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SPE 82041 OPEC Oil Production Strategy and Its Implication On Global Oil Market Stability
SPE 82041 OPEC Oil Production Strategy and Its Implication On Global Oil Market Stability
OPEC Oil Production Strategy and Its Implication on Global Oil Market Stability
Omowumi O. Iledare,SPE, Center for Energy Studies, Louisiana State University
Moreover, information on world demand schedule is now great understanding that excess production in the international
guardedly monitored by OPEC. Also, it seems that supply oil market can decrease prices. It has been suggested that the
from many non-OPEC nations are repressed by reticent member nations in this group constitutes the collusive core
leasing policies, unfavorable fiscal terms and taxation regimes, in OPEC [3].
maturity of basins and natural resource depletion. The more Nigeria, Venezuela, and Indonesia are a heterogeneous set
limited the supply response from non-OPEC producers, the of exporters as evident in Figure 4 in terms of their export
higher the price and the more production discipline OPEC dependency on petroleum. Nigeria’s export dependency on oil,
must exercise to stabilize oil prices. Some experts may on average, was 94 percent from 1982-2001. The oil export as
disagree with this rather simplistic view on what has happened a fraction of total export, on average, for Venezuela and
since late 1999. Other experts may, however, agree that it is in Indonesia was the lowest and second lowest, respectively from
OPEC’s interest, being the dominant incremental or residual 1999-2001. The group, however historically wants a high
supplier, to seek a stable market and to be prepared to exercise output. The three countries in this group accounted for about
production discipline in the face of excess oil supply and 25 percent of production from a disproportionately low share,
falling oil prices. 15 percent, in reserves from 1982-2001. Because of their large
population, the group has pressing desires for high revenues to
Understanding OPEC Diversity feed their populations. It would therefore seem in their
national interest to wan to produce more than the allocated
Economic and technical data from OPEC member production ceilings. However, as evident in Figure 6,
countries have been used to categorize members into describing excess production from 1982-2001 by member
economic and political blocks [3, 5]. Such economic and nation, this group within the last three years seems to have
technical data that may affect production ceiling allocations to disavowed production indiscipline in their ranks. In fact,
member nations may include, production capacity, export between 1999-2001, the level of production indiscipline was
dependency, currently estimated proved reserves, and very minimal in the group, contrary to expectations.
measures of the economic performance of member nations, The perceptible political divergence in OPEC is
such as per capita GDP, balance of payments, or foreign sufficiently complicated. Some members, at least five,
exchange index. Figures 3-6 present a pictorial view of OPEC currently practice some form of democratic government. They
member characteristics, which may form the basis for the have elected public officials to run the affairs of the member
apparent alliances among members and their dispositions at nation. A more foundational political grouping, however,
OPEC extraordinary meetings. could be described as Arab and non-Arab members. The Arab
Three dissimilar groups in OPEC can be intuitively group can be subjectively classified as either conservative or
identified from Figure 3. The OPEC core, which includes radical in orientations. The Arab members of OPEC include
Saudi Arabia, Kuwait, Libya, Qatar, and United Arab Emirate, Saudi Arabia, Kuwait, Qatar, Algeria, UAE, Libya, and Iraq.
has sparsely populated desert areas with a relatively high per The Arab group controls more than 75 percent of OPEC
capita GDP and per capita proved reserves. The core group reserves and estimated capacity in 2001.
controls more than 60 percent of OPEC excess capacity
(excluding Iraq) and OPEC productive capacity (including Perspectives on OPEC’s Future
Iraq) between 1999 and 2001. It seems to be in the national
interest of this group to advocate higher production, That OPEC has survived for more than four decades is
discourage any supply-driven increase in oil prices that can incredible, considering the diversity of its members and the
subsequently encourage the entry of high cost oil into the enormity of its task to manage expediently the supply aspect
global oil market. Saudi Arabia, which accounts for nearly of the international oil markets. The difficulty of managing oil
one-third of OPEC proved reserves, has reasons to favor supply is further convoluted because of data limitation and
keeping the price of oil low to minimize incentive to develop imperfection as well as inadequate market instruments with
alternative sources by non-OPEC producers. It must be noted, which OPEC can influence the international oil markets [5, 6].
however, that despite the fact that the OPEC core group According to Kohl, OPEC is an organization of governments.
