Group formed in 1960 to protect economic interests of oil-exporting countries.
In the early 1950s, international oil companies (IOCs) developed the posted price system to help host governments estimate oil revenues in advance. Posted prices were accounting devices that host governments used to calculate the amount of taxes the companies would pay under industrywide fifty-fifty profit-sharing agreements. Despite normal fluctuations in the real prices at which crude oil was traded, posted prices were not adjusted, and fixed posted prices became an industry norm. When competitive pressures forced the IOCs to reduce posted prices unilaterally in February 1959, an immediate outcry arose from the affected host governments.
OPEC's Founding
The first Arab Oil Congress met later that year. Delegates from oil-exporting countries came to plan concerted action against the oil companies. Structural differences among national oil industries made coordination among these countries difficult technically. Conflicts of interest over investment and production shares made coordination difficult politically. Competition between Venezuela and Middle Eastern exporters was heightened by the 1959 posted price cuts. British Petroleum set lower prices in parts of the Middle East than in Venezuela in hope of breaking the As-Is Agreement, a mediated connection between world oil prices and the U.S. market. Venezuelan oil thereby became even less competitive, requiring further downward price adjustments and convincing oil exporters that their responses to the companies had to be closely coordinated.
Political conflicts ended the Oil Consultation Commission, the first producer attempt to institutionalize coordination. But when the IOCs imposed yet another round of price cuts in August 1960, five oil-exporting countries set aside their political differences to salvage their economic interests. Venezuela, Saudi Arabia, Iran, Iraq, and Kuwait formed the Organization of Petroleum Exporting Countries (OPEC) in September 1960. OPEC's first resolutions included calls to restore posted prices to their pre-February 1959 levels and to stabilize oil prices by regulating production.
The U.S. government refused to recognize OPEC, forbade U.S. oil companies to negotiate with it, and imposed trade sanctions on OPEC members to discourage other countries from joining. This suited the IOCs, which saw an advantage in continuing their accustomed practice of dealing with host governments one at a time. OPEC responded creatively, developing joint negotiating positions with the understanding that any member able to gain an additional advantage on its own should do so. Any gains would constitute a new floor for bargaining in the next round. During its first ten years, this "leapfrogging" earned OPEC members incremental gains in oil revenues, which both increased OPEC's international stature and attracted new members to the organization.
Perhaps OPEC's most significant contribution to the oil revolution was its support and implementation of "participation," the gradual nationalization of foreign-owned oil properties. Most members did not follow the participation strategy to the letter, but years of discussion provided an opportunity to prepare for the responsibilities that would come when they became full owners of their oil industries. This accomplishment was overshadowed, however, by OPEC's successful utilization of leapfrogging to achieve rapid oil price increases, by Libya in 1970 and afterward by alternating pressure exerted first by oil-exporting countries in the Mediterranean and then in the Persian Gulf. This set the stage for OPEC's takeover of crude oil pricing when the 1973 Arab - Israel War, with its well-designed Arab oil embargo, provided the opportunity.
Pricing Strategies
OPEC's success in taking over oil pricing created new problems for the group. Oil-importing countries, led by the United States, demonized OPEC as the primary cause of worldwide economic decline. Inside OPEC, structural differences among member industries led to disagreements over pricing strategies. Low-price-preference members such as Saudi Arabia, with small populations and huge oil reserves, favored moderate oil prices to discourage consumers from seeking alternative fuels. High-price-preference members like Algeria, with large populations, wanted high prices so they could pay for ambitious development programs, while their small reserves offered no incentive to support pricing policies that would sustain the long-term attractiveness of oil as a fuel. Some members with large reserves, like Iran and Libya, also favored high prices. Iran had a large population and an ambitious development program, but Libya's preference was politically motivated by Libya's desire to assert its autonomy among its OPEC peers as well as its independence from western domination.
Price positions could be flexible, however. In 1978, the threat of revolution pushed Mohammad Reza Shah Pahlavi of Iran to seek allies among his neighbors. Iran joined most of the Arab gulf countries in pushing for the adoption of a long-range moderate pricing strategy to replace what had, until then, been an ad hoc method of setting oil prices. The new system became obsolete almost before it was agreed upon, however; it was superseded by pressures that doubled oil prices in one year thanks to panic buying during the Iranian Revolution. Predictably, oil demand fell, but the availability of new, non-OPEC supplies from the North Sea and elsewhere allowed major importers to shift their purchases, making OPEC the marginal supplier of crude oil to the world market.
Market weakness in the early 1980s caused OPEC to focus on oil production sharing as a strategy for controlling oil prices by regulating crude supply. A voluntary production-sharing plan was launched in 1982 but, as had happened to the voluntary oil import quota in the United States during the 1950s, producers ignored it. A mandatory quota system was introduced in March 1983, and crude prices were reduced for the first time since OPEC had assumed its price-setting role in the hope of stimulating consumer demand. An Austrian accounting firm was hired to monitor member production in order to discourage cheating on the quotas.
