What is OPEC? | An Overview and Implications on Crude Oil

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In international news, crude oil is often a central tenet of headlines and discussions due to its ubiquitous demand and volatile price environments. Price dynamics change based on the basic supply and demand fundamentals associated with how much oil is needed in the marketplace and the amount of crude oil that is mobilized by producers. The narratives surrounding these price drivers span the scope of trade, domestic policies, environmental effects, and all key players in production and consumption.

 The supply side of the equation has historically focused on the actions of a few large players – namely a cohort of oil-exporting countries: the Organization of Petroleum Exporting Countries (OPEC).

What is the Purpose of OPEC? A Definition

The Organization of Petroleum Exporting Countries is a cartel that unites under one common goal: maintain and stabilize international crude oil prices.

OPEC provides nearly one-third of the world’s oil, which makes even slight changes to their collective output more notable than most other exporters. Since their inaugural meeting in Baghdad in 1960, OPEC maintains a mission to “coordinate and unify the petroleum policies of its Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry.” 

Balance is key and maintaining a profitable price point without over-restricting the marketplace remains the organization’s main goal.

Founding members Iraq, Kuwait, Iran, Saudi Arabia, and Venezuela created OPEC to monitor the prices and balance of the oil market. Prior to this, these price dynamics were previously determined by a series of US-dominated multinational oil companies. Including additional allied stakeholders like Russia, OPEC now includes over 18 countries, supplying over one-third of the world’s crude oil production and controlling more than 80 percent of the world’s proven crude oil reserves.

a chart depicting the production levels of all OPEC members including Algeria, Angola, Conco, Ecuador, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, United Arab Emirates, and Venezuela.
OPEC production totals are currently dominated by Saudi Arabia and Iraq, with disruptions in Venezuela and Iran marking much lower output than has historically been seen in those member countries.

Today, these representatives meet twice a year in Vienna, Austria, where they collectively decide whether to raise or lower oil output to maintain a stable market. Such manipulation of supply has historically been an effective means of oil price control for the cartel. But this is changing in today’s US-centric oil market.

What Role do OPEC decisions Play? 

OPEC’s supply decisions could be viewed as either a mechanism to secure consistent oil supply or as a method to maintain prices at a profitable level for their organization. Regardless, it’s also important to view the larger story of production and consumption worldwide when evaluating the organization’s historical impact. 

With more than three-quarters of the world’s proven oil reserves controlled by member nations, OPEC has historically modulated prices with the knowledge that most countries could neither compete with its abundant oil reserves nor create a competitively viable energy alternative. Because of this, a cyclical market dynamic naturally develops.

When worldwide oil supply outweighs demand, the cartel is more likely to consider curtailing production. Conversely, in a tighter oil market where supply and demand are closer to equilibrium, their satisfaction with prices makes intervention less likely.

An Evolution of OPEC\’s Influence on Price Dynamics

Increasing Relevance of Non-OPEC Players

In the years of economic expansion that characterized the early 2000’s, this was an effective method of price stabilization. Large global economies like the US and China expanded and increased demand sending oil prices toward highs near USD $140.00 per barrel. 

A side effect of these high prices, however, was that it also made it profitable for non-OPEC countries to develop and test new ways of exploring and extracting oil at home. This prompted the US to develop new shale oil extraction techniques to become profitable producers in this high-price environment.

The U.S.\’s Growing Presence as a Dominant Oil Producer

Although the 2008 recession temporarily halted the development of shale hydraulic fracturing technology in the US, the years of expansion that followed saw a dramatic increase in its adoption and utilization as a means of crude oil extraction. Not bound by OPEC’s decisions, the US and other producers grew supply levels, which eventually culminated in the crash of global oil prices at the end of 2014.

