9 April 2020 - 11:55
  • News Code: 301456
OPEC vs. Non-OPEC

TEHRAN (Shana) -- The oil price slump following failure of OPEC+ talks in March is the biggest blow to the oil market since the third oil shock; a new scenario is emerging for the oil market.

The economic crisis caused by the paralyzing COVID-19 outbreak in the world is expected to crush global economic growth by minus 2.5 to 3% in 2020, in the best case scenario; a figure that was previously estimated to stand at at least 3.5 percent for the year. The pandemic has destroyed demand in an unprecedented fashion. In the meantime, direct manipulation of the market by major oil powers such as Russia, Saudi Arabia and the United States, is fueling the price war, dealing a heavy blow to the prices never seen since 1986.

More importantly, marginalization of the Organization of the Petroleum Exporting Countries (OPEC), the world's only powerful and influential third-world organization which responsibly managed the oil market in the past half a century, prompted us to take an analytical look at the ongoing events and review the history of OPEC developments and actions since its formation over five decades ago. We shall also consider possible scenarios and optimal policies to be portrayed for each of the members, especially Iran, to ensure their interests and those of other member states in the turbulent oil market.

Iran is currently bearing the blow of a one-two punch by the US sanctions and the Russia-Saudi Arabia production war over market share leading to the current paralyzing price slump, and is pursuing short-term and long-term interests in OPEC. As a rule, Tehran should seek to bring back empathy and cooperation among fellow OPEC members.

When OPEC was formed in the 1960s on the initiative of Iran joined with some oil-rich countries, namely Saudi Arabia, Venezuela and Iraq, oil producers were fresh from decade-long disputes with international oil companies; Iran had nationalized its oil industry, and there were domestic struggles and national unrest in certain other oil-rich countries. The time was ripe for oil-producing countries to close ranks and form a solid body to ensure or, at least, pursue their interests.

Today, the organization has over-half-a-century of history in playing roles in the oil and energy markets. Albeit, its impact is not limited to price management or ensuring supply/demand balance in the market, it has also foisted structural alterations in both the production and consumption sides of the international energy arena. Here is a brief review of the main developments in OPEC history:

1- OPEC and the first Oil Shock

From its earliest years, OPEC, emboldened by gaining upper hand in contractual dealings with oil companies and revolutionized regulatory frameworks between members and international oil companies, in its most important move, not only took oil pricing away from those companies and ended the era of “posted prices” by them, but also imposed a fourfold price surge on the market which raised oil prices to around $10 per barrel; a huge move known as the "first oil shock" which sent shockwaves to the industrial and consumer world. Faced with strong criticism from international critics, who blamed OPEC for acting irresponsibly against oil consumers, especially poorer importers, the organization set up the OPEC Fund in order to help such consumers and keep the critics quiet.

Perhaps the best period of cooperation between OPEC members was in its early years. However, this move did not remain at the level of simple trade and price increases, and a set of action and reactionary movements followed, including the following.

Continued conflicts with international oil companies:

Heartened by role-playing in the international energy scene, OPEC member states sought more concessions from the consuming world, and, to this end, confronted international oil companies. As an example, the Iranian government unilaterally converted its contract with the oil consortium from a privileged model to a service one, which consisted until the 1979 Islamic Revolution which also became a law (the Oil Act approved in 1974).

2- Arab Oil Embargo against the Western World

The embargo followed the Ramadan War between Arabs and Israel and the West's support for Israel. It coincided with the first oil shock which had already quadrupled oil prices in the oil market, which got things out of proportion, prompting consumers to consider working out a solution to confront the producers amid their negligence.

3- West’s Retaliation

The most important consumer response to OPEC members that revolutionized the energy sector as well as the global industry was the initiative of then-Secretary of State Henry Kissinger to form the International Energy Agency (IEA). The agency was primarily tasked with reducing dependence on oil, especially from the Middle East and OPEC. It quickly expanded to all industrialized nations, including the United States, Europe, and Asia, and relied on the following to put OPEC in a difficult defensive position in the mid-1980s:

-Cutting demand in a comprehensive manner by optimizing industrial efficiency in all sectors, including transportation, power generation and industrial, commercial and domestic sectors.

-Boosting oil supply by developing oil fields outside of OPEC and the Middle East, even at much higher costs, which led to the emergence of the “non-OPEC” as a power, which quickly captured a market share twice that of OPEC. This share has been preserved over the past few decades.

4- Second and third oil shocks and OPEC

The "second oil shock" came as a result of the Islamic Revolution in Iran in 1979, which once again pushed the prices up nearly threefold to nearly $40 per barrel. Subsequent events, such as the Iraq war against Iran, which severely reduced the flow of oil from both countries, also contributed greatly to the scale of the shock, but failed to undermine the process initiated by non-OPEC.

