Wednesday, February 10, 2016

A Guide to OPEC, Oil Prices, and the Global Economy

Oil continues to function as an increasingly important commodity, despite considerable advancements in alternative energy sources. Industrialized nations use oil to power their cars, heat their homes, and fuel planes that make international travel possible. Oil is also used in the production of common household items including shampoo, shaving cream, and even deodorant. It is not surprising, considering its many uses, that the presence of oil can make the difference between poverty and wealth in a nation or region. More than five decades ago, a group of five major petroleum-producing nations gathered and formed OPEC, an organization that has remained influential in the world since its inception.

What is OPEC?

OPEC stands for Organization of the Petroleum Exporting Countries and was founded in 1960 in Vienna, Austria. The organization was created by five founding members: Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. OPEC has grown to include Algeria, Angola, Ecuador, Indonesia, Libya, Nigeria, Qatar, and the United Arab Emirates. Since Saudi Arabia is the most profitable oil producer in OPEC, it has become the organization’s de facto leader. Representatives from member nations meet semiannually at the OPEC Conference in Vienna, and the organization ensures each member has only one vote. Altogether, OPEC countries produce roughly 40% of the world’s crude oil, and their oil exports account for 60% of the international petroleum trade. In addition, more than 80% of the world’s “proven” oil reserves are located in OPEC countries. OPEC’s effect on the world economy is therefore substantial and cannot be ignored.

How does OPEC affect the global economy?

Because OPEC controls such a large share of the world’s petroleum supply, it has a major influence on the global economy. Regional and international politics can lead to an increase in oil prices, as it did from 1973-1974 during the oil embargo imposed by OPEC on the United States and other Western countries that took Israel’s side in the Yom Kippur War. The countries affected by this embargo then formed the International Energy Agency. A worldwide economic recession developed following the embargo, with unemployment and inflation rising considerably. Fuel rationing occurred in the US and some European countries until the embargo ended in March 1974. This incident demonstrates the severe consequences of an OPEC embargo and led nations to begin seriously considering long-term oil conservation and alternative sources of energy.

What else does OPEC do?

OPEC also wields influence in the international development sphere. In the 1970s, the organization established a Fund for International Development (OFID) to promote cooperation between member countries and other developing nations around the world. Some of its activities include funding humanitarian emergency relief, financing private sector projects, and extending loans for development initiatives and trade financing. The organization also finances projects in agriculture, education, health, and water and sanitation. Since its establishment, OFID has provided support to initiatives and entities in 134 countries.

How does OPEC influence oil prices?

Crude oil prices have fallen to a trading price of around $30 a barrel. This price is the lowest in 12 years. The reasons for the drop are complex, but a few big factors come into play. First, experts have cited high production as one of the causes—in December 2015, OPEC tossed aside production limits for its member countries, which it typically imposes to control prices, although member countries have often ignored these caps. Instead, OPEC effectively decided in favor of limitless production, in what industry observers say is an attempt to elbow other producers out of the market. Besides oversupply, experts also point to falling demand, particularly in China, as a reason for falling oil prices, while also claiming that the strength of the dollar contributed to the current situation as well. International politics are also partially involved, as Iran and Saudi Arabia ended diplomatic ties recently.

In general, supply is an important factor when considering oil prices and production. For many years, industry experts and academics have debated the true total extent of the world’s oil supplies.

What is peak oil?

Peak oil is a theoretical point in time when the maximum petroleum extraction rate is achieved, following which the rate continually declines. This theory is rooted in the observed rise, peak, fall, and end of petroleum production in individual oil fields over time. The peak oil theory has proliferated throughout the science and business communities, as well as the general public, since 1919, when it was first proposed by David White, then the Chief Geologist of the US Geological Survey.

While the theory has persisted for many years, the exact timing of this point—and even its existence—is a matter of hot debate. White incorrectly believed it would happen within three years of his proposal of the theory. The late geoscientist M. King Hubbert, who advanced the theory considerably, was also incorrect in his estimation that the world would hit peak oil in 2000. Today, some pundits predict that oil production will begin to decline after 2020.

However, the truth is that there is no consensus about peak oil. New technologies, such as hydraulic fracturing, have allowed for access to previously inaccessible deposits, effectively increasing the world’s supply. If other new technologies are developed, other deposits now considered inaccessible may be exploited in the future. Other matters that complicate the idea and timing of peak oil include the fact that many countries’ “proven” reserves have not been verified by independent audits, and there are economic reasons for them to overstate or understate their true numbers. 

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