OPEC and the global energy order
From its Origins to the Present Time
New York University ABU DHABI
18-20 April, 2017
Once upon a time, there was an intruder called OPEC …
I – The origins of OPEC
History has taught us that great events are the result of the conjunction of other more or less important events. They are like the pieces which are put together in a puzzle to make the final image. This was the case of the creation of OPEC.
Very large oil deposits were discovered all around the world over the course of the 1950s. In Iraq, Libya, Algeria, Nigeria, China « elephants » were born. There was euphoria within the ranks of the producing countries, who expected their oil revenues to rise. But the Seven Sisters had a different opinion. In order to avoid the price drop that they expected, they decided unilaterally to restrain their production; the fact that they didn’t consult the host countries, caused the anger and the frustration of the latter. This was the first piece of the puzzle.
Second piece of the puzzle: would OPEC have existed, were it not the troublemaking actions of the chief officer of ENI Enrico Mattei? We don’t know, but we know for sure that he played a key role in the process. His company, a Western oil company, was the first to propose a 75%/25% split of profits with the oil producing countries; a 50%/50% split was the commonly used rule at the time. The Engineer, as they called him in Italy, simultaneously entered into negotiations with the Soviet Union for the purchase of crude oil and got a much lower price than the one practiced by the Seven Sisters. This time the anger was in the ranks of the majors, but business is business : they decided to push down the posted prices. That was another unilateral decision which caused a new clash with the producing countries.
The third piece of the puzzle is the seemingly innocuous intervention of the journalist Wanda Jablonski, which brought the two main actors of the creation of OPEC, Abdullah Al Tariki and Juan Pablo Perez Alfonso, to know each other better. In the aftermath of the price drop decided by the majors, the defence strategy of the two ministers took shape. The representatives of Saudi Arabia, Venezuela, Iraq, Iran and Kuwait met in Baghdad from the 10th to the 14th of September 1960 and decided to create the Organisation of Petroleum Exporting Countries, OPEC .
« We are writing history, » said the Venezuelan minister at the end of the conference. And he was right, even if the newspapers and the world public opinion gave no particular importance to the event; for a long time they considered the new organisation to be an empty shell. How could it be otherwise knowing how unbalanced the division of power between the majors and the producing countries was ? It was David versus Goliath. But the creation of such a gathering was already a great victory in itself, even if OPEC was, during the first years of its existence, just a high tribune from which members expressed different demands. The historical context was very favorable to the Third World countries who were becoming more and more aware of their very existence and discovering their political and economic rights. We have to remember that the majority of them were just emerging from a long colonial night. They began questioning the current world order which seemed to be established forever, and were assembling in new political forums, the most important of them being the the non-aligned movement which held its first Heads of States Summit a few years earlier in Bandoeng. In the newly created organisation OPEC, member countries were only requesting the right to be heard. All they asked for was that the Seven Sisters should consult them before taking any decision concerning the way they exploited their oil, that raw material so vital for their peoples.
The adoption of the OPEC charter in Caracas, a year after its birth, showed to the world that these states were willing to « coordinate and unify the oil policies of the member countries and to determine the best means of safeguarding their interests, individually and collectively « . As early as 1964, OPEC countries succeeded in imposing on the oil companies operating on their territories a 12.5% ??royalty that had to be included in the operating costs, bringing the State’s share of the profits to 56.25%. For a new born baby, it was already a great achievement. However, it was during the following decade that the biggest breakthroughs would be made.
II – The Golden Age of OPEC
During the 1960s the producing countries expressed three quantitative demands – a production increase, a posted prices increase and a tax rate increase – and one qualitative, to be consulted for any decision related to the exploitation of a natural wealth located in their subsoil. Things started changing at the very beginning of the 1970s.
