This is the Current State of Oil Market Prices

Since perhaps bottoming out in February 2016 -- a period where the price of crude fell more than 70 percent from its peak -- prices have increased more than 45 percent. Many attribute this spike to three important events: first, the supply outages in Iraq, the United Arab Emirates and Nigeria; second, indications of a drop in non-OPEC production; and third, Iran’s as-yet unfulfilled pledge to flood the market with oil.

Financial Firms Weigh In on the Future of Oil Prices

The current situation has invited additional inquiry and scrutiny. Some financial firms, including Morgan Stanley, believe that the price of oil had bottomed out and is now in the midst of recovery. The bank states, “Oil prices now seem to have bottomed, even though they are likely to stay subdued for the rest of this year before starting to move higher in 2017.”

Other organizations, such as the International Energy Agency (IEA), credit the rebound to a decrease in non-OPEC produced oil, particularly of U.S. domestic production, which reached its lowest point since December of 2009. The IEA also believes that oil prices have bottomed out and should continue to rally.

Many analysts do not agree with the assumptions and predictions of Morgan Stanley, the IEA and others, citing that increased prices will once again lead to ramp up production. “My concern is if the market surges right back to $50 a barrel…we just end up with another problem six months from now,” said one head of research at Goldman Sachs Group. “You’d be taking a lot of risk entering this market early.”

The Impact of the Commodities Market and Other Factors

An interesting trend of note is that several commodities have undergone a price spike -- copper, gold, and iron ore, cocoa, and lean hogs among them. This rise in the price of many other commodities raises another question: is the price increase a temporary benefit, a by-product from a widespread drop in commodities production? History has demonstrated that the commodities market is especially prone to overproduction following a price surge.

The answer to the oil price question may depend on other important factors. For instance, many who are bullish about oil prices don’t appear to account for the supply outages -- outages that occurred in countries that are the 6th-, 8th-, and 13th-highest producers of the world’s oil. These widespread outages almost certainly had a measurable impact on oil production and affected global oil prices to a degree.

Another important factor is the unpredictability of Iran’s oil supply. As of late February, the country was -- and still is -- adamant that it will continue ahead with aggressive production. Iran is the world’s 7th-leading producer of the world’s oil supply and is eager to reclaim its standing in the world oil market.

OPEC’s Proposed Production Freeze

The proposal put forth by some OPEC member countries to freeze production appears bleak. Any robust plan to decrease oil production was bound to be met by resistance from other member countries, and indeed it was. For one, Iran reemphasized its plans to significantly boost production despite any proposed plan.

Saudi Arabia also doesn’t appear to be taking any measured steps to reduce or freeze output: “Saudis want the price of oil to be low so that they can knock out the Americans,” said Gal Luft, senior advisor of the United States Energy Security Council (USESC). This is a potentially significant development, as Saudi Arabia is the world’s second-leading producer of crude oil.

Luft continued with his criticism of the proposal: “The Russians want it [the price of oil] to be high. I don’t see that there is a middle ground, between those that want high and those who want lows. I think (the March 20 meeting) will be a talk for the sake of talk, but nothing concrete will come out of it.”

Furthermore, economists continue to remain apprehensive about plans to freeze production, instead stating that a reduction in oil production is the only noteworthy action to stabilize the price of oil. Such economists also believe that the recent spike in oil prices is due to rare and unforeseen circumstances, not a measured and deliberate effort to freeze production.

Stakeholder Response and Future Developments

Stakeholders in the oil market -- investors, executives, workers, and national leaders -- are traditionally quite reactionary when oil prices suddenly swing in either a positive or negative direction. All things considered, it is very difficult, if not impossible, to predict the short- and long-term trends of oil production and oil prices.

Taking into account the turbulent nature of the world’s oil politicking, the degree of difficulty in making such predictions heightens. The uncertainty surrounding Iran, Iraq, Saudi Arabia, and Russia alone are enough to warrant caution about making reactionary decisions and predictions.

