Abstract
New developments in the Middle East and within OPEC have once again upset the oil market But despite the recent turmoil, long-term fundamentals of the global energy balance remain essentially the same
Back in mid-1986, there was widespread jubilation in major oil consuming countries over the price collapse. The end of the Iran-Iraq war was predicted to turn the 1986 oil glut into a flood, with the oil price seen heading toward a $5 barrel. OPEC’s (the Organization of Petroleum Exporting Countries) relative importance in strategic oil supply calculations was regarded as permanently diminished. The organization’s demise (predicted many times since 1973) was pronounced with more certainty this time. But, as some observers warned at that time (see “Oil Price Turmoil” Finance & Development, June 1986), the situation could change rapidly; and it did.
Several developments in the last four years—before the Iraq-Kuwait conflict—are worth noting. First, annual demand for oil increased worldwide despite a rise in oil prices. Second, crude prices followed an upward trend, albeit at fluctuating rates and still lagging in real terms behind those in 1980. Third, after a decline in the 1980s, OPEC’s share in the global market supply moved up, although still below the 1979 level. Fourth, a spirit of pragmatism within OPEC, and a tacit understanding with some non-OPEC producers, produced a cease-fire in the oil price war. Fifth, OPEC’s annual oil revenues recovered dramatically to nearly double the mid-1980s level, although still only slightly more than half the annual income at the beginning of that decade. Finally, a new “oil balance” emerged, although the basic issues facing major oil consuming nations seem to remain largely the same as before the first oil crisis. It is time now to take a fresh look at the oil market and the changing nature of OPEC.
Recent developments
Changes after mid-1986 and mid-1990 in world oil demand, price, output, market structure, and global balance reflect vastly different crosscurrents. World oil consumption, earlier projected to rise by no more than 1-1½ percent a year, increased more than twice as fast, and is now projected to grow by 1½-2 percent a year for several years, should the oil price remain at around $20 a barrel in constant 1990 dollars. As a result of rising oil demand, crude prices firmed up. Despite periodic forecasts of a durable oil price collapse (the latest in 1988-89), world oil prices rose between 1987 and 1990. Interestingly, while OPEC exports steadily increased by more than 50 percent since their lowest volume in 1985, average crude oil prices also increased in tandem—albeit in a volatile manner. The price rose from a low of $7-8 a barrel in July 1986 to $23.60 in January 1990, then turned back to $13-14 a barrel in late spring, recovered to $18-20 a barrel shortly before the Iraq-Kuwait conflict, and reached $26.50 a barrel on August 6, 1990. Contrary to expectations, the 1988 Iran-Iraq ceasefire had a positive influence on the oil price. In real terms, however, the mid-1990 oil prices still remained lower than they were in 1974.
The global oil supply structure also changed markedly (see table). US domestic oil output has declined steadily in recent years, reaching 7.6 mb/d (million barrels per day) in the first half of 1990—a 26-year low. It is projected by most analysts to fall to 6.4 mb/d in 1995, and 5.8 mb/d by the year 2000—barring new technological breakthroughs and no appreciable rise in the real price of oil. The Soviet Union has also seen its output fall from 12.6 mb/d in 1987 to a low of 11 mb/d in early 1990, with a possible further decline by 1995—without considerable new investments in exploration and drilling. In the likely absence of new Alaskan or North Sea oil discoveries, and excluding a new price explosion, non-OPEC countries as a whole are expected to continue at, or below, their current output levels. Sustainable excess capacity in all these countries is currently no more than 1 mb/d. OPEC’s excess capacity, by contrast, is already three to four times as much, and it is expanding.
In addition to changes in oil consumption and sources of supply after mid-1986, a new change occurred in the attitude toward energy efficiency. Despite some scattered voices of caution, the drive toward energy conservation (and oil substitution) seemed to lose much of its steam. On the conservation side, the ratio of global energy use to growth of world gross product, which was brought down to 0.5 in the early 1980s from 1 in the 1970s, climbed back to 0.75. Regulations on fuel use have been relaxed. Larger motor vehicles and longer automobile trips have become desirable again. On the substitution side, coal, natural gas, nuclear energy, and exotic alternatives have not been able to replace petroleum due to the still relatively low price of oil, the high production costs of alternatives, environmental considerations, safety concerns, or infrastructural requirements.
