OPEC in a Changing World

Western leaders have long criticized OPEC’s power to raise oil prices, but the bloc’s influence is on the wane as U.S. oil production has soared and alternative energies have come to the fore.

Introduction

The Organization of the Petroleum Exporting Countries (OPEC) is a bloc of fourteen oil-rich states spanning the Middle East, Africa, and South America. Combined, the group controls close to forty percent of world oil production. This dominant market position has at times allowed OPEC to act as a cartel, coordinating production levels among members to manipulate global oil prices.

OPEC’s golden era occurred in the 1970s, when the United States became increasingly reliant on foreign oil as a result of rapid economic growth. Ever since, U.S. presidents from Gerald Ford to Donald J. Trump have railed against the oil cartel as a threat to the U.S. economy.

In recent years, several challenges to OPEC’s influence have come to the fore, including divisions within its membership, the emergence of the United States as a major oil exporter, and the global shift to cleaner energy sources. Strained relations between the United States and Saudi Arabia, OPEC’s largest exporter, might also test the bloc in the coming years.

OPEC Is Born

OPEC was established in 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela; its membership has expanded and contracted over the years. The original five sought to build a united front to respond to oil price cuts imposed by the multinational oil companies that controlled most petroleum imports into Western countries, as well as U.S. government import caps that depressed prices of foreign oil in the 1950s. OPEC’s founding members not only set out to negotiate higher global posted prices for oil but also pursued greater control over their own resources through the nationalization of international oil company concessions. Most OPEC nations now own all of their oil reserves.

   

Member states coordinate policies on oil prices and production levels at regular and emergency meetings around the world, often at OPEC’s Vienna headquarters. Delegations are usually led by the oil ministers of each member country, and a secretary-general appointed by the bloc is entrusted with the day-to-day management of the organization.

Age of Influence

OPEC burst onto the world stage in 1973. Late that year, Egypt and Syria launched a surprise attack against Israel, and the United States responded with a $2.2 billion military aid package to the Israelis. Led by the Arab oil ministers, OPEC retaliated with an embargo against the United States and a few other allies of Israel and began to cut production. Consumers panicked and markets tightened. U.S. President Richard Nixon instituted price controls on gasoline, which exacerbated the situation and led to long lines at the pump. Secretary of State Henry Kissinger hurriedly began to negotiate an end to the war and to OPEC’s embargo.

At first, OPEC profited handsomely. From 1972 to 1977, the combined petroleum earnings of its members more than sextupled, from $23 billion to $140 billion. Meanwhile, in the West, higher oil prices caused recessions. U.S. gross domestic product (GDP) fell 6 percent from 1973 to 1975, while unemployment doubled. As CFR’s Amy Myers Jaffe and economist Edward Morse write, OPEC’s embargo was “hailed at the time as the first major victory of ‘Third World’ powers to bring the West to its knees.”

The OPEC of the 1970s was both celebrated and feared for its ability to impose economic pain on the West, a reputation it has clung to even as events in the decades since have dented its market power. Brown University’s Jeff D. Colgan explains, “OPEC perpetuates the myth that it regularly manages the world oil market. That reputation means its members receive more diplomatic attention than they otherwise would.”

The Rifts Within

OPEC’s power has waned amid divisions within the group. Some of these were driven by regional power struggles. Others were spurred by differences in opinion over strategy and target prices for the cartel.

In the 1980s, OPEC conferences were typically characterized by disagreements between so-called price doves, who pushed for higher output and lower prices, versus price hawks, typically from member states with large populations and strained budgets. Historically, the doves have been OPEC’s wealthier countries that are willing to tolerate lower prices if it helps preserve their dominant position in oil markets—Saudi Arabia, the United Arab Emirates (UAE), and Kuwait—while the hawks have included Iran in the 1980s, Iraq under Saddam Hussein, and Libya.

In recent years, cartel politics have been further complicated by swelling budgets in some wealthy member states, which have raised their break-even oil price, or the price at which they remain solvent.

Squabbles among OPEC members have occasionally metastasized into conflicts. For example, Iran and Iraq waged an eight-year-long war that led to hundreds of thousands of deaths. While Iran accused its Arab neighbors of holding oil prices artificially low to help Iraq, neither Iraq nor Iran left OPEC, which remained officially neutral.

OPEC’s worst-ever crisis, according to energy expert Daniel H. Yergin, was Iraq’s 1990 invasion of Kuwait. In his book The Prize, Yergin writes that for the first time “sovereignty and national survival and not merely the price of oil” were at stake. The invasion removed four million barrels of oil from the world market and caused prices to jump. Other member states feared that Iraq would soon invade Saudi Arabia and leapt into action, rather than remain neutral as they had during the Iran-Iraq War. As a military coalition came together, most of OPEC’s remaining members increased production to compensate for lost output from Kuwaiti and Iraqi oil fields.

