Author: Paweł Kowalewski

Economist, works at NBP, specialises in monetary policy issues and FX markets

The 60th anniversary of OPEC: little to celebrate

The 60th anniversary of OPEC was a good opportunity for reflection. The sad conclusion is that a dialogue between consumers and oil producers has been and is impossible. This is due to the pursuit of particular interests and the lack of any willingness whatsoever to understand the other side.

Before OPEC was founded in 1960, the oil market probably had even less in common with a free market than after the establishment of this organization. Nevertheless, the generally unfavorable perception of OPEC is largely the organization’s own fault.

A besieged fortress

Its Vienna headquarters (both the old building and the new one) have been suffering from a “besieged fortress” syndrome. Obtaining access to the organization’s library requires considerable effort and determination. And it isn’t only about the thorough inspection carried out prior to entry.

The official documents released by OPEC leave a lot to be desired. Its flagship publication — “Monthly Oil Market Report” — sometimes devotes more attention to the condition of the Polish economy than to the issue of oil production in the OPEC member states. The description of the latter boils down to just two tables — one of them illustrates the oil production volumes according to domestic sources (and more precisely, direct communication, whatever that’s supposed to mean), and the other presents the production volumes according to secondary sources, without any explanation of what is meant by that.

It’s relatively easy to arrange a meeting with analysts working for OPEC, and such meetings are held in a relaxed atmosphere. At the same time, however, it is almost impossible to learn anything insightful from them. When we add to this the lavishness displayed at the OPEC summits, it is hardly surprising that the attitude of the public towards this organization is generally unfavorable. Many observers aren’t even hiding that they wish this organization the worst, including its imminent breakup. This perception is pretty biased and is most likely the result of the self-absorption of Western countries.

At this moment OPEC seems to be going through an existential crisis. However, almost every person with extensive knowledge of the OPEC’s history would agree that it would be dangerous to simply write this organization off.

It has experienced several crises. But despite its almost innate ability to rise like a phoenix from the ashes, the current crisis does not bode well for the organization. This may be due to the fact that the current difficulties are largely the result of generational change taking place in one of the organization’s crucial member states, that is, the Saudi monarchy. The mistakes made by the young Saudi prince have already brought irreparable losses.

Since the 60th anniversary of OPEC is not a reason for special celebration, then perhaps it would be a good pretext for a discussion on the past 60 years? And more specifically, the discussion on whether it was possible to pursue a different kind of policy which could have protected OPEC from the current crisis?

The seven sisters

It’s hard not to agree with the thesis brought forward in the mid-2010s by the former Minister of Foreign Affairs of Austria, Karin Kneissl. In her book entitled “Der Energiepoker – Wie Erdoel und Erdgas die Weltwirtschaft beeinflussen” (Energy Poker: How the Oil and Natural Gas Market Influences the Global Economy) she claimed that energy-related issues were at the root of almost all major military conflicts in the world.

In keeping with this thesis, it is difficult to determine whether OPEC actually caused these conflicts or whether it was rather their victim. In order to give a clear answer to a question formulated in this way, we need to explore the history of the organization. In the beginning, there were no signs of the possible escalation of tensions between the consumers and producers of oil. The latter participated in an informal group, which went down in history as the “Seven Sisters”. This group consisted of seven Anglo-Saxon oil companies (British Petroleum BP, Royal Dutch/Shell, Texaco, Mobil Oil, Gulf Oil, Standard Oil of California, and Standard Oil of New Jersey).

The term “Seven Sisters” was coined by the president of the Italian company Agip, Enrico Mattei. His main goal in life was to join this privileged group of “siblings”. However, the nature of privileges is that they are reserved for a really small group of people or entities. As a result, Mr. Mattei’s efforts ultimately failed, and he himself died in a mysterious plane crash.

The period preceding the formation of OPEC coincided with the end of the economic boom caused by the reconstruction of Europe from the ashes of war, as well as the subsequent Korean War. As dark clouds were gathering over the oil sector, even the privileged “sisters” started to look for ways in which they could improve their financial standing.

One of the ideas was to renegotiate the agreements with countries in which the “sisters” were extracting oil. As we can guess, the oil companies sought to ensure that an even lower percentage of the profits would fall to the countries holding the oil deposits. It’s hardly surprising that the said countries weren’t happy with the Anglo-Saxon oil companies’ new and extremely selfish attitude. Therefore, they decided to act together in order to protect their interests. Their efforts ultimately led to the organization of the meeting in Baghdad, whose 60th anniversary has been celebrated recently.

The Polish traces

At the beginning, the creation of OPEC wasn’t really a source of concern for anyone. In fact, it was quite the opposite. According to Ms. Kneissl, we could even talk about a certain sense of relief. Mainly because the creation of OPEC prevented the implementation of an alternative plan promoted by the then Egyptian President Gamal Abdel Nasser who wanted to set up a special organization for energy. It was supposed to be headquartered in Cairo and operate within the structures of the League of Arab States. Nasser’s plans were rejected by Iraq.

On the other hand, the fact that the initiative concerning the establishment of OPEC came from Caracas, Venezuela, and that the group of stakeholders included Iran, gave the newly formed organization a slightly more global profile. It’s worth noting that a person of a Polish descent made a considerable contribution to the creation of OPEC. It was an American journalist Wanda Jablonski, a daughter of a Polish geologist, Eugene Jablonski. She arranged a meeting between the Venezuelan oil minister, Juan Pablo Perez Alfonso and his Saudi counterpart Abdullah Tariki. The meeting must have been fruitful, and the two ministers went down in history as the actual founders.

During the first years of its operation, OPEC wasn’t pursuing any ideas such as nationalization or price wars. The member states were more concerned about protecting their interests, and their decisions were marked by common sense and pragmatism. The decision to move the organization’s headquarters to Vienna was the best example.

