The nearly 50% decline in oil prices questions the future of the Organization of the Petroleum Exporting Countries (OPEC) and casts doubt on its ability to influence prices. However, the role of OPEC has historically been overplayed, and the latest tumult is merely further evidence of the group’s weakness.
Formed in 1960 “to coordinate and unify petroleum policies” and offset the influence of major multinational oil companies, OPEC enjoyed the peak of its geopolitical influence in 1973 when it cut production and stopped shipments to the U.S. and countries supporting Israel in the Yom Kippur War.
Yet, the impact of the embargo was amplified by bad U.S. energy policies. Rather than OPEC, inappropriate schemes such as price controls and Congress’s allocation of oil to various regions and industrial sectors were the primary drivers of the disruption.
Ironically, OPEC’s most influential moment inspired changes in Western energy policy that have eroded the group’s power. A combination of smarter U.S. domestic energy policies, increased investment in alternative energy, improvements in energy efficiency, and innovation in oil technology outside of OPEC regions has boosted the West’s independence from the organization.
The frailty of OPEC and its changing roles were evident long before the recent jump in North American production. After surviving the price slump of the mid-1980s, OPEC had a difficult time in the following decade when weak demand growth and large spare capacity limited its ability to collude. An inability to punish members that refused to adhere to quotas was clearly exposed.
The group regained some footing from 2000 to 2008 as rising prices provided an environment more conducive to collusion. However, even during this time, OPEC was largely a residual supplier, adjusting its output at market prices rather than acting as a price setter.
Importantly, since the financial crisis, Saudi Arabia has taken on a more commanding role, which has been particularly apparent in recent months. OPEC is most effective when limiting supplies, but that option has been put aside by Saudi Arabia’s decision to battle for market share.
At its November 27 meeting, OPEC surprised markets by agreeing to maintain its production target at 30 million barrels a day. The group’s reasoning behind the move was that the lower prices will force U.S. drillers to cut output as their business models become unsustainable.
The decision, driven by Saudi Arabia, was likely unpopular with other OPEC members. Yet in challenging times, national interest takes precedence.
Saudi Arabia has about 85% of global spare production capacity, with an estimated 1.5 to 2 million barrels per day of spare capacity on hand to aid it in the market share battle. Conversely, other members have limited ability to cut exports and lack the cohesion to reduce supplies in the face of Saudi Arabia’s opposing intentions.
The loss of market share and price decline of the mid-1980s was particularly costly to Saudi Arabia, and the Kingdom seems to have no intention of remaining passive in the current environment. Its ambitions marginalize other OPEC members, and highlight the fickleness of the group’s solidarity. OPEC’s influence has often been exaggerated and recent events may prove to be the catalyst for the group’s decline of influence.