How OPEC (and Non-OPEC) Production Affects Oil Prices

Crude oil holds a prominent position in the global commodities market because oil price changes affect the global economy. Thus, those countries or groups that produce crude oil also impact economies worldwide.

Oil prices are largely dependent on two factors: geopolitical developments and economic events. These two variables can lead to changes in oil demand and supply levels, which drives oil price fluctuations from one day to the next. For instance, the 1973 Arab oil embargo, the 1980 Iran-Iraq war, the 1990 gulf war, the Asian financial crisis of 1997, and the global financial crisis of 2007 to 2008 are some of the historical geopolitical developments that have significantly affected oil prices.

Understanding OPEC and Oil Prices

Organization of the Petroleum Exporting Countries (OPEC) is an organization that sets production targets among its members to manage oil production. OPEC member countries produce about 40% of the world's crude oil. Additionally, OPEC's oil exports represent about 60% of the total petroleum traded internationally, according to the United States Energy Information Administration.

Because of this market share, OPEC's actions have a huge influence on international oil prices. In particular, OPEC's largest producer of crude oil, Saudi Arabia, has the most frequent effect on oil prices. Historically, crude oil prices have seen increases in times when OPEC production targets are reduced.

The Impact of OPEC and OPEC+ on Oil Prices

Countries involved in global oil production are either members of OPEC, OPEC+, or non-OPEC nations. OPEC has 13 members: Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela.

Ten non-OPEC nations joined OPEC to form OPEC+ in late 2016 to have more control on the global crude oil market. These countries were: Azerbaijan, Bahrain, Brunei, Kazakhstan, Malaysia, Mexico, Oman, Russia, South Sudan, and Sudan. Not surprisingly, OPEC+ has a level of influence over the world economy that is even larger than OPEC's.

Responding to the highly dynamic economic and geopolitical developments, these groups make changes to their oil production capacities, which affect the oil supply levels and result in oil price volatility.

OPEC's Control of the Market

OPEC's oil exports account for roughly 60% of the total petroleum traded worldwide. The Energy Information Agency also reports that more than 80% of the world's proven crude oil reserves lie within the boundaries of the OPEC countries. Of that, roughly two-thirds lay within the Middle Eastern region in 2021.

Additionally, all OPEC member nations have been continuously improving technology and enhancing explorations leading to further enhancements to their oil production capacities at reduced operational costs.

Saudia Arabia

Within the OPEC group, Saudi Arabia is the largest crude oil producer in the world and remains the most dominant member of OPEC. It is also the leading exporter of crude oil globally. Each time there is a cut in Saudi oil production, there is a sharp rise in oil prices, and an increase in Saudi oil production stimulates a drop in oil prices.

Since the 1973 Arab oil embargo, Saudi Arabia has managed to call the shots as far as oil prices are concerned, by controlling supply. All major oil price fluctuations in recent history can be attributed to changing production levels in Saudi Arabia, along with other OPEC nations.

Source: Worlds Top Exports (Exporters) and U.S. Energy Information Administration (Producers)

OPEC+

OPEC+ controls over 50% of global oil supplies, according to Tamas Varga, senior analyst at PVM Oil Associates and quoted by CNBC. OPEC+ remains influential due to three primary factors:

1. An absence of alternative sources equivalent to its dominant position.
2. A lack of economically feasible alternatives to crude oil in the energy sector.
3. The comparatively low-cost price advantage against the relatively high-cost non-OPEC production.

In short, OPEC+ has the economic capability to disrupt or enhance the supply of oil to substantial levels at any time, severely affecting oil prices. For example, the 1973 Arab oil embargo by OPEC saw prices quadruple from $3 to $12 per barrel, and more recently, the sudden ramp-up in production by Saudi Arabia in March 2020 led to a sharp decline in the price of oil. On April 20, 2020, following the temporary lack of coordination between Russia and Saudi Arabia added to the lockdown, the front-month May 2020 West Texas Intermediate (WTI) crude contract dropped 306%, or $55.90, for the session, to settle at negative $37.63 a barrel on the New York Mercantile Exchange. This suggests that holders of oil had to pay in order to get takers to their production.

The Impact of Non-OPEC Production on Oil Prices

Non-OPEC oil producers are crude oil-producing nations outside of the OPEC group and shale oil producers. Interestingly, some of the top oil-producing countries are non-OPEC nations. This includes the United States of America, which is the number one producer, as well as Canada and China.

Most non-OPEC countries have high consumption levels and, thus, limited capacity to export. Many are net oil importers despite being high producers, which means they have minimal influence on oil prices. However, with the discovery of shale oil and shale gas, non-OPEC oil producers, particularly the United States, have enjoyed increased production and greater market share in recent times. While this has been a game-changer of sorts, shale oil technology requires substantial upfront investments, which acts as a deterrent to shale oil producers.

So far, the jury is out as to whether non-OPEC producers can have a material impact on the price of crude oil. High production levels from non-OPEC members from 2002 to 2004 and in 2010 did not result in price declines and instead brought higher oil prices. This is probably because non-OPEC members did not have sufficient market share to affect the market price of oil. High production from 2014 to 2015, however, did cause prices to decline. Market pundits have opined that the decline in prices was probably due to an increase in supply from OPEC producers to counter the threat posed to their hegemony by non-OPEC producers.

OPEC and Non-OPEC Countries vs. Market Forces

Oil prices are also affected by geopolitical developments and economic interests. Additionally, "black swan" events, or unexpected events, greatly affect the supply/demand paradigm.

One such event occurred in January 2020 when the global economy was roiled by the pandemic. The plummeting global demand for oil led to a fracturing of OPEC+, specifically between Saudi Arabia and Russia, the two largest oil exporters. In response, Saudi Arabia ratcheted up production. This overt attempt to capture market share led to a precipitous decline that saw the price of WTI breach $20/barrel.

An "extraordinary" meeting between OPEC and non-OPEC (read: Saudi Arabia and Russia) led to an agreement to cut production by about 10 million barrels per day (B/D). In what was a classic buy-the-rumor-sell-the-fact trade, oil prices rose and then cratered as the market was not impressed by a global supply cut of 10 million B/D while global demand was projected to decline by 30 million B/D.

The Bottom Line

The dynamics of the oil economy are complex, and oil prices depend on more than the rules of demand and supply, although at its most primal level, the market is the final arbiter of the price of oil. Under normal global market conditions, OPEC+ will continue to maintain its dominance in oil price determination. Despite challenges such as fracking technology and oil discovery in non-OPEC regions, OPEC's share of the global market allows the organization to manipulate production quotas and continue to be a central player in oil price determination.