A few months after he came to power, Colonel Muammar Gaddafi took action that triggered major upheaval on the world oil scene. Since the global negotiations on prices and taxation initiated in January 1970 with the international oil companies (IOC) failed, the Libyan government started bilateral talks with each one of them separately, imposed lower production levels and promised to revise the quotas should the IOCs accept the requested changes. This strategy proved to be a winning one since, after a 9-month restriction, the weakest link of the group, Occidental Petroleum (Oxi) finally cracked causing the others to fall with it like dominoes. The price of a barrel of Libyan oil then rose from $ 2.21 to $ 2.53. This thunderbolt in a world previously controlled by the Seven Sisters was followed by a cascade of events elsewhere in the world. Iran, in its turn, asked the consortium of companies operating in the country to enter into negotiations in order to increase the production and threatened to cancel some of the existing concessions should the discussions fail. But the decisive turning point in the relationship between the producing countries and the IOCs came at the meeting of the OPEC Council of Ministers in Caracas in December 1970. The resolution 120 that was then adopted, is probably the most important one in the annals of the Organisation to date; it recommended raising the tax rate on profits of oil companies to at least 55% and supporting in advance any government that would take such a step. The host country of the conference, Venezuela, set an example and switched immediately to 60%. The resolution also called on member states to seek a general increase in posted prices, to standardize them in line with the highest, and to encourage countries to proclaim such prices by themselves. The conference also decided to adopt new bases for the establishment of a scale of crude prices by introducing the concept of differentials in relation to the benchmark crude, the Arabian Light delivered at Ras Tanura. At the same meeting, the ministers approved the Libyan restrictions and decided to index oil prices on the development of inflation in the client countries.
In the aftermath of this twenty-first Ministerial meeting of the Organization, the world’s attention was focused on Tehran and Tripoli. During the first days of January 1971, a tripartite meeting between Iran, Iraq and Saudi Arabia held in Tehran decided to convene representatives of companies operating in the Gulf area for negotiations on prices and taxation and to fix a scale of prices of different qualities of crude. To support such a step, OPEC decided at an extraordinary ministerial meeting that, in the event that the cartel of companies refused to negotiate, all the members of the Organization would undertake a common action, including a total embargo on deliveries, if necessary. The firm position of the producing countries made the oil companies cartel give up; they agreed to talk about posted prices, thereby abandoning for the first time what they considered to be an attribute of their sovereignty.
They also admitted the necessity of safeguarding the purchasing power of oil-producing countries by price indexation and the allocation of geographical premiums to certain crude oils as well as a revision of taxation. The benchmark crude oil price (i.e. the Arabian Light) rose then from 1.79 $ a barrel to 2.17, while the tax rate increased everywhere to 55% of the profits. More subtly, the cartel recognized OPEC as a valid interlocutor, acting on behalf of all member countries, with whom a comprehensive agreement should be reached. This was in fact a strategic step that they took, but it didn’t succeed. What the IOCs were really aiming at was to make the ongoing negotiations in Tripoli obsolete, because they feared that the two groups of OPEC negotiators in Tehran and Tripoli would use the leapfrogging technique, meaning that each one of them would alternatively take advantage of the results obtained by the other one and raise the stakes.
In Tripoli where negotiations on Mediterranean oil were going on, the solidarity within OPEC was even more spectacular. On the10th of February 1971, when the Tehran negotiations seemed to be coming to an end, Saudi Arabia and Iraq decided to stop all deliveries at the Mediterranean terminals in order to support Libya in its efforts, since the battle was very tough on that side as well. After a March full of twists and turns, an agreement was signed in Tripoli on April 2nd 1971, pushing the posted price of the 40° API Libyan oil up to $ 3.447 per barrel and the tax rate to 55%.
Then came the period of nationalizations. Algeria was the first to break the glass ceiling that the producing countries were bumping into since the unfortunate Iranian experience of 1951.On the 24th of February 1971, the government of President Houari Boumediene decided to restore the sovereignty of the State over the country’s reserves of hydrocarbons. He declared the nationalization of 51% of the assets of the foreign companies on oil fields, 100% on gas deposits and 100% on all pipelines. Other countries shortly followed Algeria’s example. And then, in September 1971, the OPEC Ministerial Conference adopted a resolution that proclaimed that nationalization was a sovereign right of the Member States and engaged them to take shareholdings in the oil companies present on their territories.
