OPEC vs. the U.S.: Who Controls Oil Prices? — An Overview
Up until the middle of the 20th century, the United States was the largest producer of oil and controlled oil prices. In the years to follow, OPEC controlled the oil markets and prices for most of the latter part of the 20th century. However, with the discovery of shale in the U.S. and advances in drilling techniques, the U.S. has re-emerged as a top producer of oil. In this article, we explore the historical battle between OPEC and the United States to control oil prices and how world events have influenced that struggle.
Oil was first commercially extracted and put to use in the United States. Consequently, pricing power for the fuel lay with the U.S., which was, at that time, the largest producer of oil in the world. In general, oil prices were volatile and high during the early years because economies of scale during extraction and refining (which mark the current extraction and drilling processes) were not present. For example, in the early 1860s, according to the Business Insider, the price per barrel of oil reached a peak of US $120 in today's terms, partly due to rising demand resulting from the U.S. civil war. The price fell by more than 60% over the next five years and rose by 50% during the next five years.
In 1901, the discovery of the Spindletop refinery in eastern Texas opened the floodgates of oil in the U.S. economy. It's estimated that 1,500 oil companies were chartered within a year of the discovery. Increased supply and the introduction of specialized pipelines helped further reduce the price of oil. The supply and demand for oil rose additionally with the discovery of oil in Persia (present-day Iran) in 1908 and Saudi Arabia during the 1930s and World War I, respectively.
By the mid-twentieth century, the use of oil in weaponry and the subsequent European coal shortage further ratcheted demand for oil, and prices came crashing down to $40 in today's terms. American reliance on imported oil began during the Vietnam war and the economic boom period of the 1950s and 1960s. In turn, this provided Arab countries and OPEC, which had been formed in 1960, with increased leverage to influence oil prices.
OPEC or the Organization of the Petroleum Exporting Countries was formed to negotiate matters concerning oil prices and production. In 2018, OPEC countries included the following 15 nations:
- Equatorial Guinea
- Saudi Arabia
- United Arab Emirates
The 1973 oil shock swung the pendulum in OPEC's favor. That year, in response to U.S. support for Israel during the Yom Kippur War, OPEC and Iran stopped oil supplies to the United States. The crisis had far-reaching effects on oil prices.
OPEC controls oil prices through its pricing-over-volume strategy. According to Foreign Affairs magazine, the oil embargo shifted the structure of the oil market from a buyer's to a seller's market. In the magazine's view, the oil market was earlier controlled by the Seven Sisters or seven Western oil companies that operated a majority of the oil fields. Post-1973, however, the balance of power, shifted towards the 12 countries that comprise OPEC. According to them, “What the Americans import from the Persian Gulf is not so much the actual black liquid but its price.”
The cartel derives its pricing power from two trends: the absence of sources of energy and a lack of viable economic alternatives in the energy industry. It holds three-quarters of the world's conventional oil reserves and has the world's lowest barrel production costs. The combination enables the cartel to have a wide-ranging influence over oil prices. Thus, when there is a glut of oil in the world, OPEC cuts back on its production quotas. When there is less oil, it increases oil prices to maintain stable levels of production.
A number of world events have helped OPEC maintain control over oil prices. The fall of the Soviet Union in 1991 and the resulting economic tumult disrupted Russia's production for several years. The Asian financial crisis, which had several currency devaluations, had the opposite effect: It reduced oil demand. In both instances, OPEC maintained a constant rate of oil production.
As of 2018, OPEC controlled roughly 72% of the world's total crude oil reserves and produced 42% of the world's total crude oil output.
OPEC vs. the U.S. — The Future
But OPEC's monopoly over oil prices seems to be in danger of slipping. The discovery of shale in North America has helped the U.S. achieve near-record volumes of oil production.
According to the Energy Information Administration, U.S. oil production was 10 million barrels per day in 2018, making the U.S. was the world's largest oil producing country. However, the claim for the top spot has shifted back and forth between the U.S. and Saudi Arabia.
Shale is also gaining popularity beyond American shores. For example, China and Argentina have drilled more than 475 shale wells between them in the last few years. Other countries, such as Poland, Algeria, Australia, and Colombia, are also exploring shale formations.
The Iran-U.S. nuclear debate has heated up and subsided over the years and will undoubtedly impact oil production and supply in the future. Iran, which is a founding member of OPEC, produces roughly 4 million barrels per day of oil.
Other factors that impact the price of oil include the budgets of Arab nations, which need high oil prices to fund government spending programs. Also, demand continues to increase from developing economies, such as China and India, putting additional influence on prices in the face of constant production.
Theoretically, oil prices should be a function of supply and demand. When supply and demand increase, prices should drop and vice versa. But the reality is different. Oil's status as the preferred source of energy has complicated its pricing. Demand and supply are only part of the complex equation that has generous elements of geopolitics and environmental concerns.
Regions that hold pricing power over oil control vital levers of the world's economy. The United States controlled oil prices for a majority of the previous century, only to cede it to the OPEC countries in the 1970s. Recent events, however, have helped to shift some of the pricing power back towards the United States and Western oil companies.
Although OPEC produces more oil than the U.S. on a daily basis, the United States is the top producing nation. As oil prices rise, U.S. oil companies pump out more oil to capture higher profits. The result limits OPEC's ability to influence the price of oil. Historically, OPEC's production cuts had devastating effects on global economies. Although still influential, OPEC's influence on prices has diminished with the U.S. now a top oil producer.
Also, the U.S. is one of the world's top consumers of oil, and as production at home increases, there will be less demand for OPEC oil in the U.S. There may come a day when OPEC loses the U.S. as a customer.
- As of 2018, OPEC controlled roughly 72% of the world's total crude oil reserves and produced 42% of the world's total crude oil output.
- However, the U.S. was the world's largest oil producing country in 2018 with more than 10 million barrels per day.
- Although OPEC still has the ability to drive prices, the U.S. has limited the cartel's pricing power by ramping up production whenever OPEC cuts their output.