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What is OPEC and how it influences the Oil Price

Energy/oil is to the economy, what blood is to our body. Our life would come to a standstill without energy in the form of oil, coal, electricity etc. which runs every industry and every utility device in our modern technology driven life. Obviously then any increase in the world oil prices trickles down to each and every part of the economy causing inflation in every sector. Oil policies form an important part of national policy making in all oil consuming countries. Some countries provide subsidy on oil and petroleum products to promote domestic industries and check inflation, whereas some countries impose tax on oil consumption to check demand and conserve. Economies all over the world constantly monitor the oil price movements.

It is generally believed that OPEC (Organisation of Petroleum Exporting Countries), which has the largest oil reserves in the world is responsible for all the supply and prices of petroleum products. To some extent this is true, and therefore it is interesting to know more about the mighty OPEC and its functioning.

What is OPEC

OPEC (Organisation of Petroleum Exporting Countries) is a permanent intergovernmental organisation which currently has 12 oil producing and exporting countries, as members. Spread across three continents,America, Asia and Africa, the 12 member nations of OPEC are – Algeria, Angola, Ecuador, the Islamic Republic of Iran, Iraq, Kuwait,the Socialist People’s Libyan Arab Jamahiriya, Nigeria, Qatar, Saudi Arabia, UAE and Venezuela. Oil is the main internationally marketable commodity of all these countries.

OPEC was formed on September 14, 1960 in Baghdad, Iraq, with five founder members – Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. OPEC was registered with the United Nations Secretariat on November 6,1962.

Objectives of OPEC

  • To c-ordinate & unify the petroleum policies of the member countries and to determine the best means for safeguarding their individual and collective interests.
  • To seek ways and means of ensuring the stabilization of prices in international oil markets, with a view to eliminating harmful and unnecessary fluctuation; and
  • To provide an efficient, economic and regular supply of petroleum to consuming nations and a fair return on capital to those investing in the petroleum industry.

Functioning of OPEC

As stated in the objectives the OPEC countries work together to ensure supply of petroleum to the consuming nations and strives to maintain stable world oil prices by regulating supply according to the market demand.

Representatives of the OPEC member countries meet at the OPEC Conference to co-ordinate and unify their petroleum policies in order to promote stability and harmony in the oil market. The Conference is the supreme authority of the organisation. It consists of delegations headed by the minister of oil, mines & energy of the member countries. The conference generally meets twice a year in March and September and in extraordinary sessions whenever required. It is responsible for formulation and implementation of policies for the member countries.

Oil price and OPEC

OPEC members determine the oil price based on OPEC basket.The OPEC basket is a weighted average of oil prices collected from various oil producing countries. This average is determined according to the production and exports of each country and is used as reference point by OPEC to monitor worldwide oil market condition.

OPEC’s petroleum production and reserves- In 1960, the five founding members of OPEC held a total of 200 billion barrels of reserves (2/3 of the world oil reserves) and supplied an average of 8 million barrels per day of crude to world markets representing more than 1/3 of the total world production. Today 50 years later OPEC reserves have increased to 1 trillion barrels and its daily production is 29 million barrels per day. At the end of 2009, OPEC had proven oil reserves of 1,064,288 million barrels of crude oil, representing 79.6% of the world’s total.

How does OPEC affect oil prices

OPEC member countries produce about 42% of the world’s crude oil and 18% of its natural gas. OPEC’s crude oil exports represent a significant 58% of the crude oil traded internationally. Therefore, OPEC has a significant influence on world oil markets.

Another fact that significantly strengthens the OPEC’s position is the fact that among all the world’s oil producing nations only OPEC nations have a significant spare oil production capacity. Because they have around 80% of the world’s oil reserves, they can expand oil production when demand increases. OPEC member countries respond to market fundamentals and forecast developments by co-ordinating thier petroleum policies. If demand grows or some producers are producing less oil, OPEC can increase its oil production in order to prevent a sudden rise in prices. It can also reduce production in response to market conditions.

But increasing oil production is not a simple procedure. In order to expand their output the member countries need to be sure that the oil industry will continue to be profitable. Oil producers invest billions of dollars in explorations and infrastructures. A new field can take 3 to 10 years to locate and develop. Sometimes when it is not used or used less than capacity for a long period, the plant may suffer irrepairable damage. It is also difficult and a colossal loss if a plant in the middle of the ocean has to be shut due to lack of demand. If oil producers do not invest enough money and do it far enough in advance, then the world could face a shortage of oil supplies in future.

From the early 1970s to the mid 1980s, the OPEC did set crude oil prices. It is not so today. The price of crude oil is affected by movements of three major international petroleum exchanges – the New York Mercantile Exchange (NYMEX), the International Petroleum Exchange in London (IPE) and the Singapore International Monetary Exchange (SIMEX). International Energy Agency (IEA) of Paris and US Energy Information Administration (EIA) are also important players.The spot and future trading in these affect the oil prices.

Even though today OPEC is not entirely responsible for oil prices, OPEC member countries do voluntarily restrain their crude oil production in order to stabilize the oil market. Sometimes it does so to maintain profits so as to maintain the member countries’ economic growth. This may happen when these countries, whose sole earning is from oil exports, suffer losses due to sluggish demand caused by restrictions like taxes on oil import & consumption.

Security of oil supplies relies on security of oil demand. The year 2008-09 were the first time since 1981 when global oil demand declined in two successive years due to global recession. Demand fell by 1.8 million barrels per day and the price of a barrel of crude lost almost 100 $ in less than 6 months from mid 2008, resulting in unused production capacity.

Some facts

  • Global oil demand for 2010 and 2011 is fore-casted to be higher owing to the global economic recovery resulting in stronger GDP assumptions.
  • World demand for oil which was 85 million barrel/day in 2009, will be 86.6 million barrel/day in 2010 and 87.9million barrel/day in 2011.
  • World crude oil prices went up from $ 71.72 per barrel on July 9, 2010 to $ 76.77 per barrel on August 13, 2010.
  • It is fore-casted to be $ 81 per barrel in the forth quarter of 2010 and $ 84 per barrel in 2011.

Prices are fore-casted to rise due to global economic recovery (leading to increased oil demand), and slower growth in non-OPEC oil supply and continuous production restraint by members of OPEC.

Despite environmental concerns and various conservation policies, the energy demand is bound to grow due to economic growth, expanding population and higher standards of living. Energy growth can be expected to grow by more than 40% by 2030. Fossil fuels, oil and natural gas will continue to meet most of the world’s energy needs and thus OPEC having the maximum oil reserves will remain the leading player in the world oil scenario.

(References: Oil Market Report (OMR) Public Website of International Energy Agency,OPEC Website.)

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