At OPEC, Some Worry as Oil Prices Start Falling by Mouawad - Article Example

An Overview of OPEC through Mouawad's New York Times Article Table of Contents Introduction 3 Origins of OPEC 3 Economics Of OPEC 5 Conclusion 9 Appendix 10 References 13 At OPEC, Some Worry as Oil Prices Start Falling 15 Introduction Jab Mouawad's recent article in the New York Times refers to a level of concern among some OPEC nations about decreasing oil prices in current market conditions. OPEC is a highly influential organization in world affairs today. Energy is the principal driver of modern economies and oil is currently the major currency and source of energy. "Oil continues to be the world's most important fuel, contributing 39 percent of the global energy supply." (Kohl, 2005) An understanding of OPEC, its origins, its history and its current role in world affairs is instrumental in coming to an understanding the modern world. In terms of economics OPEC is, for all intents and purposes, a cartel organization. A review of the many functions of OPEC and its economic implications will offer insight to modern affairs. This paper will briefly review OPEC in reference to Mouawad's New York Times article. Origins of OPEC OPEC today consists of 11 nations from the Middle East, Africa, South America and South-east Asia. The Middle Eastern contingents include Iran, Iraq, Saudi Arabia, United Arab Emirates, Kuwait and Qatar. From Africa there is Algeria, Libya and Nigeria. South America and South-east Asia contain the lone contingents of Venezuela and Indonesia respectively. OPEC originally formed in the early 1960s in response to the imposition of US quotas on oil production in the area. Initiated first by Venezuela and then joined by a number of the Middle Eastern countries an attempt was made to try to control production in order to garner higher prices. This is a classic example of a cartel, that is an organization that limits production and thus supply ensuring a higher demand and in turn higher prices. This flouts the idea of competition in the marketplace but it has been possible because the OPEC nations collectively have a majority of the world's oil reserves the unique status of political sovereignty. Political factors have played a huge role in the running of OPEC's organization. There are many factors to consider here. The contentious history of Israel's existence in the region has led to many problems. US support for Israel in the 1973 Yom Kippur war led to a reaction by the Middle Eastern countries represented by OPEC which responded by reducing production of oil, leading to a crisis across throughout the world. The shortages . were seen in North America during this time were also worsened by President Nixon's policy at the time of setting a fixed price for oil leading to widespread shortages. The pattern of the oil market like all markets is influenced by the stability of the regions in which it is produced. The Middle East in the postwar period has been characterized by a high level of political instability. This is been reflected in the volatility of this market. Saddam Hussein's 1992 invasion of Kuwait was a case of one OPEC nation infringing on the political sovereignty of another. Considering the levels of vital oil reserves that were threatened by this act it is hardly surprising that it precipitated intervention of the United States in the first Gulf War. This article makes reference to the recent conflicts between Hezbollah and Israel. The seeming current state of truce has reduced the level of anxiety in the security of the region and this has seen itself manifested in more balanced prices. Economics Of OPEC OPEC is an unusual organization. "Thee Organization of the Petroleum Exporting Countries (OPEC) stabilizes petroleum prices to promote the economic prosperity of its member nations for which oil is a substantial export." (Moore, 2003) It brazenly operates as a cartel but it is able to do so with impunity since the member nations collectively own the rights to two thirds of the world's oil supply and presently are responsible for over 40% of the world's oil production. This is further reinforced by the rights to sovereignty that each of the member nations have and their ongoing argument that they work in response to potential unfair market practices against them. Since OPEC works as an organization of states its policies are not always uniform. As a cartel it depends on the individual member states not breaking rank and maintaining the agreed-upon prices of the member states. In practice this agreement does not occur as cheating going on all the time. Saudi Arabia, the largest producer among the OPEC nations is often undercut by the overproduction of smaller OPEC nations that seek to gain their own particular advantage. This oversupply released to the market inevitably offsets prices that OPEC tries to impose as a group. Price in free markets occurs at the intersection of the demand and supply curves as can be seen in figure 1. By limiting supply namely by reducing production or keeping production at fixed levels OPEC nations attempt to keep the demand high as a consequence the prices high as well. As can be seen in figures 1 and 2 the practice of imposing a price ceiling where supply and demand are not controlled only works as a control of market forces when the prices are below the competitive price. Imposing a price control of this nature will inevitably lead to shortages as a supply and demand curves are not abstract entities. They are indexes of the real availability of the products in question and these are finite. “ The OPEC nations finally faced the consequences of their arbitrary price escalations. Since petroleum is a politicized commodity and pricing is as much determined by the law of supply and demand as it is by the political factors that remain outside the Global Oil Market, it is not surprising that political decisions can have a direct bearing on the price.” (Dorraj, 1993) So OPEC nations principally achieve their controls by controlling production. This is a complicated proposition since oil is such an important commodity and such a important driver of world markets so it is not in the interests of OPEC nations to impose too high prices for their product. Eventually this would lead to crises in the countries whom depend on this resource and a recession in these countries that high oil prices can trigger will inevitably effect demand for oil. “ The past 15 years should have made clear that the world oil market's problem is not high prices or low prices per se but price instability, which underlies the boom-bust cycle not only in the world energy market but also, because of oil's centrality, in the world economy as a whole. (Georgiou, 1987, p. 295) “ The mutual nature of his relationship is further compounded by the currency of exchange for oil reserves in the US dollar. Weakness in this currency seen in decreased economic performance will result in far reduced revenues by the OPEC nations. Therefore it becomes in the interests of OPEC nations to ensure that the American economy is strong. This requirement is often at odds with conflicts in American foreign policy such as the aforementioned area of conflict between the status of Israel in many Middle Eastern countries. Mouawad's article highlights some of the discord that exists within the OPEC organization. As the article indicates Saudi Arabia the largest producer in OPEC is currently happy with the demand pattern for oil. A decrease in price eases pressure of increased production and them as the largest producer of oil. The situation is reversed among the smaller OPEC nations. As the article indicates these countries are more than disconcerted by the reduced demand reflected in the decreasing prices of oil. Since so much the drivers for their own economies depend on overreaching their reduction quotas they are presently at a loss when there is a glut on the market. Conclusion OPEC formed in the 1960s gradually increasing its membership through to the 70s to its current contingent of 11 nationstates. This organization was formed to perceived sense of inequity with the dominant nations of the world mainly in the Western world. The organization is a cartel. It has attempted to control the price of oil by mutually agreed upon production quotas among its nationstates. This is not always been an easy agenda to achieve since there has been competition within the organization between the larger the smaller suppliers. The relationship has also been a complicated one between OPEC and the developed world which depends so highly on the oil produced. Conflicts in foreign policy such as between Israel and the Middle Eastern nations to name just one is often at odds with the deeply embedded nature of OPEC's success and the success of Western economies. Mouawad's article shines a spotlight on the current state of flux in OPEC's relationship with its markets. Appendix Normal Supply and Demmand Curve.( Fig. 1 ) Different levels of Price Ceiling ( Fig. 2 ) Price Ceiling set below the intersection of demmand and supply curves; below the market price and therefore generating excess demmand. ( Fig. 3 ) References Dorraj, M. (1993). Will OPEC Survive?. Arab Studies Quarterly (ASQ), 15(4), 19+. Retrieved September 12, 2006, from Questia database: http://www.questia.com/PM.qst?a=o&d=5000256003 Georgiou, G. C. (1987). Oil Market Instability and a New Opec. World Policy Journal, 4(2), 295-312. Retrieved September 12, 2006, from Questia database: http://www.questia.com/PM.qst?a=o&d=95721187 Ghosh, A. (1983). OPEC, the Petroleum Industry, and United States Energy Policy. Westport, CT: Quorum Books. Retrieved September 12, 2006, from Questia database: http://www.questia.com/PM.qst?a=o&d=23343062 Kohl, W. L. (2005). The Perfect Storm: OPEC and the World Oil Market. Harvard International Review, 26(4), 68+. Retrieved September 12, 2006, from Questia database: http://www.questia.com/PM.qst?a=o&d=5008875192 Moore, J. B. (2003). The Natural Law Basis of Legal Obligation: International Antitrust and OPEC in Context. Vanderbilt Journal of Transnational Law, 36(1), 243+. Retrieved September 12, 2006, from Questia database: http://www.questia.com/PM.qst?a=o&d=5002006204 Rueda, A. (2001). Price-Fixing at the Pump. Is the OPEC Oil Conspiracy beyond the Reach of the Sherman Act?. Houston Journal of International Law, 24(1), 1+. Retrieved September 12, 2006, from Questia database: http://www.questia.com/PM.qst?a=o&d=5000945081 At OPEC, Some Worry as Oil Prices Start Falling By JAD MOUAWAD Published: September 11, 2006 VIENNA, Sept. 10 — What a difference a few weeks can make. As OPEC ministers prepare to meet here Monday, the question on their minds is not how high oil prices will rise, but how far they may drop. Crude oil prices have fallen more than $10 a barrel in the last month, driving down the retail price of gasoline and providing some relief for consumers. While energy prices remain high, they have not risen to the heights that many analysts had feared, in part because of a light hurricane season this summer, the cease-fire between Israel and Hezbollah, and the fact that the United Nations has not imposed