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Many of the largest oil producing countries in the world are part of a cartel known as OPEC. In the short term, the Organization of Petroleum-Exporting Countries (OPEC) has significant influence on the price of oil. Over the long term, its ability to influence the price of oil is quite limited, primarily because individual countries have different incentives than OPEC as a whole.

Key Takeaways

  • The Organization of the Petroleum Exporting Countries (OPEC) is a cartel consisting of 14 of the world’s major oil-exporting nations.
  • OPEC aims to regulate the supply of oil in order to set the price on the world market.
  • In recent years, other nation's capacity to produce oil, such as in America, has crept in to OPEC's ability to control supply.
  • Even though OPEC is powerful and controls more than 70% of the world's oil reserves, market forces and aggregate demand will always prevail in the long-run.

Oil Price and Supply

As a cartel, the OPEC member countries collectively agree on how much oil to produce, which directly impacts the ready supply of crude oil on the global market at any given time. As a result, OPEC tends to keep the price of oil relatively high in order to maintain profitable operations.

For example, if OPEC countries are unsatisfied with the price of oil, it is in their interests to cut the supply of oil so prices rise. However, no individual country actually wants to reduce supply, as this would mean reduced revenues. Ideally, they want the price of oil to rise while they raise revenues. This issue often arises as OPEC pledges to cut supply, causing an immediate spike in the price of oil. Over time, the price moves lower when supply is not meaningfully cut.

On the other hand, OPEC can decide to increase supply. For instance, on June 21, 2018, OPEC met in Vienna and announced that they would be increasing supply. A big reason for this is because of the extremely low output by fellow OPEC member Venezuela. Russia and Saudi Arabia are big proponents of increasing supply while Iran is not. 

Market Forces

In the end, the forces of supply and demand determine the price equilibrium, although OPEC announcements can temporarily affect the price of oil by altering expectations. One case where OPEC's expectations would be altered is when its share of world oil production declines, with new production coming from outside nations such as the U.S. and Canada.

In March 2020, Saudi Arabia and Russia failed to reach an agreement with OPEC and instead boosted oil supply. This happened at a time when oil demand also fell sharply as a result of the global COVID19 pandemic. As a result, the market forces overrode OPEC's desire to keep oil prices high.

Brent Crude oil, as of March 2020, costs around $36 per barrel while WTI Crude oil costs $33 per barrel —a return to the fallout of 2008 and post-oil crisis conditions in 2014-2015 when oversupply caused prices to fall as low as $40-$50 per barrel. Oil price fluctuations created huge incentives for innovation in new production techniques that led to oil extraction and more effective drilling methods.