Changes in the market
By far the most noteworthy developments, however, occurred in the structure of the oil market, with OPEC gaining some lost ground. OPEC began to enjoy an increasingly dominant position as a residual supplier, having developed a new market strategy, new intragroup relationships, and stepped up its search for a larger global oil coalition. The increase in world oil demand since 1986 was met mostly by OPEC members.
A significant trend could be observed in OPEC’s price and marketing strategy. Long considered to be an oil price setter and defender of an official selling price, OPEC began to treat the organization’s official price (e.g., $21 per barrel, set in mid-1990) only as a “reference” target rather than a fixed price to be strictly maintained by mandatory changes in output. The old, unilateral, posting of oil prices was replaced by a complex and interactive process in which OPEC is only one of the major players. Noncontract (spot) sales, oil futures, options, and paper-barrel transactions in New York and London are priced by market forces of demand and supply. OPEC’s influence in both short- and long-term price trends takes different forms. Members’ daily output and sales directly affect prices. Disputes among OPEC members, quota decisions, policy declarations, and even statements by OPEC leaders tend to influence market prices indirectly and often inordinately.
There is, however, an asymmetry on price control. Leading OPEC producers are quite potent in driving oil prices down to low levels almost anytime because they have the capacity to flood the market. But they find it much more difficult, if not impossible, to force prices up by much for an extended period, because their critical dependence on oil revenues keeps them from cutting output to very low levels. Sharp price rises are now often triggered by political events.
Oil supply and demand
(In millions of barrels per day)
Based on a price of $17.50 a barrel, in constant 1988 dollars.
Excluding the Soviet Union, Eastern Europe, and China.
Net exports from nonmarket economies.
Addition or withdrawal from stock, and discrepancies.
Oil supply and demand
(In millions of barrels per day)
| 1979 | 1985 | 1989 | 1995 1 | 2000 1 | |||
|---|---|---|---|---|---|---|---|
| Demand | |||||||
| OECD | 41.6 | 34.1 | 37.3 | 38.9 | 38.9 | ||
| OPEC | 2.7 | 3.6 | 3.9 | 4.0 | 4.2 | ||
| Other2 | 7.9 | 8.8 | 10.6 | 11.9 | 13.4 | ||
| Total | 52.2 | 46.5 | 51.8 | 54.4 | 56.5 | ||
| Supply | |||||||
| OECD | 15.1 | 17.4 | 16.0 | 14.6 | 14.1 | ||
| OPEC | 31.7 | 17.5 | 23.5 | 26.0 | 29.5 | ||
| Other | 5.9 | 9.5 | 9.6 | 10.5 | 10.0 | ||
| NME net3 | 1.1 | 2.0 | 2.1 | 1.9 | 1.5 | ||
| Stock changes4 | 1.6 | 0.1 | 0.6 | 1.4 | 1.4 | ||
| Total | 52.2 | 46.5 | 51.8 | 54.4 | 56.5 | ||
Based on a price of $17.50 a barrel, in constant 1988 dollars.
Excluding the Soviet Union, Eastern Europe, and China.
Net exports from nonmarket economies.
Addition or withdrawal from stock, and discrepancies.
Oil supply and demand
(In millions of barrels per day)
| 1979 | 1985 | 1989 | 1995 1 | 2000 1 | |||
|---|---|---|---|---|---|---|---|
| Demand | |||||||
| OECD | 41.6 | 34.1 | 37.3 | 38.9 | 38.9 | ||
| OPEC | 2.7 | 3.6 | 3.9 | 4.0 | 4.2 | ||
| Other2 | 7.9 | 8.8 | 10.6 | 11.9 | 13.4 | ||
| Total | 52.2 | 46.5 | 51.8 | 54.4 | 56.5 | ||
| Supply | |||||||
| OECD | 15.1 | 17.4 | 16.0 | 14.6 | 14.1 | ||
| OPEC | 31.7 | 17.5 | 23.5 | 26.0 | 29.5 | ||
| Other | 5.9 | 9.5 | 9.6 | 10.5 | 10.0 | ||
| NME net3 | 1.1 | 2.0 | 2.1 | 1.9 | 1.5 | ||
| Stock changes4 | 1.6 | 0.1 | 0.6 | 1.4 | 1.4 | ||
| Total | 52.2 | 46.5 | 51.8 | 54.4 | 56.5 | ||
Based on a price of $17.50 a barrel, in constant 1988 dollars.