accounted, on average for over 60 percent of OPEC total Unlike firms who can form alliances and collude to control
reserves from 1982-2001, the group accounted for just about supply and raise prices, most decisions from OPEC meetings
50 percent of OPEC production, on average, over the same are by consensus. Political compromises and the formation of
period. Thus, it is plausible to suggest that the core group has a shifting coalition from time to time embody most decisions
been very willing to keep in perspective the overall objectives by the OPEC Ministerial Conference, the highest governing
of OPEC, even as they pursue their national interest authority of the Organization [2,5,6]
within OPEC. These compromises and the shifting of alliances, not
The second group within OPEC may be described as withstanding, OPEC is very much aware of the significance of
“revenue maximizer” because they favor high oil prices. The other important economic and political factors. For example
countries in this group include Iran, Iraq, and Algeria. The price elasticity of demand (Eopec ) for OPEC oil , a measure
countries have larger population than the core group and are of the responsiveness of the demand for OPEC oil to a change
also characterized with small per capita reserves and a in price, determines must determine OPEC oil price (P) mark
relatively greater development potential than the OPEC core up over the marginal costs (MC) such that:
group. The group characteristically prefers and advocates
high prices to generate high revenue with less output, with a P / MC = Eopec / (Eopec - 1) (1)
SPE 84021 3
That the short run price elasticity of oil is inelastic is not and demand to ensure stability in international oil markets is
conjectural, however, in the long run there are possible the changing structure of the global E&P structure and the
substitutes for OPEC oil. Thus, a misjudgement of the evolving operational strategy of E&P firms. It will certainly
elasticity may send a wrong signal with respect to the be quite favorable to OPEC if multinationals continue to
appropriate production adjustment that would balance supply engage in prospecting for petroleum all over the world
and demand to ensure stable and reasonable the international including OPEC countries, making it possible to develop
oil market price. Such misjudgment, assuming OPEC price cheap oil first. And as E&P firms develop and use new
determines world price, can definitely affect OPEC’s technology to lower finding and development costs, there will
influence in global oil supply as an incremental producer. be pressure on oil prices to adjust according to the dictates of
Another economic factor that OPEC must keep in the global market environment. In addition, as the industry
perspective in its adjustment of production ceilings to global becomes more efficient as a result of industry restructuring,
oil supply is non-OPEC supply response to a change in price. one expects the industry to be less susceptible to price
According to the basic law of demand, a change in world price disruption. Thus, making the managing of the supply aspect
(∆P) will lead to a change in global demand for oil (∆qworld). of the international market less difficult to OPEC.
However, if the global residual demand for OPEC oil In Adelman’s words, “OPEC has no power of its own. It
(∆qopec) is defined such that: is an organization and forum, within which members must
from time to time (emphasis mine) assemble a coalition …”
∆Qopec / ∆P = ∆Qworld / ∆P - ∆Qnopec / ∆P (2) [6]. In the future, OPEC will still not be able create its own
market power, except that which is given to it as a result of
Then the market power of OPEC is equally dependent on high oil depletion patterns in almost every non-OPEC
other factors such as the responsiveness of non-OPEC supply countries, petroleum basin maturity in some of these countries,
to price change, non-OPEC productive capacity levels, and and less than favorable petroleum development policy. OPEC
world oil demand response to price change. Equation (3) still has a lot to learn, however, from the global supply process
describes the relationship between the elasticity of demand for in late 1998. As stated by Adelman (2002), the success to
OPEC (Eopec), world oil demand elasticity (Eworld) and non- bring price to a reasonable level came as result of the level of
OPEC supply response (Enopec) as follows [3]: cooperation by nearly all OPEC members to exercise
production discipline.
Thus, OPEC can still have and wield significant weight on
Eopec = fworld Eworld + f nopecEnopec (3) the international oil markets if they continue to form and
reform alliances when needed using political compromises and
Where fw = Qworld / Qopec and fnopec = Qnopec / Qopec keeping in mind institutional developments in OPEC and
Qworld represents world oil demand some important economic factors affecting the global oil
Qopec represents residual demand for OPEC oil market. For example, conflict resolution approach may
Qnopec represents non-OPEC supply become more relevant to OPEC stability as the relevance of
market shares become significantly less important. There may
The future role of OPEC in global oil supply and pricing also be need to put instruments in place to detect cheating
also may depend on the rate of economic growth in the major among members and enforce some retribution for cheating. An
oil consuming nations, the OECD. Economic growth in OECD agreeable mechanism governing production ceiling allocations
nation can significantly affect the rate of depletion of oil in on the basis of concrete factors/criteria can also facilitate
most OPEC member nations and subsequently increase high production discipline among members thereby enhancing
cost of extraction. Under such circumstances, production equitable distribution of any new incremental call for OPEC
capacity would have to rise and more reserves discovered to oil in order to minimize supply disruption and
decrease rising cost of extraction. It is also expected that price instability.