sanctions on Iran. While there is no sense of urgency about oil price increases, some members of OPEC are beginning to express anxiety about further price declines. Nigeria’s representative, Edmund Daukoru, who currently holds the rotating presidency of the group, said Sunday, “I am very concerned about the drop in prices. We do not know how much further they can go and we need to review that in depth.” Others are more optimistic. Ali al-Naimi, Saudi Arabia’s oil minister, said on Saturday, “Demand is very well satisfied — you read the numbers, you see the inventories rising. I think the market is very comfortable and very well supplied. We are very happy with the situation.” Members of the Organization of the Petroleum Exporting Countries account for 40 percent of the world’s oil exports, and they have been pumping at maximum capacity over the last year in an effort to drive down prices. It is unlikely that the OPEC ministers will alter at Monday’s meeting their current policy of keeping markets well supplied with oil. But some of them are beginning to think about whether to cut output next year, an effort that would be aimed at keeping prices from declining further. One consideration is that a sharp infusion of new energy supplies is expected to hit the market from producers outside of OPEC. The biggest increases are likely to come from African producers like Angola, from Russia and from Caspian nations, and from unconventional sources of fuel like ethanol, biodiesel or liquefied gases. “OPEC will have to cut supplies at some point, it’s a no-brainer, but not until new supplies come on the market,” said Deborah White, an energy economist with Société Générale in Paris. “There were forecasts for substantial non-OPEC supplies for 2005, but everything is running late and behind schedule.” She added, “The only thing OPEC is capable of doing is setting a floor for prices, but not a ceiling.” Like most oil producers, OPEC’s 11 members have struggled to catch up with rising demand in the last two years. For some, production has dropped because of armed conflicts, like those in Iraq and Nigeria; for others, lower production has stemmed from restrictive policies at home, as in Iran and Venezuela. Still, oil prices have dropped. Crude oil futures on the New York Mercantile Exchange fell on Friday to their lowest level in five months. The light, sweet crude contract for October delivery closed at $66.25 a barrel. Oil markets seem to have evaded predictions that the price would rise to $100 a barrel, but they remain at the mercy of sudden production interruptions. The hurricane season is only at the halfway point, the United Nations may still agree to impose sanctions on Iran, and Nigeria’s output remains crimped by violence in the Niger Delta region. Oil traders have recently been encouraged by signs that the physical market — actual barrels that are traded — is oversupplied, helping bolster fuel stockpiles in the United States to higher-than-average levels and helping to push prices down. Commercial stockpiles of crude oil and products are 6 percent higher today than they were last summer. Greg Priddy, an analyst in Eurasia Group’s Global Energy practice, said: “We’ve had two sets of factors moving in opposite directions: fundamentals are pulling the market down a little. But the political issues like Iran and Nigeria are still around.” At a meeting in June 2005, OPEC set an official quota of 28 million barrels a day for all its members except Iraq, which has not had a production target for years. Since then, the group has met five times without changing its output goal. OPEC members are currently pumping about 27.8 million barrels of crude oil a day, 200,000 barrels less than the quota. With Iraq, the group’s output is closer to 30 million barrels a day. As a group, OPEC failed to anticipate the rapid growth in consumption from China and the United States, an oversight that contributed to a sharp increase in energy prices. Production disruptions in Alaska and the Gulf of Mexico, and geopolitical tensions in the Middle East, have increased fears of supply shortfalls in the global energy markets. But just a few weeks ago, oil analysts and forecasters were issuing bleaker predictions still. The Atlantic hurricane season was expected to be as bad as last year’s; Iran, a top oil producer, was defying the United Nations over a nuclear research program; and BP was forced to shut down a major field in Alaska because of a pipeline leak. Then there was a monthlong war in the Middle East, which sent oil prices spinning to their highest levels in three decades, almost $80. Gasoline prices soared in the middle of the driving summer season. But just as suddenly, the bubble seems to have deflated. So far, there has been only one major hurricane, compared with six at the same time last year, including Hurricane Katrina, which flooded New Orleans and shattered the offshore oil infrastructure in the Gulf of Mexico. The war between Israel and the Hezbollah in Lebanon stopped last month without escalating into a regional conflict. And the prospect of sanctions against Iran seemed further off Sunday, as Iranian and European negotiators appeared to make some headway in their discussions, which are also taking place here. Of course, oil prices have tripled in the last five years. But when adjusted for inflation, prices have yet to reach records from the 1970’s, which would translate into more than $90 a barrel in today’s prices. Regular gasoline averaged $2.68 a gallon last week, an 11 percent drop from last month, according to the Energy Department. Read More