Excluding the Soviet Union, Eastern Europe, and China.
Net exports from nonmarket economies.
Addition or withdrawal from stock, and discrepancies.
National price and output strategies within the organization also no longer follow the traditional pattern. For instance, not all large-reserve countries can be counted on to routinely advocate low oil prices; nor do all low-reserve members uniformly favor drastic production cuts, or a stiff price rise. The one thing all members seem to prefer is relative price stability because uncertainties with regard to future oil revenues play havoc with their domestic planning and budgeting operations.
Another aspect of OPEC’s market strategy is a move toward a new relationship with the major multinational oil companies (“majors”). Joint ventures for “downstream” operations (distribution, sales, etc.), new oil exploration, and addition to capacity have been set up between national oil companies and the major multinational oil companies by Abu Dhabi, Libya, Nigeria, Saudi Arabia, and Venezuela. These joint ventures reflect a near-perfect marriage of convenience. The oil “majors” are anxious to replenish their own dwindling supplies of crude oil at home with supplies from secure overseas sources. On their part, OPEC members need venture capital and modern technology to increase their productive capacity—estimated at $60 billion for an addition of 6 mb/d; they also want to acquire reliable outlets within consuming countries for their exports.
Changes within OPEC
Prior to the Iraq-Kuwait conflict, OPEC’s internal relationships reflected new realities. Despite occasional open rifts, public confrontation, and periodic breakdowns of discipline among members, OPEC’s stance was increasingly guided by five lessons learned in the past few years:
• Attempts to raise market shares of members through discounts were found to be a losing proposition. (A 55 percent increase in oil exports by one member, because of price cuts, reportedly netted its treasury 20 percent less revenue.)
• A deliberate low-price policy on the part of large-reserve members to drive off marginal producers was seen as a double-edged sword: while inefficient foreign suppliers might indeed be driven off the market, the revenues of the large-reserve countries would be smaller, domestic development outlays would be jeopardized, public opposition would be encouraged, friendly coproducers would be antagonized, and foreign governments would be enticed to impose an oil import fee in order to protect domestic producers. OPEC’s lost revenue in the 1986 price war exceeded $50 billion, according to one estimate.
• Low-revenue members had come to realize that an overly rapid rise in oil prices would lead to increased oil supplies, emergence of alternative fuels, conservation efforts on the part of consumers, endless friction over output quotas, and macromanagement problems at home.
• Almost all members reached the conclusion that their individual and collective survival depended on self-discipline in adhering closely to OPEC agreements on prices and production. The recalcitrants misjudged the consequences of their behavior.
• Finally, OPEC as a whole was able to do what it was originally created to achieve: find a mutually acceptable position out of divergent members’ interests, while preserving its collective solidarity against many odds.
Three other developments are also of interest. First, although officially OPEC had no “swing producer” after 1985 when Saudi Arabia declined that responsibility, an informal buffer existed at all times as some members chose to stick close to their assigned quotas and let other members take advantage of increased demand (and export beyond their production limits). This “tolerance,” however, proved to have its limits for some members, as subsequent events showed.
Second, bargaining on quota allocation became more politicized than before. In addition to the traditional criteria, such as capital needs, size of population, proven reserves, and output capacity for claiming production quotas, members sought relative ranking in the 13-member line-up on the basis of national political and prestige considerations.
Third, there were attempts by some OPEC members to elicit formal or informal cooperation from other Third World oil exporters such as Angola, China, Colombia, Egypt, Malaysia, Mexico, and Oman to stabilize the oil markets. At an unprecedented joint meeting of those two groups in April 1988, attended also by two sympathetic Western observers from Norway and the Texas Railroad Commission, a 5 percent cut in output by both groups was proposed in order to support sagging oil prices. Although the idea of a joint production cut collapsed, some non-OPEC producers seem to have shown substantial restraint in their subsequent export policies.