As a result, the third oil shock pushed the prices to below $10 a barrel in mid-1986. Of course, during this period, and parallel with the Iraq-Iran war, OPEC also suffered divisions and infighting. Iraq, desperately seeking to replace Iran in OPEC and become the second largest OPEC producer, attracted the support of OPEC's Arab members, and other members such as Algeria, Libya, and to some extent Venezuela and Ecuador, with closer ties with Iran, were relatively opposed to the Arab members.

Here, the consumer market reaped the largest profits. During this period, the Arabs even barred the election of the Secretary-General of OPEC for a long time, and the OPEC Secretariat was run by OPEC Acting Secretary General Fadhil Jafar al-Chalabi who was an Iraqi economist, who later founded the Centre for Global Energy Studies (CGES) together with former Saudi Oil Minister Sheikh Ahmed Zaki Yamani.

5. Oil industry’s arrival into the stock market and securities transactions

Other important developments in the second half of the 1980s were the emergence of stock exchanges, securities and "futures" transactions, and, in particular, the attitude of oil companies to offer their stocks on international stock exchanges, which instead of being accountable to their home governments, were only tasked to meet the interests of their shareholders disregarding their nationality.

The trend was accompanied by the supermerger of big oil companies of various nationalities across the world, which diminished, or even faded away, any form of government interference in their international relations, except for legal sanctions such as embargoes which in many cases include unilateral and cross-border US sanctions on countries like Iran and Libya which were often ignored by non-US-based companies.

The phenomenon of merging oil companies with different nationalities with the aim of reducing the risks and increasing synergy of the capabilities that occurred in the early 1990s, also contributed greatly to distancing the companies from governments; a fact that some uninformed analysts about the history overlooked regarding Iran’s efforts to develop international cooperation with the aim of building capacity, creating wealth, and most importantly, undermining US sanctions at the time.

Examples of such supermergers include the merger of the British BP oil companies with Amoco and Arco of the United States and the formation of the large BP Company, which is now more American than British, or the merger of Total and Elf with the Belgian Petrofina and the formation of the great Total Company. In the United States, mergers were more widespread at the level of large corporations, such as the merger of Exxon and Mobil or Chevron and Texaco, Conoco and Phillips, and so on.

Oil pricing on stock exchanges due to extensive paper trading - many times as much as physical oil trading - has since taken away the pricing power of other organizations, including OPEC, and it is these stock exchanges that determine the prices and even future horizons and market trends and make them available to countries and companies. This, of course, must be seen as a positive development away from historical competition on both sides of the market, which brings the oil market closer to the free market with less interference by the powers.

6. From all of Iraqi regime to emergence of US shale Oil

In the 1990s and early 2000s, the world witnessed many changes, including the oil war in the Middle East that eventually led to the fall of the Iraqi regime, the economic crises in Asia and South America that led to diminished demand, and the 2005 price hike which continued until 2014 when unconventional shale oil and gas were introduced to the market in the US, which brought its 5.5 million barrels per day (mbd) output in 2014 to 8 mbd the same year.

OPEC, during the post-Iran-Iraq years, by policies of empathy and cooperation within OPEC – in whose shaping Iran played a significant role - and in the turbulent 1990s, despite having a smaller market share than non-OPEC, managed the market well. For non-OPEC producers, very low price levels were unbearable, as the cost of producing in the areas operated by such producers was generally high, and naturally, investment firms had to reap the minimum benefits at reasonable prices in order to keep their stakeholders satisfied.

The oil market realities led Saudi Arabia, which has always been a supporter of market share and the expulsion of non-OPEC rivals by keeping the prices low, and members whose economic needs prompted them to favor higher prices, to conclude that OPEC should support logical prices levels and manage the market at these levels by exploiting their production capacity.

The policy of setting quotas or price ranges of $22 to $28, which was implemented in the 1990s, is a clear example of this optimum management within OPEC, which was formed in the shadow of the sympathy and cooperation of all members and brought about favorable results.

The price rise in the second half of the last decade did not upset anyone; rather, the tempting benefits drained away all such theories, as the Saudi Arabia’s market share.

Non-OPEC producers were also very happy with the prices and spared no time to invest heavily in unconventional high-cost oil and gas projects. Consequently, the role of organizations such as OPEC diminished in the market development processes, but today, amid unprecedented price slump, OPEC is once again in the spotlight on both sides of the market. However, further powerful currents are preparing scenarios for the oil market and its management.

7- Sanctions on Iran and Saudi Arabia's role in the region

Developments in the region, especially Saudi Arabia's role in supporting terrorist and Takfiri groups and the waging the Yemen war, which is justified as a move to curb Iran's influence in the region, have once again created a competition within OPEC at a time when Iran is heavily influenced by sanctions and its role in the market is the weakest even prior to the coronavirus outbreak.

