The Organization of the Petroleum Exporting Countries (OPEC) was established in Baghdad in 1960. The founding members were Iraq, Iran, Kuwait, Saudi Arabia and Venezuela. Later on, the following members joined the organization: Qatar, Indonesia, Libya, United Arab Emirates (UAE), Algeria, Nigeria, Ecuador, Angola, Gabon and Equatorial Guinea. OPEC aims at coordinating and harmonizing the petroleum policies of oil-exporting countries to ensure fair and stable prices for producers and adequate return on oil investments (OPEC Brief History).
OPEC produces around 43% of the world’s total crude oil and more than 20% of the world’s natural gas. OPEC possesses approximately 80% of the world’s crude oil reserves and 48% of the world’s natural gas reserves. In 2015, OPEC produced around 38.2 million barrels of crude oil, out of which Saudi Arabia, the largest producer within OPEC, contributed 12 mb/d. Most of OPEC production is exported to the Asian-Pacific region, while the US imports around 34% of its total oil imports from OPEC members. The OPEC References Basket (ORB) plays an important role in oil pricing. The basket consists of 12 oil blends from member states (OPEC Statistics & Facts). In 2016, the Energy Information Agency (EIA) estimated that OPEC members received about $433 billion in net oil exports revenues, compared to $509 billion in 2015, a decline ascribed to lower oil prices and, to a lesser extent, decrease in OPEC exports (OPEC net oil export revenues).
Since the 1970s, OPEC has gained power by the virtue of its size, controlling around 50% of the global crude oil production. Therefore, it was in a position to influence prices through manipulation of production. Fattouh (2007) argues that the OPEC pricing power is not unconstrained, with its ability to influence oil prices varying according to market conditions. Moreover, it was found that OPEC’s influence is affected by geographic location, for example, where member states develop reserves and gain larger market share. However, some empirical investigations show that OPEC is a price taker and acts as cartel only with a subgroup of its members. Nevertheless, the results indicate that OPEC influence underwent variations over time in tandem with changes in the oil pricing system (Bremond et al. 2012). While some researchers consider OPEC as a textbook model of cartels, others consider it a fringe of non-cooperative producers led by Saudi Arabia. Some structural factors make the coordination of OPEC members difficult, for instance, given individual differences in characteristics, fiscal stance and reserves and the absence of compensation and enforcement mechanisms. These factors are instrumental in determining the scope for coordination (Behar and Ritz 2016).
Within the network of oil production, some countries assume more prominent roles than others. The Saudi role, for instance, was not undermined by the re-emergence of Russia and Iraq, underpinning factors such as capacity- increasing investments aimed at preserving spare capacity. Spare capacity is essential for stabilising the international oil market and maintaining Saudi Arabia’s leadership in the oil arena and its role as a price maker (Fattouh, 2007). Manescu and Nuno (2015) employ a general equilibrium model of the global oil market, where Saudi Arabia assumes the dominant firm position vis-a-vis other producers who are considered the competitive fringe. As far as the impact of unconventional oil is concerned, their results suggest that the bulk of anticipated rise in US oil supply from the shale revolution has already been absorbed in oil prices. Around the end of 2014, OPEC adopted a new strategy to increase its market share, a step that analysts perceived as an endeavour to drive shale oil producers with high costs out of the market. However, four factors to rationalize OPEC’s new strategy: the US shale oil production growth, slackening international oil demand, decline in OPEC’s integration as a cartel, and upsurge of non-OPEC’s production (Behar and Ritz 2016).
Although the non-OPEC states produce around two-thirds of the world’s total oil production, they are not as influential as OPEC for reasons such as lack of coordination with market variables in the absence of spare capacity, to make up for short supply, and high production (Khadduri 2013). Ratti and Vespignani (2015) use Granger causality to test for the impact the non-OPEC oil production growth on the OPEC oil production growth during 1974–1996. They found that OPEC production declined with positive shocks in non-OPEC production. However, this is not valid for the period 1997–2012. They also show that between 1997 and 2012, the “cumulative effects of structural shocks to non-OPEC oil production and to real oil price on OPEC oil production are large and that the cumulative effect of structural shocks to OPEC production and real oil price on non-OPEC production are small.”
OPEC and non-OPEC countries started coordination in the late 1980s, with the objective of reducing production. However, this coordination did not achieve its goals because of disagreement on quotas, parities, and ceiling. During the 1998–1990 crisis, Mexico and Venezuela conformed with Saudi Arabia, and after the 1999 meeting, which was attended by Algeria and Iran, an agreement was reached to cut production by more than 4 mb/d. Thus, there was a price hike in the same year and years after. The agreement was supported by other OPEC and non-OPEC countries. Another recent example of successful cooperation between OPEC and non-OPEC is the December 2016 agreement led by Saudi Arabia, Russia, Qatar, and Algeria and joined by another 19 countries. The agreement resulted in cutting the production by 1.8 mb/d, and then the first-ever joint monitoring system was introduced (Al Muhanna 2017). The future of oil will be driven by factors such as growth in world population, technology, and renewable energy. By 2040, the world population is expected to increase by 1.7 billion. This increase will be reflected in higher demand for oil. Therefore, fossil fuel will continue to play a prominent role in economic welfare (OPEC Bulletin 2016).
