OPEC: who, what and why?

Lesson 2 in the BUX Homeschooling series is a short history lesson. The oil price has dropped to a historic low, and one thing you keep hearing about is OPEC. But who are they and what have they got to do with the oil price?

Crisis after crisis

OPEC is short for Organization of the Petroleum Exporting Countries. Basically, a club for the world’s biggest oil barons. The club was founded on September 14, 1960, and, like many big alliances, OPEC came together out of dissatisfaction.

What happened? About a month before OPEC formed, August 9, 1960 to be precise, Standard Oil of New Jersey (now ExxonMobil), the largest US oil company, cut its oil price by 7%. That forced the other big oil companies to lower their prices too. Oil producers grew angry.

These producers included Venezuela, Saudi Arabia, Iraq, Iran, and Kuwait. Together, they pumped out 80% of the world’s oil at the time. This partnership could make group decisions about the production of oil (and therefore the supply), so a good price could be guaranteed. Sounds like a plan, and the first five members of OPEC shook hands.

At first, OPEC managed to stop the fall in the oil price. But things didn’t always go smoothly in the years that followed. Sometimes the members of OPEC clashed among themselves. Sometimes they were rocked by an outside crisis. It’s not exactly chill in the region where they extract oil. Here’s a small sample of events that have rocked the oil trade since the 1950s:

The Abadan crisis; the US-British coup in Iran; Gaddafi’s coup in Libya; the Yom Kippur War; the Iranian Revolution, the Gulf War and the 9/11 attacks. So quite intense external factors.

No friend zone

In the meantime, more countries joined OPEC. The idea behind the pact is attractive for the countries involved because they can arrange production and price agreements together. And yes, we know that’s exactly how a cartel works and it’s not usually allowed. Companies that do this can face huge fines from regulators. But it’s not technically illegal if there’s an international agreement between states based on their own sovereignty. Problem solved!

Well, actually not quite. Because, even if you forget about all the external crises, the members can’t stop arguing. There are now 13 members of OPEC and they haven’t always got on over the years. Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Libya, the United Arab Emirates, Algeria, Nigeria, Gabon, Angola, Equatorial Guinea and Congo-Brazzaville are the current members.

They’re a colourful group with diverse interests. For example, Saudi Arabia is sort of the captain of the club because it’s the biggest exporter by far. They want to sell as much oil as possible and they don’t mind if the price goes lower as a result. And Iran faces lots of Western sanctions that limit their exports. If they’re lifted, Iran will want to turn the oil tap on full blast.

But smaller and poorer nations like Venezuela and Algeria can’t afford to mess around with prices. They want the highest possible price for their oil. And things don’t always stop at the negotiating table. Iran and Iraq were engaged in a long and bloody war between 1980 to 1988. And in 1990, Iraq invaded Kuwait leading to the Gulf War. Nope, it’s never been friendly in the OPEC clubhouse.

And those were just the years when OPEC dominated the market. Today, they only control about 40% of global oil production. Large oil countries like the US, Canada, and Norway don’t belong to OPEC. Then there’s Russia and Mexico – member of OPEC+ which is an extended version of the main group. But there’s no guarantee of friendship. Russia and Saudi Arabia were the latest to start a price war, which is what triggered this recent price drop.

You can now add the coronavirus crisis to the long list of conflicts and crises. Global oil demand has plummeted and oil prices haven’t been this low in 20 years. The OPEC nations did sign a deal this month to cut production by 10 million barrels per day, but that’s a drop in the ocean and hasn’t stopped the free fall. The question of whether OPEC should still play a significant role in the oil market is therefore growing louder and more important than ever.

All views, opinions or analysis expressed in articles are that of the author and do not represent the views of BUX. Neither BUX nor the author provide financial advice and these articles should not be construed as such.