With a daily production of more than 10 million barrels of crude oil, Saudi Arabia has offset Iran’s supply losses in the market. By relying on its domestic and regional power, Riyadh has always favored low prices and hence putting pressure on Iran. However, Saudi Arabia's new role in the new scenario has been different; providing the best market for all types of expensive oil for new oil powers.

Certainly, the global oil industry will not support low prices at levels Saudi Arabia’s Zaki Yamani had opted for in order to squeeze high-cost producers out of the market; such producers would consider $60 to $70/d as a price floor to maintain their lifeblood. Therefore, connection between Saudi Arabia's OPEC policies and external events as well as regional policies in competition with Iran have certainly overshadowed the OPEC Summit.

8- OPEC+ and the developments ahead

In the early 1990s, as an initiative Iran, major producers, including OPEC members and major international oil firms and leading consumers, gathered at an important seminar in Isfahan to study the oil and energy market in the next century and to establish a cooperation structure between the two sides of the market, i.e. producers and consumers. They set up the organizational milestone of what was later formally established in Paris as the International Energy Forum, or IEF, which was expected to play a decisive role in expanding cooperation and regulating market stability, which unfortunately did not take place as wished, and the role is still being born by OPEC. Honestly, the market has to acknowledge that OPEC did this job well over three exciting decades since the 90s, creating a relatively stable market with only one-third of global production. The events of the last three decades have been frequent, very complicated and influential, and some of which can be described as follows:

The collapse of the Soviet Union, the oil war and occupation of Kuwait and the setting on fire of almost all of Iraq's oil wells, the US invasion and occupation of Iraq and the regime change in that country, the Arab Spring and the great structural changes in such countries as Libya, Egypt and later Syria, formation of the Islamic State and regional conflicts, the start and continuation of the Yemen war; all these political-structural events did impact the oil market; the jump in demand growth due to the economic growth of major consuming countries such as China, which has been double-digit for a decade, and the high economic growth of India, Korea and the Middle East and their oil demand growth, expansion of US shale oil output, production surge in Russia and some middle-Asian countries, like Kazakhstan and Azerbaijan, the expansion of Iraq's production capacity to almost double and the price jump in 2005 were among the main drives for supply enhancement in the market. Managing the destabilizing impact of all these development on the market was done by OPEC which was relatively successful.

But in recent years, we have witnessed more governments intervening in the oil market. Major and new oil powers have once again turned oil into a political weapon in transactions between themselves and others. With the shale revolution in that country, the United States increased its shale oil output from 1.5 mbd in 2012 to 8 million in 2019, and bring its total production to 14 million barrels per day.

Despite the fact that the US needs to import 6 mbd, it has also become an exporter of oil to make optimal use of this tool in political interactions. The US has pursued a similar policy in shale gas, and while it still imports gas from Canada through a pipeline, it exports gas to Mexico and liquefied petroleum gas (LNG) to the Middle East; to Kuwait and the UAE in Iran’s neighborhood which are natural gas export markets for the country. Russia has not lagged behind in this competition and has increased its production to 11 mbd so that it does not stay behind in the market.

Saudi Arabia, which has a wide production gap with fellow OPEC members, has always displayed commitment towards the organization's decisions, in the new market conditions, under Bin Salman, prefers to be with these new actors and, of course, act as a catalyst for US policies.

OPEC+ and its 2018 constructive decision to cut output was a glimmer of hope for OPEC cooperation with at least part of non-OPEC. Economic parameters such as Russia's need for oil revenues in the face of the devaluation of the ruble and some sanctions showed its persistence with OPEC.

But at the recent summit, and certainly with a larger political goal, Russia has ceased to cooperate with OPEC, starting a price war with Saudi Arabia- which the author believes, is not aimed at supporting OPEC but at the behest of the United States to pressure Russia to enter into political and trade engagement- which had pushed the prices to their lowest levels since the third oil shock. Russia is well aware that the US oil power depends on prices of at least $65 to $70 a barrel. So it can be inferred that Russia's self-harm, which is also heavily dependent on oil revenues, must be for a higher goal. In the United States, on the other hand, while we see declining oil production and activity, the number of active rigs has dropped by about 30 percent, but the US president says he has never liked OPEC and considers it illegal and has started direct negotiations with Russia and Saudi Arabia. What seems to be a new scenario for the oil market is being formed by the above three countries and their Arab allies in OPEC, so that the world can take a different path with an ineffective OPEC or even without it.

By Seyed Mehdi Hosseini, former senior Iranian oil executive

English Version: Abbas Hajihashemi

News Code 301456

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