The quota system had many flaws. Even small producers were required to accept a quota, prompting Ecuador to leave OPEC in 1993 to escape its quota obligations. Saudi Arabia, OPEC's largest producer, refused to accept a formal quota that it said was an unacceptable infringement on its sovereignty. This marginalized Saudi production within OPEC as crude from many sources flooded the market and total demand for OPEC oil declined. Without a quota and its implied entitlement to produce a defined share of OPEC crude, the Saudis had to accept the informal role of swing producer, one which would vary its production to satisfy market demand remaining after other producers had supplied their quota amounts. As OPEC's swing producer, however, Saudi Arabia would have to absorb more than a proportional share of demand reduction. This already unpleasant situation would be complicated in the Saudi case by its heavy dependence on associated natural gas, which led to shortages of fuel for power generation when oil production there fell to below 3 million barrels per day in mid-1985. Shortly afterward, Saudi Arabia decided to produce oil with only its own needs in mind. Global supplies burgeoned and oil prices plummeted, dipping below $10 U.S. per barrel in June 1986. Although oil prices recovered, they have yet to return to pre-1985 highs.
Political Divisions
Political conflicts continued to divide OPEC members during this time. The first Gulf War, between Iran and Iraq (1980 - 1988), so split the organization that OPEC could not agree on a new secretary-general when it was Iran's turn to nominate one of its nationals. An assistant secretary-general, Fadhil al-Chalabi of Iraq, served as acting secretary-general from 1983 to 1988. Hostility among members during this period made meetings acrimonious and reduced the usefulness of OPEC as a forum for coordinating policy.
The end of the Iran - Iraq War provided an opportunity to mend intra-OPEC relations, but the second Gulf War, which began when Iraq invaded Kuwait in 1990, brought new turmoil to oil markets and to OPEC itself. Before Iraq invaded Kuwait, world oil prices were depressed and virtually every OPEC member with excess production capacity was producing over its quota. Unfortunately for Kuwait, it was the only country small enough and close enough to suffer Iraq's wrath directly. After Kuwait was liberated in February 1991, U.N. sanctions against Iraq, imposed in retaliation for the invasion, ended legal oil exports from Iraq. Starting in December 1996, Iraqi income from smuggled oil was augmented by earnings from the U.N. Oil-for-Food Program, which supervised the marketing of some 3.4 billion barrels of Iraqi crude between the start of the program and March 2003, when the United States and Britain invaded Iraq. The United Nations also ensured that the Iraqi share of oil-for-food income was spent only to meet humanitarian needs. The rest went for war reparations (25 percent after December 2000, 30 percent before), the cost of U.N. weapons inspections (0.8 percent), and administrative and operational costs for the program (2.2 percent).
Overproduction by OPEC members remains a problem during periods of ample crude supplies, but political turmoil and consequent supply disruptions in member countries, from Venezuela and Nigeria to Iraq and Indonesia, have masked the problem of excess capacity by creating or even merely threatening war-related shortages. Yet members able to do so are expanding production capacity, which will add to conflict over production ceilings and quota allocations as growing supplies from Iraq come to the market.
Overall, OPEC's difficulties in managing and stabilizing the international oil market continue to be beyond member control. Following the collapse of the Soviet Union, the new Central Asian countries offered attractive terms to potential investors in oil and gas exploration and development. Now rising production from this region adds to pressures on the price structure. The need for capital investment is another axis of competition pitting OPEC against Central Asian and non-OPEC African producers, leading many OPEC members to reconsider their positions on nationalization. IOC operations are expanding in virtually every OPEC nation, while the occupation of Iraq could leave a privatized Iraqi oil industry as one of its legacies.
OPEC's gravest failure has been its concentration on oil market conditions rather than on the economy as such. Consequently, it has failed to develop strategies to prepare members for a post-oil world. As long as prices are low and supplies seem secure, oil will remain a competitive fuel in global markets and the deep restructuring necessary to wean member economies from their addiction to oil revenues can be avoided. Yet whether post-Saddam Iraq will be reintegrated into OPEC or not, relying on hydrocarbon revenues as the mainstay of their economies leaves members vulnerable not only to the day-to-day vagaries of the market but also to the impact of long-term structural change. The almost exclusive concentration of governments, press, and public on oil pricing actually prevents OPEC from devoting significant intellectual and financial resources to other aspects of industry development, including research on alternative sources of energy for export and domestic use. Kuwait's early research into solar power, for example, was quickly abandoned as its oil reserves expanded and reliance on oil revenues seemed less risky than devoting substantial resources to bringing a competing energy source to markets where it already had an advantage. Yet with concerns about pollution and global climate change encouraging consumers to shift out of hydrocarbons, OPEC members' acute dependence on oil and gas revenues leaves their economic security as vulnerable to changes in market structure as they are to political conflict.
Bibliography
Mikdashi, Zuhayr. The Community of Oil Exporting Countries: AStudy in Government Cooperation. Ithaca, NY: Cornell University Press, 1972.
Mitchell, John, et al. The New Economy of Oil: Impacts on Business, Geopolitics, and Society. London: Earthscan, 2001.
Skeet, Ian. OPEC: Twenty-Five Years of Prices and Politics. Cambridge, U.K.: Cambridge University Press, 1989.
Tétreault, Mary Ann. Revolution in the World Petroleum Market. Westport, CT: Quorum Books, 1985.
Weisberg, Richard C. The Politics of Crude Oil Pricing in theMiddle East, 1970 - 1975. Berkeley: University of California, 1977.
— MARY ANN TÉTREAULT
