gain. For them, it is a chance to obtain guaranteed sources of long-term supplies at prearranged prices.
Renewed demands for a consumer/producer “dialogue.” The advocates of such a dialogue want OPEC and OECD governments to make oil price stability the cornerstone of an international energy policy. They also believe that producers and consumers should work together toward (1) rational capacity expansion to cushion sudden rises in demand; (2) environmental protection through joint research; and (3) efficiency optimization through the transfer and spread of technology. And they insist that the objective is to put an end to the post-1973 boom-and-bust cycles—not to fix prices.
This idea, which was first put forward by OPEC in the mid-1970s, now seems to be resurfacing with a more sophisticated agenda and new supporters. France hosted a consumer/producer conference in June 1991 and Norway held a similar session in July 1992. But to date—not surprisingly—the idea has not found favor with the major oil importing countries, and it has not managed to gain many converts among strict free enterprisers.
Tests to come…
So far, OPEC has been able to successfully deal with the latest oil crisis. It has managed to maintain internal cohesion among its members, despite the war and its aftermath; it has enforced output discipline more effectively than in the past, albeit in a firm market; and it has helped crude prices climb gradually toward the organization’s target. Moreover, new developments since the war seem to have strengthened the group and created a climate where OPEC may be expected to be a more assertive, although more cautious, player. But whether it can play such a role depends on a number of factors, of which a favorable global oil balance and the organization’s internal solidarity are the most significant.
Projections by oil analysts for world petroleum demand during the rest of this decade vary widely, largely because of different assumptions about global economic growth, energy efficiency, and the substitutability of various energy sources. Demand for OPEC oil is further predicated upon oil supplies from non-OPEC sources (particularly the level of net exports from the states of the former USSR).
At this stage, OPEC forecasters expect world gross product outside the former centrally planned economies to grow at an average annual rate of 2.7 percent from 1990-2000, and world oil demand, at 1.1 percent, raising world consumption by nearly 6 mb/d over the ten-year period. With oil output in the United States and Western Europe already on the decline, and oil production in other non-OPEC suppliers expected to remain unchanged, this would mean calling upon OPEC for an extra 7 mb/d by the end of this century. To meet this call, the organization would have to expand its sustainable output capacity to some 32 mb/d from the current 27.5 mb/d. By the end of the decade, the average oil price (in 1990 dollars) would be expected to reach $27 a barrel.
Under these assumptions, OPEC’s growing leverage, if not dominance, in the world petroleum market may be expected. And, despite a minority view to the contrary among OPEC watchers, such an OPEC-friendly scenario could unfold, for the following reasons:
• A price drop into the low teens or below would be harmful for some western oil producing countries with high oil costs per barrel. For them, a low oil price is a double-edged sword: It stimulates growth, lowers inflation, and improves the balance of payments; but it also is likely to spur demand, stifle conservation, disadvantage the domestic oil industry, and increase dependence on imports.
• Several non-OPEC oil-producing countries (notably Norway and Mexico) have shown an increasingly cooperative attitude, willing to cut production to help bolster prices.
• The environmentalist movement, which was expected to undermine OPEC by spearheading a drive away from oil toward “cleaner” sources of energy, may also, ironically, end up working to OPEC’s advantage. With coal and nuclear energy considered environmentally inferior to oil, and the methane emission of gas now judged to be worse than carbon dioxide, a more cleanly refined oil may not be looked at unfavorably. Besides, environmentalists hold that the social cost of ecological damage from hydrocarbon use (air pollution, global warming, and the “greenhouse effect”) must be included in the price of oil at the retail level. Such a “full-cost pricing” of energy (as discussed in the UN Conference on Environment and Development’s “Agenda 21” in Rio de Janeiro in June 1992) clearly rules out a very low price for oil.
To be sure, the forecast of higher oil prices in the mid- to late-1990s will be highly sensitive to such developments as a new move in the OECD countries and elsewhere to reduce oil consumption (e.g., the European Community’s proposed “carbon tax” on gasoline); greater energy efficiency; and unexpected new supplies from non-OPEC sources (particularly some of the states of the former USSR). Any substantial decline in the demand for OPEC oil would undoubtedly be a blow to the group’s influence and clout. By contrast, any rapprochement between producers and consumers would enhance OPEC’s prestige and power.
The issues of internal cohesion and external cooperation are thornier and less predictable. While the lingering conflict over long-term price strategy seems to have lost its significance for the time being, other internal differences remain unresolved. For example, members that invested heavily in new capacity have been resisting giving up their large market shares and will probably insist on establishing a new quota formula based on production capacity (or average daily output) instead of the July 1990 arrangement. At the same time, members in a financial crunch believe the largest exporter should absorb most of the brunt of any future output adjustment. Should Kuwait and Iraq resume their full prewar output before the world demand for OPEC oil reaches 26-27 mb/d, quota allocations would be a nightmare.
On the external side, coordinating production and exports with non-OPEC exporters will be a complicated task. And establishing a regular producer/consumer dialogue—much less an understanding or an accord—will be nothing short of a diplomatic breakthrough. It remains to be seen if the group’s recent experience will enable it to achieve much beyond mere survival.