The years 1972 and 1973 saw a constant escalation of the confrontation between the two camps, consumers versus producers. The conception of the petroleum strategy of the consumer camp had ceased to be the prerogative of the multinationals only. The governments of the OECD member states began to intervene more and more directly in oil affairs, always with the same objective: to challenge the price increases made by the producing countries, to reduce their own dependence on OPEC oil and to acquire the tools needed to oppose the organization, whose role had become unavoidable on the world oil scene. Among the measures taken by the OECD member countries, the most important were those taken by the US government when it decided to end the convertibility of the dollar to gold, before announcing two devaluations in December 1971 and February 1973. To compensate for the decline in revenues caused by these devaluations, OPEC entered again into negotiations with the petroleum companies’ cartel. The price increases obtained during the two rounds, known as Geneva I and Geneva II, were not sufficient to cover the deficit; so OPEC decided to adopt a basket of currencies for the determination of oil prices.
The end of 1973 was marked by an unprecedented situation: in order to support Egypt’s war effort, the Arab oil-producing countries put the United States, South Africa, Rhodesia, Portugal and the Netherlands under embargo and decided to reduce their oil production. This decision of the OAPEC group led to a complete upheaval of the world oil scene for a very long time. Some of its consequences are still visible today. It had considerable repercussions on the development of new energy sources, on the North-South relations, on the energy policy and the economy of Western countries, and on the US policy in the Middle East. The immediate result was soaring prices because of the dog-eat-dog policy prevailing in the consumer camp and because of the action of speculators. That was the outbreak of what has been called the first oil shock. Then OPEC took things in its hands and succeeded in maintaining the price increase within a reasonable margin, while the profits of the Seven Sisters rose by some 60% that year. This proved that the price increase was in fact a good fit for their business, since they had launched very large investments in Alaska, the North Sea, and the Gulf of Mexico and had already started exploitation of shale oils, all in the name of reducing dependence on OPEC oil.
As early as January 1974, the United States prepared for a battle against OPEC. From their point of view, it was necessary to organize a front of OECD countries with a comprehensive response to the initiatives of the producing countries. This proposal took shape during a conference in Washington, from 11 to 13 of February 1974, which gave rise to the war machine that Henry Kissinger wanted, i.e. the International Energy Agency (IEA). The agency only really became effective a year later and ended up being a formidable instrument in the service of its members. Defying all expectations IEA opposed the official position that the West had taken up to this point. Faced with the frenzied lobbying of the Seven Sisters and that of the American Secretary of State, one of the first decisions taken by the agency was to advocate the establishment of a high minimum price of oil. It became then clear to everybody that the violent campaign led against OPEC during the last months, accusing it of wanting to impose high prices of oil, actually aimed to cutting it off from its natural allies, the countries of the Third World, who were in reality the biggest losers of such a policy.
Taking the plight of the poorer nations into consideration, the Sovereigns and Heads of States of OPEC, gathered at the first OPEC Summit in Algiers in 1975, reaffirmed in a solemn declaration the «natural solidarity which unites their countries with the other developing countries in their struggle to overcome under-development» and established a special fund whose goal was to help these countries and provide them with the financial resources required to carry out their economic and social development. It also decided to extend the struggle to the other raw materials.
To resume, we can say that the main objective pursued by the producing countries during the decade of the 1970s was a permanent battle to assert their sovereignty over the natural resources of their subsoil. It was an extremely difficult challenge because oil is, as we know, a strategic matter. It irrigates the world economy as does blood in a body, but it is also thanks to oil and because of oil that wars are conducted. This wealth was, since that historic meeting in Achnacarry in August 1928, controlled by a cartel of incredible power. The Seven Sisters considered that power to be their exclusive right and the idea of wresting it from them was simply unthinkable. The impossible happened however, thanks to the unfailing solidarity that existed between the members and also with the other Third World countries. But the wheel of History turned and things changed fundamentally during the following decade.