favorable tax policies to promote restricted development and
production of domestic oil reserves in OECD countries as well
as consumption related taxes to encourage conservation has Modeling OPEC Production Ceiling Allocations
potential implication on global oil supply and pricing and the
role of OPEC. The underlying assumption for this modeling framework is
In fact, the U.S. energy policy objectives of optimal that OPEC is an incremental or swing oil producer with a
energy efficiency, cheap and secure energy, and clean corporate desire to promote stability of the international oil
environment, when fully developed and implemented, will market and prices. In addition, we posit that OPEC is in
have significant impact on global oil supply and prices as agreement to do what it takes to ensure stability in oil prices,
evident in the relationship described in equation (3). keeping in perspective the need to eliminate the burden of
Moreover, diversification of oil supply sources and energy price volatility on the global oil market. Furthermore, OPEC is
mixed for industrial production can be expected to reduce the committed to expand its production capacity to balance the
hitherto irresponsible response to any little political global oil market, and when the need arises, it will exercise
disturbance in the Middle East. production discipline to curb any excess oil supply in the
Another factor that can significantly affect OPEC’s search market. Thus, OPEC as an institution expects member nations
for an appropriate production approach which balances supply to be prepared to produce oil within the dictates of global
market demand for its oil.
4 SPE 82041
increases, the relative change in (natural logarithm of) Qworld = World oil demand
production allocations also increases, even though Qopec = residual demand for OPEC oil
inelastically. Meaning a one percent change in the relative Qnopec = non-OPEC supply
price of oil will lead to less than one percent change in ∆P = change in oil price
production ceiling allocations, ceteris paribus.
∆qworld = change in world oil demand.
∆qopec = change in OPEC supply
Summary and Conclusion
∆qnopec = change in non-OPEC supply
This paper evaluated OPEC data on reserves, production fw = Qworld / Qopec
ceiling allocations, estimated production capacity, oil prices, fnopec = Qnopec / Qopec
per capita GDP, and export dependency indicator. To
understand and analyze the impact of these factors, especially Acknowledgment
prices on production allocation mechanism, an empirical
model was specified and estimated using a panel data in which The author acknowledges the research assistance provided
the cross section is represented by each OPEC member over by Richard Pincomb. All conclusions and errors are the sole
the time period 1982-2001. responsibility of the authors.
The estimated model confirmed that as oil price increases
ceteris paribus, production ceiling allocation to OPEC References
member is expected to increase. The responsiveness is, 1. Organization of the Petroleum Exporting Countries (OPEC).
1980. The Statute of the Organization of the Petroleum
however, inelastic. This means that a one percent price Exporting Countries, OPEC Secretariat, Vienna, Austria.
increase will lead to less than a one percent increase in 2. Dahmani, Atmane and Mahmoud H. Al-Osaimy. 2001. “OPEC
individual quotas to member nations. The results also showed Oil Production and Market Fundamentals: a Causality
that production allocations to member nations increase with Relationship.” OPEC Review, Vienna, Austria: OPEC
capacity expansion and reserves. However, the relative Secretarial., December 2001, pp 315-337.
change in allocation to each member is higher with respect to 3. Griffin, James M. 1980. Energy Economics and Policy, New
a relative change in capacity than the change with respect to York, NY: Academic Press
reserves. Thus, member nations seeking a significant higher 4. U.S. Department of Energy, Energy Information Administration.
allocation from incremental demand for OPEC oil must 2002. International Energy Outlook, 2002. DOE/EIA-0484
(2002), Washington, D C.
demonstrate a substantial increase in capacity, bearing in mind 5. Kohl, Wilfrid L. 2002. “OPEC Behavior, 1981-2001.” In Oil
the contemporaneous nature of OPEC allocation criteria. and the Economy: Recent Experience in Historical Perspectives,
Finally, the results suggest that if OPEC really wants to James L. Smith, ed., Quarterly Review of Economics and
accomplish a stable oil market, then each member nation must Finance, vol. 42, no.4, pp.209-233.
accept some joint responsibility and bear some equitable 6. Adelman, M.A. 2002. “World Oil Production and Prices, 1947-
production reduction based on these criteria as and when 2000.” In Oil and the Economy: Recent Experience in Historical
necessary. Such an agreeable mechanism governing Perspectives, James L. Smith, ed., Quarterly Review of
production ceiling allocations can significantly reduce the Economics and Finance, vol. 42, no.4, pp.169-191.
apparent lack of production discipline among members, which 7. Organization of the Petroleum Exporting Countries
has hitherto mired the organization in its effort to ensure (OPEC). OPEC Annual Statistical Bulletin 2001.
sustainable and realistic oil price levels.
Nomenclature
60.0 $40.00
Share Price
$35.00
50.0
$30.00
40.0
$25.00
30.0 $20.00
$15.00
20.0
$10.00
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12.00
10.00
MMBbls/day
8.00
6.00
4.00
2.00
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1979
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1980s
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Figure 3: Average Per Capita Gross Domestic Product for OPEC Members
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8 SPE 82041