Opec Case Study

What is OPEC?

The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its Member Countries. It was founded at a meeting held on 10–14 September 1960 in Baghdad, Iraq, by five oil-producing countries: Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. (These countries are referred to as the Founder Members of the Organization)

This unified front was created primarily in response to the efforts of Western oil companies to drive oil prices down. The original members of OPEC included Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. OPEC has since expanded to include seven more countries (Algeria, Angola, Indonesia, Libya, Nigeria, Qatar, and United Arab Emirates) making a total membership of 12.

The first move towards the establishment of the Organization of the Petroleum Exporting Countries (OPEC) took place in 1949, when Venezuela approached Iran, Iraq, Kuwait and Saudi Arabia and suggested that they exchange views and explore avenues for regular and closer communications between them. The need for closer cooperation became more apparent when, in 1959, the oil companies unilaterally reduced the posted price for Venezuelan crude by 5¢ and 25¢ per barrel and that for the Middle East by 18¢/b. OPEC’s principal aims are the coordination and unification of petroleum policies of Member Countries and the determination of the best means for safeguarding their interests, individually and collectively.

The Organization also seeks to devise ways and means of ensuring the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations, due regard being given at all times to the interests of the producing nations and to the necessity of securing a steady income for them; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on their capital to those investing in the petroleum industry. OPEC MEMBER NATIONS

Oil supply scenario before 1960 After World War II, all middle east oil business was controlled by Anglo-Iranian Oil Company (later British Petroleum now BP), Compagnie Francaise de Petrole (now Total), Royal Dutch/Shell, Standard Oil of New Jersey (now Exxon) and Socony- Vacuum (later Mobil, now part of Exxon), Gulf, Standard Oil of California (now Chevron) Texaco (now part of Chevron). Together there were eight companies, but they were called “Seven Sisters” depending who was doing the counting. What lead to formation of OPEC?

In 1959 the U.S. government established a Mandatory Oil Import Quota Program (MOIP) restricting the amount of crude oil (and refined products) that could be imported into the United States. The MOIP gave preferential treatment to oil imports from Mexico and Canada. This partial exclusion of the U.S. market to Persian Gulf producers depressed prices for their oil. As a result oil prices 'posted' (paid to the selling nations) by the major oil companies were reduced in February 1959 and August 1960. At the longstanding posted price of $2.04 a barrel, a host government received 92 cents and the oil company took $1.12.

These countries were in the dire need of foreign revenues, due to lack of technology they were not self sufficient to explore and produce the oil on their own, so they gladly accepted it. This deal was very healthy for the sisters they were able to generate a whole lot of margin by refining their crude oil (at that time development cost in middle east was 20 cents per barrel). In this cold war era Soviet oil production kicked up and around 1960 the Soviet Union displaced Venezuela as the second largest oil producer in the World, behind the United States.

With the world economy less thirsty for oil than it today, due to flooding crude from Soviet, set the oil market into turmoil and prices moved to very low level. Price war became so nasty between the Sisters and Russia that at one point the crude price of Russian oil was almost the half of the posted price of sisters. To overcome their loss, British Petroleum took the chance by reducing posted price by 18 cents, which triggered the already angry host governments’ resentment Towards the Sisters. Then again on August 9, 1960 Monroe Rathbone’s (Chairman of Standard oil of New Jersey) suggested another price cut from the posted price without even consulting the host nation.

This cut was another 14 cents; this really made the Middle Eastern countries furious. Scarcely a month after Rathbone’s blustering move, representative of five countries that collectively produced 80 percent of the world’s oil- Iraq, Iran Kuwait, Saudi Arabia and Venezuela-gathered in Baghdad, a four day conference gave birth to the OPEC. Organization of Petroleum Exporting Countries (OPEC) on September 14’ 1960. The groups’ mission was to defend the price of oil and win a bigger share of petroleum revenues.

Thereafter, OPEC was augmented by Qatar in 1961, Indonesia and Libya in 1962, UAE in 1967, Algeria in 1969, Nigeria in 1971, and Ecuador and Gabon in 1973. OPEC was composed of thirteen members prior to the first oil crisis in 1973. Ecuador and Gabon left OPEC later in 1993 and 1995, respectively. What is an Oligopoly Market Structure?

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). The word is derived from the Greek for few (entities with the right to) sell. Because there are few participants in this type of market, each oligopoly is aware of the actions of the others. The decisions of one firm influences, and is influenced by the decisions of other firms. Strategic planning by oligopolists always involves taking into account the likely responses of the other market participants.

In an oligopoly, firms operate under imperfect competition and a kinked demand curve which reflects inelasticity below market price and elasticity above market price, the product or service firms offer are differentiated and barriers to entry are strong. Following from the fierce price competitiveness created by this sticky-upward demand curve, firms utilize non-price competition in order to accrue greater revenue and market share. In an oligopolistic ally competitive market, firms will not raise their prices because even a small price increase will lose many customers.

However, even a large price decrease will gain only a few customers, Factors which lead to emergence of an Oligopolists market

1) Availability of product ( small number of sellers) OPEC represents a considerable political and economical force. Two-thirds of the oil reserves in the world belong to OPEC members; likewise, OPEC members are responsible for more than half of the world's oil exports. The fact that OPEC controls the availability of a substance so universally sought after by modern society renders the organization a force to be reckoned with.

2) Limiting the Output OPEC controls the amount of production of oil and gas by imposing production quotas on each member nation. This automatically fixes the amount of oil and gas the group can produce to the world market. This has often helped to control production and hence price of oil and gas. The production quota is usually in proportion to the deliverability capacity of the member nations. However, it can lead to reduction in revenue to its member nations when they have to cut-back production when they think the supply of oil and gas is in excess of the demand.

OPEC is in many ways a CARTEL—a group of producers that attempts to restrict output in order to raise prices above the competitive level. The decision-making center of OPEC is the Conference, comprising national delegations at the level of oil minister, which meets twice each year to decide overall oil  output—and thus prices—and to assign output quotas for the individual members.

Those quotas are upper limits on the amount of oil each member is allowed to produce. The Conference also may meet in special sessions when deemed necessary, particularly when downward pressure on prices becomes acute. Following table shows the figures of production ceilings for a period of time given to the OPEC member’s countries.

Conclusion: OPEC is collectively formed by a group of producers of petroleum products. The main purpose of formation of the organization was to protect the interest of the members nations. OPEC has stood the test of the time and since its creations has proven to be one of the most prosperous and effective industrial monopoly alliances.