III – 1980 – 1990: transition of leadership from OPEC to IEA
The virtual disappearance of Iranian oil from the market in the aftermath of the 1979 revolution had an immediate consequence: the price increase of the barrel of oil. In spite of what has been said, the second oil shock that ensued was not initiated by the producing countries. How could they have triggered a process that would negatively impact their political, economic and social situation? Moreover, OPEC played a rather moderating role. The official price of the Arabian Light rose only from $ 13.30 in December 1978 to $ 14.50 in April 1979; while speculators, were selling quantities put at their disposal by the Seven Sisters at twice that price: $ 35 a barrel in May 1979, for example. Why? Because they needed a high price to make oil from the North Sea, the Gulf of Mexico or Alaska profitable. Flooding the market with huge quantities coming from these areas led to the producing countries gradually loosing their market shares and caused a price crash that has been called the counter shock of 1986. Just over ten years after it’s creation, IEA reached the first objective assigned to it by Henry Kissinger, which was to regain control of the petroleum business all over the world, the final aim being to put that business back in the hands of the Seven Sisters.
The combination of economic and political events during the first half of the 1980s is the origin of this counter shock. The economic crisis provoked by the 1979/80 shock is one of them. The energy-saving measures taken by the consumers, the use of alternative energy sources, nuclear energy in particular, but also the IEA’s policy of solidarity among members, partly explain the phenomenon. The Kissinger’s strategy had another very important aim. The backbone of the Reagan administration policy was to break the Soviet Union. Among the weapons that he used for this purpose was oil: the market had to be flooded in order to drain the foreign exchange earnings of the USSR. All producing countries, whether OPEC members or not, were then heavily pressured to increase their production. The final result of this big turmoil was the counter shock of July 1986. Here is how OPEC secretariat describes that situation fifty years later. «After reaching record levels in the 1980 decade, prices began to weaken, before crashing in 1986, responding to a big consumer shift away from this hydrocarbon. OPEC’s share of the smaller oil market fell heavily and its total petroleum revenue dropped below a third of earlier picks, causing severe economic hardship for many member countries. Prices rallied in the final part of the decade, albeit only to around half of previous levels, while OPEC’s share of newly growing world output began to recover. This was supported by OPEC introducing a group production ceiling divided among member countries and a reference basket for pricing.»
Indeed, the price gradually shifted from $ 34 a barrel in 1981, to 27 in 1985 and then to 14 during the first months of 1986 with a low of $ 10 in July that year. This violent drop happened despite the fact that OPEC had introduced a system of quota allocation to the member countries for the first time in March1983. But the indiscipline of the few who did not respect the adopted rule and the action of the majors who were pushing the traders to break the prices on the spot market, made the organization’s decision obsolete.
From then on, OPEC was no longer a key actor in oil pricing; that role belonged henceforth to IEA. The transition was symbolically formalized in 1984 when the Brent oil of the North Sea replaced the Arabian Light as a benchmark crude.
IV – OPEC in a unipolar world
The last decade of the 20th century was marked by a number of extremely important events: the fall of the Berlin Wall, which opened the gates of the Caspian Sea and Central Asia to the Seven Sisters, the war against Iraq and the fundamental change that took place in the United States, where imported oil became predominant on the market.
The production of oil fields located on American soil, including those in Alaska and the Gulf of Mexico, had been declining for many years. Meanwhile, the low price of the barrel of oil during the 1980-1990 period allowed an unprecedented surge of the US economy marked by an exponential consumption of petroleum products. The conjunction of these two factors resulted in an impressive increase of imported oil; 1993 was the year that saw for the first time the United States import more oil than what it produced. When George W. Bush arrived at the White House, 10 years later, half of the oil consumed in the US came from abroad. Another consequence of the low price of oil was that the profits of the Seven Sisters had been affected; some of them disappeared and were absorbed by others, thus leading to a greater concentration of the political-economic power conferred by hydrocarbons in the hands of a smaller group.
This situation coincided with the other important event of the period, the fall of the Berlin Wall, which as we know resulted in the advent of a new world dominated by one single hyper power: the United States of America. This caused a tremendous upheaval on the world oil scene, and a notable weakening of the weight of the oil producing countries. The majors considered that they should henceforth control all the oil zones on earth. They knew that they would benefit from the unwavering support of the American administration which, in order to ensure US supremacy, was ready to use all means necessary: political, economic, diplomatic and even military. At the same time another important actor emerged on the world oil scene to challenge this dominant role: China, of course.
