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News of OPEC’s demise has been much exaggerated: Kemp

LONDON, Dec 3 – The Organization of the Petroleum Exporting Countries (OPEC) last week made no change to its production target despite a 40 percent slide in oil prices over just five months, causing some commentators to pronounce the cartel irrelevant.

If OPEC cannot act to defend the prices and revenues of its member countries, does the organization still serve any purpose?

There is an assumption among some commentators that OPEC is only relevant and working if ministers can reach a production agreement in response to shifts in prices, and that strong disagreement is a sign of dysfunction.

But the record suggests that ambitious production-cutting agreements are rare, rather than the norm, and that a robust exchange of views is typical.

There is nothing new about predicting the end of OPEC. Following one particularly acrimonious meeting in 1981, the Kuwaiti oil minister told waiting journalists: “News of OPEC’s death has been much exaggerated.” A third of a century later, the organization is still going.

OPEC has always had fierce foes eager to forecast its demise, especially in the United States, where there are still memories about the Arab oil embargo, gasoline lines and soaring fuel prices in the 1970s.

Bitter recollections of the oil crisis merge with Watergate, defeat in Vietnam, the Soviet invasion of Afghanistan and the Iranian hostage crisis to make the 1970s the most humiliating decade in U.S. history.

Little wonder, then, that some hawkish U.S. commentators, eager to ensure it never happens again, have developed a narrative in which home grown shale has finally ended the embarrassing dependence on foreign oil and ended OPEC’s dominance of the market.

But is it true? Has OPEC finally become irrelevant almost exactly four decades after it burst into the popular imagination during the first oil shock in 1973?

Related: Time to help America’s oil industry compete with OPEC

A STRANGE SORT OF CARTEL

OPEC members object to the organization being labeled a “cartel” but there is no doubt OPEC has many cartel-like features.

OPEC’s founding statute, agreed in Baghdad in 1960, commits the organization, among other things, to coordinate and unify member states’ oil policies, stabilize prices and secure a steady income for producing countries. That certainly sounds like a cartel.

If OPEC has aspired to be a cartel, however, it has always been a very strange one. The classic textbook cartel is a group of producers that control production and investment, and sometimes allocate customers and limit competition, to secure higher prices and greater returns than under competitive conditions. OPEC has never really done any of these things.

OPEC’s members have always competed fiercely with one another to sell their crude to customers, at times offering secret deals and discounts to retain market share. There has never been an agreement to allocate customers or limit price competition.

OPEC has never agreed on investment and future production. Most members, including Saudi Arabia, Iran and Iraq treat information about exploration, reserves and investment as state secrets and refuse to disclose them to one another let alone outsiders.

Even on production, OPEC has only tried to reach agreement intermittently. For more than 20 years after the organization was founded, it was concerned mostly with prices, taxes and nationalization. It did not have any targets for production at all.

The first production allocations were introduced only in April 1982 and they continued to be periodically revised until November 2006.

Since then, the organization has set an overall target but has been unable to agree on how it should be allocated among the member countries.

Even when the organization actually had country-level allocations, most of the time they were ignored. Most members produced as much as they were able.

THE PROBLEM OF NON-MEMBERS

If OPEC has tried at times to behave like a cartel, it has never been able to control anything like the whole market.

OPEC’s share of global oil production peaked at 51 percent in 1973 (which coincided with the height of its power). For most of the last four decades, however, the organization has accounted for 40 percent or less of global output.

OPEC’s problem has always been its inability to restrain production by non-members. Sustained price rises have generally brought a boom in non-OPEC exploration and production, reducing the organization’s market share.

In the 1970s and 1980s, the surge in non-OPEC supplies came from the North Sea, Alaska, the Gulf of Mexico, the Soviet Union and China. In the 2010s, it has come from U.S. shale formations.

OPEC has never had much success persuading non-members to restrain their output to ensure higher prices and better revenues for all members and non-members alike.

It has not been for want of trying. In the mid-1980s, Saudi Arabia lobbied Britain and Norway to limit output from the North Sea and maintain prices, but was rebuffed (though not before Mrs Thatcher’s famously free-market government had flirted with price fixing in a series of secret meetings).

In the 2010s, there is simply no question of reaching an agreement with U.S. shale producers because it would be prohibited by antitrust law.

THREE INSTANCES OF SUCCESS

OPEC has only coordinated its members’ production policies successfully on three occasions: 1986, 1998 and 2008.

In each case, the organization’s members agreed to cut output in response to a plunge in prices caused by soft demand (1986, 1998 and 2008) and strong growth in alternative supplies (1986).

It is worth noting the organization has been more successful in responding to periods of demand weakness (which are generally thought to be temporary) than supply growth (which poses a longer-term structural challenge of how to split declining market share).

Two of the three instances of successful coordination came in response to weakness in demand (1998 and 2008). Only one instance of coordination came in response to the problem of rival supply (1986).

But theses three instances of output coordination were relatively fleeting; most of the time, members have produced and sold as much oil as they are able.

OPEC has not deliberately restrained output for most of the last 40 years. There is no question Iran, Iraq, Nigeria, Venezuela, Libya and Nigeria would all like to produce and sell more oil if they could. Between them, these six countries are actually producing 1.5 million barrels per day less than they did in 1974, according to the BP Statistical Review of World Energy.

If total OPEC output has been constrained, the constraints have been involuntary: due to civil conflict (Iran’s revolution, Nigeria’s instability), war (Iran-Iraq, U.S.-Iraq twice), sanctions (Iran, Iraq, Libya) and expropriation (Venezuela, Iran, Libya).

If OPEC has sometimes appeared to wield enormous power, as when members agreed a series of staggering price rises during the 1970s, it was because external circumstances were unusually favorable rather than because the organization’s members discovered exceptional discipline.

Even in the supposed hey-days of the 1970s and early 1980s, ministerial meetings were riven by prolonged and bitter disagreements over pricing and strategy.

Meetings often lasted for a week or more and sometimes broke up without agreement. On at least three occasions, the veteran Saudi Oil Minister Zaki Yamani walked out either in protest, to seek further instructions or to find a working telephone (“Yamani: the inside story” 1988).

OPEC AS INSTITUTIONAL SURVIVOR

There is no question that the shale revolution has tipped the balance of power in the oil market by opening up vast new resources (just as the North Sea did in the 1980s).

But OPEC is as relevant today as it has ever been throughout its 54-year history. That is to say, it is far less powerful than its enemies and detractors fear but it is far from being irrelevant.

OPEC members still hold a large chunk of the world’s known oil reserves so their ability and willingness to produce them will continue to have a big impact on prices.

Like a host of other international bodies, including the North Atlantic Treaty Organization and the International Monetary Fund, OPEC as an institution sometimes appears to have outlived its original purpose.

But if it did not exist, most member countries would still want to discuss oil market issues with one another. If OPEC did not exist, it would be necessary to invent another organization much like it.

Crucially, OPEC provides a framework in which countries dependent on oil for exports and government revenues can exchange views and discuss common problems.

OPEC has become a part of the “international furniture.” It facilitates dialog, helps educate officials and ministers from some of the less-advanced members, collects statistics, provides useful analysis of market trends, and provides a counterpoint to the perspective of the International Energy Agency, which represents the interests of consuming countries.

And from time to time, when the circumstances are right, it is a forum in which to allocate production cuts. It has served that purpose in the past, and may do so again in future – just not right now.

 

(Editing by William Hardy)

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