Moreover, the influence of Russian and US oil production on both OPEC and non-OPEC increases over time. In contrast, the influence of Saudi Arabia is declining significantly. Furthermore, cut decisions do not have any effect on OPEC and non-OPEC coordination. Accordingly, oil-producing countries do not act in line with the “cut” decisions. Increase decisions have a significant and positive impact on OPEC and non-OPEC coordination. OPEC and non-OPEC countries increase their oil production coordination level and act in line with the increase decisions. The level of connectedness among OPEC members are significantly higher compared to non-OPEC oil-producing countries. Thus, only increase decisions made in OPEC meetings are effective. The coordination level of global oil production significantly increases following such decisions (Al Rousan et al. 2018).
Impact on Financial markets
In addition to trading physical quantities of oil, market participants trade future oil contracts and energy derivatives to hedge against risk and inflation, profit from price changes, and diversify portfolios. As measured by NYMEX (New York Mercantile Exchange), open interest in exchange-traded crude oil futures contracts has increased markedly since 2008. Since these positions are traded in the less transparent over-the-counter (OTC) market, data should be interpreted with caution (EIA 2018a).
Historically, stocks have comprised the largest investment market. Often, stock and commodity prices move together in response to economic conditions, which affect corporate earnings and hence demand for raw materials (i.e., commodities). Moreover, risk levels and appetites changed dramatically between 2008 and 2010, and since then, the relative risk/return associated with oil investments has been quite similar to that for stocks. During the financial crisis (when risks were increasing) and the recovery (when risks were decreasing), stocks and commodity prices (including for crude oil) tended to move in tandem.
The negative relationship between the U.S. REER (real effective exchange rate) and crude oil prices could be attributed to the fact that oil benchmarks are traditionally priced in U.S. dollars. When the dollar depreciates, the effective price of oil outside the United States decreases, thus potentially increasing consumer demand and creating upward pressure on prices (EIA 2018a). Moreover, because depreciation of the U.S. dollar decreases the returns on dollar-denominated assets when converted into foreign currencies, foreign entities may attempt to maintain higher oil prices and may find investing in commodities like oil more attractive. Likewise, U.S. investors may invest in commodities to hedge against inflation when the U.S. dollar depreciates. During downturns, there is a stronger negative correlation between oil prices and the exchange rate due to risk shocks and the financialization of oil prices (Fratzscher et al. 2014).
OPEC continues to play a role in the global economy, but changes in the economy warrant a modified re-investigation of the oil price–OPEC relationship. The recent decrease in OPEC’s spare capacity has led scholars to question OPEC’s ability to influence oil prices. While OPEC has been keeping an eye on China as an export market, China has been diversifying its import markets of crude oil, reforming its refinery sector and increasing its exports of refined petroleum. In addition to China, demand for crude oil in other Asian and non-OECD (Organisation for Economic Co-operation and Development) countries has been increasing. In this context, a concern has been the likely decrease in global oil demand, potentially due to international trade wars. Technological advances have increased the responsiveness of supply to demand and to investment spending. In particular, U.S. shale producers can ramp up production in approximately a year. The relatively inelastic price elasticities of demand and supply cause cyclicality in oil price movements which would be affected by changes in the responsiveness of supply and demand. Furthermore, since 2008, scholars have observed a closer link between oil and asset prices – particularly, a negative relationship between oil prices and the prices of assets negatively affected by financial crises (Razek and Michieka 2019).
OPEC continues to play a vital role in balancing oil markets. OPEC impacts oil market dynamics and oil prices primarily through production responses to changes in global demand. Oil prices are influenced by global petroleum demand, non-OPEC producers’ behaviour, and the demand for oil as a financial asset. The financialization of oil has a significant impact on oil price movements. China’s petroleum demand affects oil prices; however, demand from other Asian countries is another an important driver. Focusing on China rather than global demand overlooks other important market segments and hence misses some of the dynamics in the oil market and global economy. China’s impact on global demand and consequently on oil prices is driven by a surge in domestic demand and in exports of refined products. Although U.S. production could explain a larger portion of the variation in oil prices than OPEC production at shorter time horizons, the reverse is true at longer time horizons. Although it is important to consider the impact of U.S. production on oil prices, the impact of other non-OPEC production should not be underestimated, because it contributes to satisfying global demand and balancing the market