The Decline of OPEC’s Rule
Image courtesy: Akos Stiller/Bloomberg
Since its creation in 1960 and its international prominence during the 1970s, OPEC has long been considered the dominator in world oil markets, influencing oil prices at will. However, especially in recent decades, the influence of OPEC seems to be dwindling. To what extent is this true, and what could be some short-term and long-term causes?
What is OPEC?
The Organization of the Petroleum Exporting Countries (OPEC) is essentially a cartel composed of 13 members (Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela) who export oil. Founded in 1960, the founding members of OPEC sought to limit the influence of the “Seven Sisters,” which were seven international oil companies that dominated oil production. Since then, OPEC has expanded to OPEC+ in 2016, including ten further members (Azerbaijan, Bahrain, Brunei, Kazakhstan, Malaysia, Mexico, Oman, Russia, South Sudan, and Sudan). Today, these 23 members dominate oil production, holding more than 80% of the world’s proven oil reserves and producing about 40% of the world’s crude oil.
Image courtesy: Council on Foreign Relations
This allows them to increase or decrease oil prices by either lowering oil supplies or pumping more oil into the market. For example, when crude oil prices crashed during the COVID-19 pandemic, OPEC members agreed to cut oil production by 10 million barrels a day to push back the price. Indeed, oil prices went back up over $70 per barrel by 2021.
Dwindling influence
In recent years, OPEC’s supply cuts have failed to boost oil prices as much as before. In April 2023, Saudi Arabia and other major oil producers announced surprise cuts totaling up to 1.15 million barrels per day from May until the end of the year. These cuts, however, failed to make much of a dent in crude oil prices for a full month; in fact, oil prices dropped further from $79.31 in May to $74.47 per barrel in July before prices increased.
There are several reasons behind its weakening control over the oil market.
Decreasing consumer demand
Especially in the US, high interest rates, income tax, and inflation are curbing demand––including demand for travel, which uses oil. As consumers are pressured with less disposable income, spending on driving and traveling is decreasing. Just from 2021 to 2022, real median household income after taxes fell 8.8% to $64,240 due to the expiration of tax policies and relief payments such as the American Rescue Plan Act (ARPA) or Economic Impact Payments (EIP). This is significant, considering that the real median household income is almost always growing around 2.5% except during recessions. This negative growth may entail a decrease in demand for oil-consuming activities.
Source: Federal Reserve Economic Data
US petroleum production
The increasing U.S. crude oil production has significantly diminished OPEC’s influence on the global oil landscape. This surge in American oil output has bolstered global oil supplies, thereby diminishing the impact of OPEC’s oil cuts on importing nations, which now have the option to source oil from the United States. This increase in production has also intensified competition, posing a formidable challenge for OPEC to sustain elevated prices through oil cuts without jeopardizing their market share and revenue. Furthermore, by reducing their dependence on OPEC oil, the U.S. and others have reduced their dependence on OPEC oil, rendering them less susceptible to the fluctuations in OPEC’s supply decisions.
Technological advances & alternative fuel sources
Technological advances and alternative fuel sources are also steadily decreasing oil prices in the long term. Technological advances allow crude oil to be extracted and refined more cheaply, which naturally results in lower prices. For example, advances in seismic imaging technology are increasing the supply of oil and cutting exploration costs.
Source: Our World in Data
Alternative fuel sources are also becoming more attractive for consumers as technology becomes cheaper and the push towards “cleaner” energy sources rises. Unconventional oils, such as shale-based energy, are increasingly becoming more viable and abundant as seismic technology advances. Cleaner energy sources such as natural gas and nuclear power have become more attractive in recent years than crude oil as concerns about environmental degradation and global warming intensify. With more volume and alternatives to crude oil, OPEC will have a harder time influencing prices when demand for crude oil is not as guaranteed. Benjamin Zycher, senior fellow at the American Enterprise Institute (AEI), said, “These long-term market forces suggest that the economic power of OPEC inexorably will erode.”
Divisions within OPEC
OPEC’s power has also weakened due to divisions and cheating within the OPEC countries. In the 1980s, OPEC conferences were marked by disputes between “price doves” advocating for higher oil output and lower prices, and “price hawks” mainly from populous and financially strained member states. Wealthier OPEC countries like Saudi Arabia, the UAE, and Kuwait were doves willing to accept lower prices to maintain their dominance in oil markets. In contrast, hawks like Iran, Iraq under Saddam Hussein, and Libya sought higher prices. Disagreements between the doves and hawks lead to inefficient production quotas and pricing policies, as well as countries not following the quotas at all––OPEC members have strong incentives to exceed their production quotas because higher oil output leads to increased revenue, especially during periods of high oil prices. However, OPEC lacks effective monitoring and enforcement mechanisms to prevent such cheating. While Saudi Arabia has historically been seen as OPEC’s enforcer, its only real tool to punish cheating is to engage in a price war by flooding the oil market, which can harm its own and OPEC's revenues. According to a Cato Institute report, members’ production exceeded their quotas nearly 80 percent of the time, exceeded their quota by more than 5 percent nearly 45 percent of the time, and exceeded their quota by more than 10 percent nearly 30 percent of the time. This makes some economists doubt the actual power of OPEC. David Kemp and Peter Van Doren of the Cato Institute suggest that the announcement of quotas is used to “support the perception that OPEC adjusts oil production to oil prices.”
OPEC’s influence on oil prices and the wider global economy won’t disappear overnight, but it is clear that its extent is diminishing. It is not the 1970s anymore. The world has much changed since 50 years ago. And investors are starting to notice.
Kemp and Doren sum it up nicely: “So, what does OPEC do? It blusters its citizens to create the appearance of controlling the West. And, in turn, western countries reciprocate by using OPEC as a scapegoat for unpleasant oil supply or demand shocks. It is theater.”