The Organization of Petroleum Exporting Countries (OPEC) is an association of thirteen oil producing countries working together for mutual financial interests. OPEC officially describes itself on the organization’s website “as a permanent intergovernmental organization” whose objective is “to coordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.” OPEC was created at a conference in Baghdad in 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. The founding members were subsequently joined by Qatar, Indonesia, Libya, United Arab Republic, Algeria, Nigeria, Ecuador, and Angola, in this order.
The Creation of a Cartel
A cartel is a group of companies or countries which work collectively to affect market prices by controlling production and marketing. To understand that OPEC is a cartel, one needs only read Article 2 of its charter which states that OPEC’s aim is “the determination of the best means for safeguarding their [members’] interests, individually and collectively, designing ways and means of ensuring the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations.” This cartel is significant in that it owns more than 70% of proven crude oil reserves and supplies 40% of the world’s crude oil, the price of which often influences the economic fortunes of many countries-small and large, developing and developed.
To maintain price control, the oil cartel periodically establishes ceilings of production under which members of the cartel are allocated quotas of production based on (estimated) reserves. The higher the reserves, the larger the quota, and, hence, the larger the revenues. Since proven reserves are, in fact, no more than good estimates, members juggle figures to justify the largest possible quota. OPEC had in the past established both floor and ceiling for prices. When the price of a barrel of oil touched the floor, production was reduced to raise the price; when price reached the ceiling, production was increased to lower the price. Cheating-i.e., failing to adhere to the established quota-was common when the price hit the floor as members desperately needed cash to supplement their quota-generated revenues. Not long ago, the floor was $12 and the ceiling was $28 for a barrel of oil. With a price of oil spiking close to $100 per barrel, the ceiling has essentially disappeared and with it the general practice of increasing production to bring prices back to within an established range.
Speculation and Hypocrisy
OPEC members have traditionally priced the product in US dollars. US antagonists among OPEC members, mainly Iran and Venezuela, are demanding that the price of a barrel of oil be denominated in a basket of currencies. Other members of OPEC, including the largest producer, Saudi Arabia, have so far adhered to the dollar peg-in Saudi Arabia’s case, partly because it has not wanted to be seen as having its course of action influenced by its Iranian nemesis. Still, one can understand the demand of the other members of OPEC for compensation for the devaluation of the dollar against other major currencies, namely, the euro and the British pound. How much compensation? No one can give a firm answer although a price increase of 25-35% would seem fair.
As a matter of fact, the price of oil has almost doubled in 2007, and there seems to be no end in sight for bursts in prices. Many members of OPEC are beginning to accumulate great wealth which, if unchecked, will lead to international monetary imbalances. However, any call for higher production to curb price hikes is answered by OPEC with a mantra: the supply is sufficient for the market needs; that prices are bursting through the ceiling is the fault of the evil speculators. It is the nature of the capitalist markets to allow risk takers to speculate in volatile commodities whether oil, gold, grains, orange juice, or pork bellies. In most cases, a sudden increase in price will indicate imbalance between supply and demand. Indeed, that is the case with oil. Rather than blame speculators, OPEC could increase production (above the 500,000 barrels/day it has sanctioned recently) to drive speculators out of business or at least reduce their alleged nefarious influence. Blaming speculators for keeping the supply restricted and keeping prices high is the ultimate hypocrisy.