The 1990s started with a war against one of the major members of OPEC, Iraq, which lived for many years under the so-called « Oil for food » policy. The disappearance from the market of a significant part of Iraq’s oil production had no influence on prices. On the contrary, they continued to decline before reaching, in 1999, the same floor level of July 1986 of 10 $ a barrel. Three other events contributed to this turnaround: 1/ the financial crisis in some Asian countries, including Japan 2/ the arrival of large quantities of oil and gas from the Caspian sea (The construction of the Baku-Tbilisi-Ceyhan gas pipeline was launched at that time) 3/ The third factor was the new strategy to increase their oil reserves adopted by the majors which contributed to pull down the prices. They decided to acquire existing oil fields or competitors rather than explore for new discoveries. This new philosophy would be a major challenge for OPEC during the following decade. For the time being, things were going rather badly for the producers because of the indiscipline prevailing in their own ranks and because there was no counter weight to the US power. OPEC had then big difficulties coordinating oil policy, since, many of its members did not respect the quota that was allocated to them. Nevertheless, faced with the real danger of prices falling below $ 10 a barrel, OPEC finally decided to drastically cut the quotas allocated to each member country and initiated a dialogue with non-OPEC countries, particularly Russia, Norway and Mexico. That brought back the prices to around $ 18 a barrel.
V – OPEC facing the challenges of the 21st Century
The arrival of George W. Bush at the White House in January 2001 and the September 11 attacks caused major turmoil on the world oil scene. OPEC had new challenges to deal with. One of the president’s first decisions was to create a working group with the task of developing a new American doctrine on energy. The New Energy Program Development (NEPD) predicted that if the US kept their pace of consumption, 2 barrels out of 3 would be imported in 2020. According to the NEPD Group Report, “such an energy deficit would damage the national economy, the living standard of the United States and constitute a very serious danger to the security of the country“. Taking this assumption into consideration, it recommended that the administration encourage and support attempts of some OPEC countries, specifically cited, to open up foreign investment in their oil sectors. The American government also had to take steps that would allow US oil companies to set up permanently in these countries. That was exactly the opposite of the policy adopted by OPEC following the Caracas Conference, and meant a return to the concession system of the 1950s. This was the first big challenge faced by OPEC since the beginning of the new century. The best example is Algeria which was close to adopting a new law on hydrocarbons that met the requirements of the American administration in all respects. The Algerian legislation stipulated that the foreign oil companies had to detain at least 70 % interest in any joint venture with the national oil company, and would be the operators on the oil or gas fields jointly exploited. If it were not a very strong opposition from the Algerian civil society and a solid solidarity within the OPEC ranks, this country would have transferred the majority of its hydrocarbons reserves to the Seven Sisters. The fall of this first domino would have brought the other producers to fall also.
The multitude of events that occurred all over the world since the millenium showed that OPEC was often unable to fulfil the commitments taken by the founding members fifty years earlier. The organisation was unable to maintain unity within its own ranks due to numerous foreign diplomatic and military interventions in the MENA region, which created enormous disorder in the exploitation of the oil fields of the region and erratic behaviour of prices on the market. The political calculations of the members, involved to varying degrees in the turmoil led them to have different points of view on the pricing policy and on the role that OPEC should adopt in order to face these events.
OPEC could not ensure neither order nor stability in the international oil market since the emergence of China as a major economic power started disrupting the hegemonic role of the United States in the oil sector, and because of the devaluation of the dollar; these were the two main events which significantly influenced price developments and their stability. Add to this the willingness, clearly displayed by US oil companies to guarantee their country’s energy security, by enhancing the production of domestic energy resources, or by searching for oil in areas considered to be politically safer.
Nevertheless, despite the September 11 attacks and the virtual disappearance of Iraqi oil on the market, prices remained temporarily low. At the end of 2003, the barrel was still quoted at around $ 30.
The world then witnessed a striking take-off of the exploitation of shale oil deposits in the United States and drilling in very high seas, at great water depths. To extract this new oil, it was necessary to resort to very expensive ultra-sophisticated techniques which needed a very high price to be profitable. That’s why the next ten years were a drastic, seemingly endless upward spiral that pushed prices to levels never reached before, with a historical peak of $ 145.3, recorded on July 3, 2008.