Regardless of how oil prices end up fluctuating in the coming months and into 2017, stakeholders would be wise to thoroughly consider events as they unfold in oil-producing countries around the world. Such events may not only predict the sustainability of short-term oil prices, but the long-term sustainability of the entire oil market.    

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. 

What Is OPEC and Why Does It Matter?

The Organization of the Petroleum Exporting Countries (OPEC) is an association of sovereign nations whose economies largely depend on their oil reserves, which are exported and sold as petroleum. The members of OPEC say that they manage oil prices in such as way as to try to ensure fair prices for everyone. Members include Saudi Arabia (the de facto leader), United Arab Emirates Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, and Venezuela.

The organization aims to ensure that oil markets remain stable so that business investors in the member countries earn steady returns, producers receive a decent income, and consumers obtain a consistent petroleum supply. OPEC attempts to achieve these goals by controlling the amount of petroleum exported by its member countries, which in turn affects the price of oil through the basic economic principle of supply and demand. This does not always work, as seen in the current oil market. Too much oil has been produced, and the demand has not increased sufficiently to keep up with the supply. This issue happened before in the 1980s.

Membership in OPEC: Tightly Controlled and Deeply Political

OPEC began with just five members: Iran, Iraq, Venezuela, Kuwait, and Saudi Arabia. All of these countries have remained in the organization for the duration of its existence. Any prospective member has to be approved by three-fourths of the existing members. This number must include all of the founding members. Moreover, Saudi Arabia is effectively the leader of the coalition. The country produces the most oil by far, and it has the second largest number of reserves only behind Venezuela. One might think that Venezuela would have influence over Saudi Arabia due to its reserves. However, Venezuela has many problems in maximizing production, and Saudi Arabia’s leadership continues.

Moreover, Ecuador and Indonesia both left OPEC years ago, and they recently rejoined. Both nations initially left the organization due to problems with the production quota and rejoined in time to become mired in the recent slump in oil prices. While OPEC’s mission is to keep the price of oil steady, tensions between smaller producers such as Ecuador and Indonesia, as well as leader Saudi Arabia, have almost certainly contributed to the collapse of prices. Many of the poorer countries want to cut production in order to keep prices high. However, the Saudis are still making profits and refuse to cut production. This has led to tensions within the organization and rumors of some countries leaving.

Similar tensions led to the nation of Gabon to leave OPEC after nearly 20 years as a member. As with Indonesia and particularly Ecuador, they felt that they wanted to produce more than the quota determined by OPEC. Saudi Arabia effectively sets the quotas, yet it produces as much as it wants and makes billions of dollars on it every year.

The Troubled and Turbulent History of OPEC

OPEC began, somewhat ironically, in response to the actions of the most powerful oil cartel of the time. The “Seven Sisters,” a group of the seven most powerful oil companies in the world, controlled prices and supply. The group cut price several times, which angered the oil exporting countries affected by the decisions. The five founding members of OPEC got together and decided they wanted to be in control of the world’s petroleum markets for both financial and political reasons. The United States and several other countries that controlled the Seven Sisters had strained relationships with the oil exporting countries. This gave these countries a reason to want to distance themselves politically. Of course, the main motive was profit. The oil-rich nations saw that they could control their supply, and manage it in a such a way that they made enormous profits.

Accordingly, OPEC was founded in 1960 in Baghdad. After several years in Geneva, Switzerland, it moved to Vienna, Austria. There were some rumors of a move to Beirut or another city in the Middle East, but these proved to be unfounded. OPEC has been located in Vienna ever since, and all of its members maintain a year-round delegation of diplomats to handle their operations with regards to OPEC.

OPEC soon realized that it could increase its power with more members, and it expanded rapidly throughout the 1960s and 1970s. The Yom Kippur War in 1973 led the Arab nations to declare an embargo on the United States and other countries that had supported Israel. The war quickly ended, but oil price remained high for the time being, and distrust between the United States and OPEC was at an all-time high.

The nations of OPEC ramped up production as a result of the high oil prices, and soon there was too much oil, which lowered prices. This is much the same dynamic that has been observed in the last couple years.