Analysts say that such a swift reaction underlines a truth about OPEC: within the membership, Saudi Arabia is first among equals. Saudi Arabia produces roughly a third of the group’s overall crude oil, a figure that could rise as U.S. sanctions on Iranian producers kick in. Saudi Arabia’s disproportionate output has stirred discussion of how much influence OPEC’s other members really have, as well as the overall power of the cartel itself, but economic research generally finds that oil prices would be lower if OPEC didn’t exist.

Tensions With the United States

Since 1973, OPEC has often had a rocky relationship with the United States. Every U.S. president since Nixon has advocated for energy independence, though economists continue to debate the merits of such a goal. Proponents say that less reliance on OPEC oil reduces the trade deficit and makes the U.S. economy more resilient in the face of oil price swings. Some say that at the very least it will allow the United States to shift its focus away from the Middle East.

Still, OPEC continues to serve as a useful foil. President Jimmy Carter tried to raise the specter of OPEC to encourage Americans to reduce fuel consumption. President Trump has been more explicit, calling OPEC a monopoly and demanding that the cartel reduce prices—a common refrain from presidents who view lower gasoline prices as a sort of tax cut for American drivers. Additionally, Congress has threatened to allow antitrust lawsuits against OPEC and its member states.

For OPEC members who see the bloc as more of a political club than an economic cartel, U.S. scaremongering about OPEC serves a purpose: it maintains the myth of OPEC’s importance and keeps Western diplomats and policymakers focused on it.

The Challenge of Alternatives

Most OPEC members view high oil prices as a short-term boon. However, those same high prices can spur importing countries to make investments in alternative fuel sources, a dynamic that is already underway.

The most prominent challenge to OPEC today comes from unconventional oils, such as shale-based energies, that have become available through recent technological advancements. In 2009, after a nearly forty-year decline in U.S. crude oil production, shale and sand-based oil extraction helped ramp up output. A decade later, U.S. production levels are higher than ever and double those of 2009.

To counter this, OPEC began to partner with Russia and several other major exporters to fashion a joint approach, which has included: coordinating production; drafting a new, shared charter; and floating the possibility of a new “OPEC+” organization. This partnership has opened a new chapter in OPEC’s history, leading to some criticisms that OPEC might no longer be free to change course without Russian buy-in. It has also created new tensions for U.S. allies in the cartel, who now find themselves juggling competing demands from Washington and Moscow.

Longer term, the advent of electric vehicles that run on renewable energy resources represents an existential threat to OPEC. Jaffe and Morse write that rising fossil fuel costs coupled with government subsidies for renewables have spurred investments in the sector. As climate change concerns take center stage in the coming years, OPEC could take a hit.

Whereas OPEC recognized clean energy as a potential challenge, the shale revolution appears to have taken the group by surprise. In 2015, OPEC reacted to the hydraulic fracturing movement by driving prices down, assuming that shale production would no longer be economically viable. But new technologies have allowed American producers to tap into previously trapped oil at decreasing cost, leading the United States to become the world’s largest oil producer in recent years.

Looking to the Future

Vast reserves of U.S. shale oil have not completely insulated American consumers from OPEC-induced price swings. Changes in U.S. production levels are the result of dozens of private energy companies’ independent decisions, and it can take months before consumers feel any adjustments. That means when there are sudden changes in market conditions, OPEC may gain substantial, if brief, market power to influence prices.

It’s still unclear what effect the shale boom will have on U.S. relations with OPEC. Less reliance on oil imports from OPEC countries could allow U.S. policymakers to be more assertive with them, potentially portending a rupture in the U.S.-Saudi Arabia relationship, or a tougher line against Venezuela. On the other hand, the growing importance of U.S. oil production has raised some worries that U.S. policymakers could move closer to OPEC on climate change policy, as the Trump administration has rolled back regulation of fossil fuels and withdrawn from global commitments to reduce carbon emissions.

The Saudi leadership encouraged the Trump administration’s withdrawal from the 2015 agreement on Iran’s nuclear program and the reimposition of sanctions on Iranian oil, and a major challenge for the bloc will be keeping supplies steady and markets calm as Iranian oil exports shrink. The sanctions have been accompanied by increasing frustration within the Trump administration, which wanted allies such as Saudi Arabia and the United Arab Emirates to keep supply high to allow the United States to sanction Tehran without disturbing oil prices. OPEC has instead cut oil production since December 2018.

Meanwhile, divisions within OPEC are likely to persist. In January 2019, for example, Qatar officially withdrew from OPEC, signaling its disapproval with Saudi Arabia’s dominance over the organization and an ongoing Saudi-led blockade of the country. If Riyadh continues to pursue a more assertive foreign policy, it could be a challenge for the cartel to remain cohesive. For OPEC and its newfound partner Russia, this possibility, combined with the rise of shale oil, increasing U.S. energy independence, and global efforts to fight climate change, portend a prolonged period of uncertainty.