The new “oil balance”
The foregoing changes in oil demand, price setting, output shares, and OPEC’s stance have set the stage for the “oil balance” in this decade, and perhaps beyond. According to data published by the UN World Economic Survey, OPEC currently holds some 77 percent of the world’s proven oil reserves of over a trillion barrels, and supplies nearly 47 percent of the world’s annual oil needs outside Eastern Europe, China, and the Soviet Union. Further, OPEC members are the only oil producers with the capacity to substantially increase output as well as the potential for new discoveries of premium low-cost oil. Saudi Arabia and Iraq are already reporting large newly found reserves of high quality oil. Seven other OPEC members also have revised their reserve figures upward, and are expected to join these two countries in increasing their combined output capacity for a total of 5-6 mb/d by the mid-1990s. Despite Mexico’s encouraging prospects, and promising new discoveries in Yemen and Syria—all non-OPEC producers—significant future increases in oil consumption will have to be met by OPEC sources, unless recent oil price increases should continue for some time.
Even with no appreciable increase in oil demand in the coming years, most analysts believe OPEC would still account for as much as 50 percent of global crude oil supply by the year 2000. OPEC is already heavily involved in other aspects of the oil industry. According to the Petroleum Intelligence Weekly, a New York-based newsletter, four of the ten largest international oil companies in terms of combined reserves, output, sales, and refining capacity, are fully owned by OPEC members.
The effects of the growing strength of OPEC on future oil prices and supplies will depend on the outcome of a set of countervailing forces at work in the global oil market. Factors that might lead to higher crude prices include: (1) the exhaustion of OPEC’s present excess capacity (probably in two to three years) without new additional facilities, substantial new finds elsewhere, or more efficient extraction methods; (2) a return to the de facto truce among OPEC members until additional demands for OPEC oil eliminate the need for bargaining over production quotas; (3) greater homogeneity of interests and outlook among leading Middle Eastern members and Venezuela due to a gradual shrinkage of membership and the departure of low reserve members within the next few years; and (4) a dramatic increase in the concentration of power within OPEC, or other unforeseen major causes of supply interruptions.
Factors that would tend to hold down price increases include: (1) a severe and protracted worldwide recession; (2) accelerated search for new non-OPEC oil to increase supply; (3) a judicious management of strategic oil reserves in the consuming countries; (4) technological advances in reducing the cost of oil and gas exploration, and production of alternative energy sources; (5) a comprehensive worldwide effort to conserve energy; and (6) OPEC’s own involvement in joint ventures and downstream operations in the consuming countries.
Projections of the real price of oil by the year 2000 vary widely, from $28 to $41 per barrel (in current dollars). The net result of the interaction of the above-mentioned forces seems to warrant three reasonably safe conclusions. First, thanks to the more than four billion barrels of crude oil stored in underground salt domes, tanks, pipelines, tankers, and other storage facilities, the possibility of a new oil shock reminiscent of 1973 and 1979, for all practical purposes, no longer exists—at least in the OECD countries. Available strategic reserves are enough to meet the OECD’s oil needs for 60-90 days at current consumption rates. The large Western storage, if properly managed, can also serve as an equilibrating force on oil prices through periodic draw-downs and replenishment.
Second, investment in oil exploration and drilling in US offshore fields, the Soviet Union’s Siberian and Caspian Sea regions, the North Sea, and parts of the developing world (in addition to OPEC’s own capacity expansion) will be a good hedge against future oil shocks. So too will a faster development of alternative fuels. An equally effective strategy—particularly in the face of fast rising oil demand in Southeast Asia, other parts of the Third World, and Eastern Europe—would be to renew endeavors to increase energy efficiency.
Third, and perhaps most significantly, sustained high oil prices of the 1973 or 1979 magnitudes will be unlikely because the lessons learned in those events cannot be easily forgotten. The majority of OPEC and non-OPEC governments now see advancement of their long-term economic interests in meeting the consumers’ needs at affordable prices. They know that a high oil price (or an oil embargo) is a recipe for the eventual loss of market share. Major consuming nations, in turn, have realized that an oil price that is too low now is a harbinger of higher prices later.
Unchanged basic issues
Surprising as it may seem, after the passage of 17 years since the first oil crisis, the original issues and equations remain essentially the same. Excluding some sort of accommodation with major oil exporters, major oil importing countries are still faced with the same realities. They have to adopt a comprehensive domestic energy policy to reduce consumption and increase fuel efficiency, and they must embark on serious efforts to develop alternative, renewable, energy sources.