Many of the largest oil-producing countries in the world are part of a cartel known as the Organization of Petroleum Exporting Countries (OPEC). In 2016, OPEC allied with other top, non-OPEC, oil-exporting nations to form an even more powerful entity named OPEC+ or OPEC Plus.
The cartel's goal is to exert control over the price of the precious fossil fuel known as crude oil. OPEC+ controls over 50% of global oil supplies and about 90% of proven oil reserves. This dominant position ensures that the coalition has a significant influence on the price of oil, at least in the short-term. Over the long term, its ability to influence the price of oil is diluted, primarily because individual nations have different incentives than OPEC+ as a whole.
- The Organization of the Petroleum Exporting Countries Plus (OPEC+) is a loosely affiliated entity consisting of the 13 OPEC members and 10 of the world’s major non-OPEC oil-exporting nations.
- OPEC+ aims to regulate the supply of oil in order to set the price on the world market.
- OPEC+ came into existence, in part, to counteract other nation's capacity to produce oil, which could limit OPEC's ability to control supply and price.
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 in the global market at any given time. OPEC+ subsequently exerts considerable influence over the global market price of oil and, understandably, tends to keep it relatively high in order to maximize profitability.
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 increase supply so that revenues also rise. But that is not market dynamics. A pledge by OPEC+ to cut supply causes an immediate spike in the price of oil. Over time, the price reverts back to a level, usually lower, when supply is not meaningfully cut or demand adjusts.
Conversely, OPEC+ can decide to boost supply. For instance, on June 21, 2018, the cartel met in Vienna and announced that they would be increasing supply. A big reason for this was to offset the extremely low output by fellow OPEC+ member Venezuela.
Saudi Arabia and Russia, the two largest oil exporters in the world who both have the ability to increase production, are big proponents of increasing supply as that would increase their revenues. However, other nations, who cannot ramp up production, either because they are operating at full capacity or are otherwise not allowed to, would be opposed to this.
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. A case in point 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, an original member of OPEC, the largest exporter, and an extremely influential force in the global oil market, and Russia, the second leading exporter and, arguably, the second most important player in the recently formed OPEC+, failed to reach an agreement about cutting production to stabilize the price of oil.
Saudi Arabia retaliated by ramping up production sharply. This sudden increase in supply happened at a time when global oil demand was slumping as the world was dealing with the COVID-19 pandemic. As a result, the market, which is the final arbiter of the price, overrode OPEC+'s desire to stabilize the price of oil at a higher level than the laws of supply and demand dictated.
In the spring of 2020, oil prices collapsed amid the COVID-19 pandemic and economic slowdown. OPEC and its allies agreed to historic production cuts to stabilize prices, but they dropped to 20-year lows.
Aside from reaffirming that market forces are more powerful than any cartel, especially in free markets, this episode also gave credence to the premise that individual nation's agendas will override cartel agenda. Brent crude oil, as of April 14, 2020, cost around $30 per barrel, a level not seen since 2004. West Texas Intermediate (WTI) crude oil, meanwhile, slumped to $20.5 per barrel, a level not seen since 2002.