OPEC vs. the United States: Who Controls Oil Prices?

Until the mid-20th century, the United States was the largest producer of oil and controlled oil prices. The Organization of the Petroleum Exporting Countries (OPEC) then took over, ruling the oil markets and oil prices in the years that followed.

However, with the discovery of shale oil in the U.S. and advances in drilling techniques, the U.S. has since re-emerged as a top energy producer. In this article, we explore the historical battle between OPEC and the U.S. to control oil prices and how world events have influenced that struggle.

Key Takeaways

  • As of 2018, OPEC member countries held 79.4% of the world's proven oil reserves and produced about 40% of the world's oil output.
  • However, the U.S. was the world's largest oil-producing country in 2019 with nearly 19.5 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 its output.

United States

Oil was first commercially extracted in the U.S. Consequently, pricing power lay with the U.S., which at that time was the largest oil producer in the world. Prices were volatile and high during the early years because the extraction and refining process lacked the economies of scale that are present today.

For example, in the early 1860s, according to Business Insider, the price per barrel of oil reached a peak of $120 in today's terms, partly due to rising demand resulting from the U.S. Civil War. Prices fell more than 60% over the next five years, only to shoot 50% higher during the following half-decade.

In 1901, the discovery of the Spindletop refinery in eastern Texas opened the floodgates of oil in the U.S. economy, leading to the rapid development of the U.S. oil industry. Increased supply and the introduction of specialized pipelines helped further reduce the price of oil. 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.  

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. 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 

The Organization of the Petroleum Exporting Countries (OPEC) was formed to negotiate matters concerning oil prices and production. OPEC countries include the following 13 nations:

  • Algeria
  • Angola
  • Congo
  • Equatorial Guinea
  • Gabon
  • Iran
  • Iraq
  • Kuwait
  • Libya
  • Nigeria
  • Saudi Arabia
  • United Arab Emirates
  • Venezuela

The 1973 oil shock swung the pendulum in OPEC's favor. That year, in response to America's support for Israel during the Yom Kippur War, OPEC and Iran stopped oil supplies to the United States. This move had far-reaching effects on oil prices.

OPEC controls oil prices through its pricing-over-volume strategy. According to Foreign Affairs, 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 toward the countries that comprise OPEC. According to the journal, "what the Americans import from the Persian Gulf is not so much the actual black liquid but its price."

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 featured several currency devaluations, had the opposite effect in that it reduced oil demand. In both instances, OPEC maintained a constant rate of oil production.

As of 2018, OPEC member countries held 79.4% of the world's proven oil reserves. OPEC countries produced about 40% of the world's supply.

OPEC+ came into existence in late 2016 as a means for the top oil-exporting nations to exert control over the price of the precious commodity. OPEC+ is an amalgamation of OPEC and 10 other oil-exporting nations such as Russia and Kazakhstan. 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. OPEC, especially Saudi Arabia, has the world's lowest barrel production costs

These advantages enable OPEC+ 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. 

OPEC vs. the United States—The Future

OPEC's monopoly over oil prices seems to be in danger of slipping. The discovery of shale oil in North America has helped the U.S. achieve near-record volumes of oil production. According to the Energy Information Administration (EIA), America's oil production was almost 19.5 million barrels per day (BPD) in 2019, making it the world's largest oil-producing country, followed by Russia and Saudi Arabia. However, Saudi Arabia is still the global leader in exporting oil followed by Russia and Iraq. OPEC's oil exports represent about 60% of the total oil that is traded internationally.

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 exploring shale formations, too. A viable alternative to OPEC+ could shift the power structure.

The Iran-U.S. nuclear debate may also impact oil production and supply in the future as further discord could provoke more sanctions to curtail production, which would affect prices. Other factors that impact the price of oil include the budgets of Arab nations, which need high oil prices to fund government spending programs. In addition, demand continues to increase from developing economies, such as China and India, further influencing prices in the face of constant production.

The dynamics of the oil economy are complex, and the oil price determination process goes beyond the simple market rules of demand and supply, though at its most primal level the market is the final arbiter of the price of oil. Theoretically, oil prices should be a function of supply and demand. When supply and demand increase, prices should drop and vice versa.

However, the reality is often quite 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 toward the U.S. and western oil companies, which led OPEC to form an alliance with Russia et al. to form OPEC+.

As oil prices rise, U.S. oil companies pump out more oil to capture higher profits, limiting OPEC's ability to influence its price. Historically, OPEC's production cuts had devastating effects on global economies, although this is no longer always the case. 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.

Nevertheless, it is important to note that, although the United States is the top producing nation, the top exporters are predominantly members of OPEC+, which means that they are still the key player in the oil price determination process. There may come a day when OPEC loses its clout but that day is not yet here.