Meet OPEC, Manager Of Oil Wealth

By Marv Dumon AAA

The Organization of the Petroleum Exporting Countries (OPEC) was formed in 1960 to co-ordinate economic policies related to oil among member nations, which spend billions of dollars investing in drilling platforms, pipelines, storage terminals, shipping, and refineries in order to extract and export crude petroleum.

Because oil is the primary revenue generator for these countries, they have a collective interest in ensuring that prices are stable and that global energy demands are steady. However, supply and demand trends have provided both opportunities and challenges for OPEC, new resources add competing production outputs and ever-increasing demand places limits on the division of those resources. Additionally, concerns over oil prices and global warming are spurring investments and development of alternative fuel sources. I

n this article, we'll take a look at OPEC, its role in the world economy and how it affects consumers and investors. (Don't believe the water-cooler talk - big oil companies aren't to blame for high prices. Read more in Why You Can't Influence Gas Prices.)

History of OPEC
OPEC was formed on September 14, 1960, by five founding members: Iraq, Iran, Kuwait, Saudi Arabia and Venezuela. As of 2009, eight additional members have been added, including Algeria, Angola, Ecuador, Indonesia, Kuwait, Libya, Nigeria, Qatar and United Arab Emirates. Indonesia withdrew from OPEC in 2008.

According to OPEC's 2007 estimates, the 13 member countries produce about 40% of the world's oil outputs, and 15% of its natural gas. OPEC in 2007 possessed 78% of the world's proven oil reserves, which totaled 1.2 trillion barrels.

The organization typically meets twice a year, and maintains its headquarters in Vienna, Austria. Its stated objectives are:

  1. The co-ordination of petroleum policies between member countries and the safeguarding of its individual and collective interests
  2. Ensuring the stabilization of international oil markets
  3. Creating an economically efficient supply of petroleum to consuming nations and a fair return of capital to investors in the industry

Motivations
OPEC was formed to manage and stabilize the economic and geopolitical landscape in the Middle East as well as the vast global energy markets. By far, oil is the main marketable commodity and revenue generator for member nations. With most of the members' income tied to a single commodity - in other words, all eggs in one basket - their citizens are largely dependent on government programs funded by these petrodollars; programs such as education, healthcare, economic initiatives, infrastructure, employment and defense. Thus, members assess energy market fundamentals and supply and demand scenarios. Such analyses then contribute to the raising or lowering of oil production quotas. If members deem price to be too low, they cut back on production in order to raise the price of oil. Alternatively, if they consider the price of oil to be too high (which can reduce both the short-term and long-term demand for oil, and also ripen conditions for alternative sources of fuel), then they can increase production. (For related reading, see A Guide To Investing In Oil Markets.)

The oil producers of OPEC invest billions of dollars in exploration and production activities - in drilling activities, pipelines, storage and transportation, refining and staffing. These investments take place up front, and successfully harvesting a new oil field can typically take between three to 10 years. Thus, member countries want to ensure that they receive sufficient returns on their capital. They are most comfortable with stable demand for oil without big fluctuations in prices. (To learn about investing here, see Unearth Profits In Oil Exploration And Production.)

Oil Embargo and Western Response
During the 1970s, criticism of OPEC became more widespread, and the organization came to be viewed as a monopolistic cartel in many circles. The organization triggered high inflation and low fuel supplies around the world by imposing oil embargoes in 1973.

Member countries ceased providing oil to the United States, Western Europe and Japan for their support of Israel in its military conflict with Egypt, Iraq and Syria. The embargo resulted in drastically higher oil prices in the West; nervous investors pulled capital out of the U.S. markets, resulting in big losses at the New York Stock Exchange. Inflation ensued and gasoline rationing practices were enforced. OPEC eventually restored oil production and exports to the West, however, the 1973 crisis had lingering negative effects on international relations. In response to the crisis, the West attempted to curtail its dependence on OPEC and stepped up efforts in offshore oil production, particularly in the Gulf of Mexico and the North Sea. In the 1980s, overproduction worldwide combined with reduced demand, resulting in a significant drop in oil prices. (For more about this period in economic history, see Stagflation, 1970s Style.)

Contemporary Role and Trends
Billions of dollars in new investments and new discoveries in locations such as the Gulf of Mexico, the North Sea and Russia have somewhat diminished OPEC's control over global oil prices. The continuing extraction of petroleum from offshore drilling, advances in drilling technology and the emergence of Russia as an oil exporter (exports to the U.S. doubled in 2007 over 2004 levels according to the U.S. Energy Information Administration) have brought fresh sources of crude oil over the years. Global energy demands, however, have also risen significantly. Strong economic growth in India and China has contributed to the price of oil reaching record levels yet again in 2008.

By mid-2008, oil prices saw extreme fluctuations in price, at one point almost reaching $150 a barrel, and then dropping to below $90 a barrel in a matter of a few weeks. As many experts advocate the "peak oil" theory - that oil production has peaked worldwide - many investment groups, companies and governments are increasing funding and the development of various means of alternative fuel sources, including wind, solar, nuclear, hydrogen,and coal. While OPEC has raked in hundreds of billions of dollars in oil profits in the 2000s (when the price of oil skyrocketed), member countries are seeing a lot of long-term risk to their rainmaking commodity investment and cash cow. (Learn a little more about the "non" part of this nonrenewable resourcePeak Oil: Problems And Possibilities.)

Conclusion
OPEC's decisions over the years have had considerable influence on worldwide oil prices. However, it is also in OPEC's collective interest to ensure that prices remain "reasonable" to consumers. Otherwise, they merely provide massive incentives to the market to generate alternative products for energy-consuming masses. Oil is increasingly coming up against some heavy opposition, as the harmful effects that carbon dioxide is believed to have on the environment, particularly as a contributor to global warming, are providing added incentive for policymakers, institutions and citizens to rapidly deploy non-oil sources of energy.

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