This unprecedented increase in oil prices was attributed as usual to OPEC. Taking into consideration the prevailing environment, it was totally unfair to blame OPEC which was really overwhelmed by the speculators who were, in fact, interfering with the marketplace. They were supplied directly or secretly by the majors who absolutely needed very high oil prices.
The problem is that this price evolution had been differently perceived by the OPEC members. Some of them thought that it was an opportunity for the oil producing countries to take advantage of the bargain offered by the market and supported the high price policy, while others thought that OPEC should not adopt the same conduct as the speculators. Of course, both sides said that the price that they advocated was the fair one. A few years later, they discovered that whilst they were bickering internally at OPEC about the price of the barrel of oil (should it be in the vicinity of 70 to 80 $ or around 120 to130) other forces were taking control of the market. By the time they realised this, it was too late; they finally discovered in 2014 that all of them were losers and that the exploitation of tar sands and of shale oils had become an unavoidable reality.
In order to stop the invasion of the market by American shale oil producers, OPEC decided in November 2014 to maintain a 30,5 million barrels a day production but revealed itself to be powerless to control the resulting price decline. Two years later and in association with other producers, it decided otherwise. Of these two resolutions, which one will safeguard the legitimate interests of the member states? We don’t know yet.
VI – Conclusion
After this journey of more than 50 years through the history of OPEC, can we guess what its future will be? Of course, not. Asked about the future of the oil industry, Sheikh Ahmed Zaki Yamani responded elliptically that the stone age ended, not because there were no more stones, but because man discovered alternative minerals for manufacturing his tools. This prediction, made a couple of decades ago, is even more evident today.
If we try to foresee how the future may look like, we have to start by mentioning some facts which may constitute the first pieces of the puzzle to come. We know that the organization has lost the dominant role that it had during the 20 years that followed its inception. The last Vienna meeting held in November 2016 clearly demonstrated this. Other oil producers, non-member countries of OPEC, had to be involved in the decision making to reduce world oil production, hoping that such a step will allow prices to increase somewhat. If OPEC does not control prices anymore, what should its other objectives be?
Marion King Hubbert warned us in 1956 that world conventional oil production will reach its peak in 1995. In a study published some 5 to 6 years ago, IEA said more or less the same thing and added that any increase could come only from unconventional oil. We know that this new industry has grown very quickly in the United States since the millenium. We also know that for many oil producing countries, hydrocarbons are the only source of revenue. Meanwhile, a very strong opposition from citizens to the exploitation of shale oil and gas has been noticed all over the world. Some countries have banned such activities on their soil, others have called a moratorium on their development. Even Pope Francis has rejected fracking. Last but not least, many producing countries do not completely master the techniques currently used to extract non conventional hydrocarbons and have therefore to rely on foreign firms to produce them. So, the question is : taking all these facts into consideration, should therefore OPEC encourage the production of non conventional oil and gas or wait until a new fracking technology is discovered?
Other factors will impact the oil industry in the near future : the geopolitical situation in the Middle East, the environmental, political and social consequences of the Fukushima catastrophe, Brexit, the increasingly key role of Russia on the political and energetic scene. We also know that the inhabitants of our planet are becoming increasingly aware of the dangers that the exploitation of fossil fuels represents to humans, fauna, flora, air, land and oceans. Even the political leaders are aware of this fact and started acting. The decisions taken at the COP 21 meeting in Paris at the end of 2015 prove it. For the first time, even the most industrialised countries, decided to take the necessary measures to combat global warming.
Even if the newly elected US president strongly asserts that he does not believe in global warming, it is more and more evident that the world is at the beginning of the end of the era of oil and at the advent of the development of renewable energies. We are approaching the point that Sheikh Ahmed Zaki Yamani made reference to. Such a scenario will not unfold without jolts, there will be ups and downs, but the process has started and inexorably tends towards such a result. Will OPEC survive after the end of the oil era? That’s the one million dollars question !