Chart comparing OPEC\'s productino with WTI price movements, highlighting the relationship one has on the other

OPEC production figures post-2014 moved opposite to WTI price for a period of two years, attributed to the organization’s decision not to cut crude oil output. At the end of 2016, however, following the decision to cut production for the first time since 2008, output decreased and has continued that downward trajectory as cuts have been extended to the end of 2019. Despite this glut of oil on the market as 2014 ended, OPEC did not choose to cut production levels. They chose, instead, to prioritize the preservation of its market share and continue producing at a rate near 30 million barrels per day (mmbd). 

Following this decision, West Texas Intermediate (WTI) crude oil and wholesale diesel prices fell close to 10 percent and continued that downward trajectory before reaching multi-year lows in 2016. The chart below depicts the relationship between the oil and diesel market, highlighting OPEC’s influence on energy prices and the international supply picture, in total.

Decisions to Cut Production to Control Prices

With the oil market becoming increasingly less profitable for the cartel and other non-US producers, OPEC and newly invested parties like Russia soon began discussions to freeze and even cut, production levels to add greater stability to oil prices. 

While the group initially had trouble arriving at an accepted metric for these cuts, at the end of 2016 the group reached a consensus. The outcome of this decision was the first production cut OPEC had made since 2008 and has since resulted in a period of prolonged cuts by the organization.

These cuts remained influential price drivers but have varied in the magnitude of their impact. In June 2017, less than a year after OPEC’s production decision, cuts were extended, resulting in an increase of almost 40 percent by the group’s meeting the following year. 

Responding to the Price Rebound

With this upward-trending market in mind, OPEC endorsed a production increase to stabilize prices during their semi-annual meeting in June of 2018. This was later rescinded as the bear market of late 2018 materialized in response to concerns of an oversupplied oil market, sending oil and diesel prices into a downward spiral to close the year.

While all of these factors initiated the transition, the emergence of “the big three” crude oil producers expedited OPEC’s more reactive role in the marketplace.

Take a deep dive into this evolution here

Economic Headwinds and Oil Production\’s “Big Three”

In July 2019, OPEC again decided to maintain production cuts. The market’s slower economic growth and its impact on global demand for crude and transportation fuels, however, has greatly reduced OPEC’s potential to push prices upward by restraining oil supply. While historically OPEC was able to manipulate prices by changing this supply, the market is currently transitioning to one that is more demand and economic driven. 

Since their decision to implement supply cuts of over 3.0 million barrels of crude per day from October 2018 levels, OPEC’s removal only modestly increased prices during their most recent round of cuts. This is due in large part to US oil production growth counterbalancing OPEC’s efforts to remove supply from the market.

Expanding OPEC’s Allies to Incorporate Larger Players

With this in mind, OPEC has recently transitioned to become OPEC+. The addition of the “+” contingent of non-members indicate countries who agree to team up on organizational decisions but are not bound by true membership. The alliance now includes Kazakhstan, Mexico, and perhaps most importantly, Russia – among others. 

Historically, OPEC nations and Russia viewed each other as rivals instead of allies, with the latter as the world’s third-largest oil producer behind the US and Saudi Arabia. Since December of 2018, OPEC+ members once again control most of the world’s crude oil supply, combining their respective influences on the global market to influence prices.

Bar graph showing crude oil outputs for Russia, Saudi Arabia, and the United States, showing the U.S.\'s production has surged past its next two competitors.
Today, the world’s “Big Three” or three largest oil-producing nations are the US, Saudi Arabia, and Russia.

While this new partnership may offer additional leverage to OPEC+, fears of global economic slowdown amidst the US-China trade war may continue to overshadow the upward momentum of supply cuts.

OPEC is Joined by Other Players in the Marketplace

Despite OPEC’s influential history of price control, new dynamics in the global economy and continued growth from the US and other oil producers may continue to reduce OPEC’s ability to manipulate prices, even as geopolitical tension heats among members located in the Middle East. Regardless of the comparative scope of their influence, OPEC and its allies will remain at the forefront of oil price volatility, whether motivating or responding to it.

Interested in reading more OPEC-related topics? Learn more

Information has been updated from its original post date on 8/16/2019.

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