Why was the Austrian capital chosen, even though the candidacy of Rome or Geneva had been considered for a long time? Well, OPEC was brought to Vienna at the initiative of Bruno Kreisky, Austria’s foreign minister and subsequent prime minister. Both parties were satisfied with such an agreement. OPEC was happy because thanks to Mr. Kreisky’s offer this relatively little-known entity acquired the status of an international organization. On the other hand, attracting yet another international organization meant a greater guarantee of security for Austria. It’s worth remembering that at that time this country was situated on the borderline between NATO and communistic Warsaw Pact armies.

Towards nationalization

Among the five founding member states of OPEC — possibly except for Iraq — there were no countries that would be a source of concern for Washington. Yet the presence of Iran, or rather the Shah ruling that country, provided a guarantee that no one would come up with ideas such as the nationalization of the oil sector, which was previously promoted by the Iranian prime minister Mohammad Mossadegh, who ruled in the years 1951-53 (and who was de facto toppled by the CIA).

Over the subsequent months and years, new countries joined OPEC. Most of them were newly liberated post-colonial states and this became one of the causes of the tensions that ensued. At some point, only a single spark was enough to ignite a fire. It came in the form of the 1969 coup d’état in Libya (which joined OPEC in 1962) led by colonel Muammar Gaddafi.

Soon after taking power, the Libyan dictator proceeded to nationalize the local oil fields. His actions became an inspiration to other countries. Even the then inherently liberal Venezuela was observing the Libyan experience with interest, but its president Rafael Caldera decided not to introduce such changes.

A lot has been written about the embargo imposed by the Arab member states of OPEC on the United States and two European countries (the Netherlands and Denmark). Therefore, it seems redundant to analyze this issue once again. At the most, it may be worth emphasizing the adjective “Arab”. The point is that not all the OPEC members joined the embargo. One of them was Venezuela. However, this was not appreciated by Washington.

Once the US administration introduced retaliatory measures against the members of OPEC for their attitude during the first oil crisis, they applied to all countries, including Venezuela. It is therefore hardly surprising that Carlos Andres Perez, the successor of Mr. Caldera, decided to nationalize the Venezuelan oil industry in 1976. However, attempting to explain this decision solely by the mishaps in the US’ foreign policy would be overly simplistic.

The example of Venezuela shows that the first oil crisis cannot be seen solely through the prism of the bonanza which took place in some Arab countries. The enormous influx of petrodollars to Venezuela led to the overheating of the domestic economy and then generated chronic macroeconomic imbalances, which ultimately brought the country on a path leading straight to a debt crisis. And the effects of the latter, along with the country’s rampant corruption, paved the way to power for Hugo Chavez.

Dependent on oil extraction

In the 1970s, nearly all OPEC countries were aware of the decreasing value of the money they were receiving from the sale of crude oil. The high levels of inflation, especially in the US and the United Kingdom, led to a decline in the value of the two currencies that the OPEC countries used for settlements and for holding their financial surplus. As it was difficult to find an alternative to the USD, the best form of protection against inflation for the OPEC states was to halt oil extraction. After all, it’s better to leave the oil in the ground rather than watch the revenues from its sales succumb to inflation.

However, despite the lofty declarations, it was difficult for OPEC members to achieve unanimity on this matter. Although low oil production guaranteed high prices, they also encouraged consumers to search for new, previously inaccessible oil deposits.

The best example of that could be the North Sea oil. On the other hand, some OPEC members became so dependent on the proceeds from oil extraction that they became their hostages. As a result, OPEC was becoming increasingly divided, and member states simply started to cheat and did not follow the pre-established production limits.

This attitude significantly weakened the effectiveness of the entire organization, especially as the lack of a common position encouraged certain important members of the organization to seek alliances outside OPEC. Of course, all these actions were taken in the name of their preferred policies. No wonder that the US reached perfection in manipulating the member states of OPEC in an almost Machiavellian manner.

The famous events from 35 years ago illustrate the best the essence of the above-mentioned manipulations. In August 1985, Saudi Arabia — at the explicit urging of the US — made the decision to flood the markets with oil, which led to a dramatic drop in prices. The decision was primarily targeted against the Soviet Union, which, as we all know, did not withstand the blow.

However, the discussed move had a „rebound effect” also on other oil producers, including Saudi Arabia itself. The low oil prices strained the public finances of even the strongest members of OPEC. In such circumstances, unexpected help came from the Venezuelan president Hugo Chavez, who contributed to a reversal of this trend using, among other things, his rhetoric. Chavez gradually grew to the rank of an oil price hawk, especially since he had the courage to openly state what others were thinking but were afraid to say. According to Chavez, developing countries had a moral right to demand high prices for their crude oil. This was supposed to be a certain kind of compensation for the decades of exploitation of the OPEC member states by developed countries.

The paradox of high prices

In the first decade of the 21st century, oil prices began to grow rapidly. However, their growth was not a manifestation of the strength of OPEC, but rather of its weakness. The organization learned from the 1970s experience and was well aware of what too high oil prices could lead to: not only to a drop in demand, but also to the exploration of new oil deposits in other locations.

Due to that, at the very beginning of this century, Saudi Arabia attempted to stabilize oil prices at the level of USD22/barrel, with a maximum deviation up to the level of USD28/barrel. For some time, this tactic worked well. However, the surge in demand from China and India made it impossible to maintain this price range any further. Oil prices began to soar almost to USD150/barrel, which was not liked by all OPEC members, especially the more far-sighted ones.

And that was right, because the soaring oil prices started to stimulate the development of the shale oil industry. In order to face the new situation, the Saudis had to enter into an alliance with someone who they had once fought fiercely. The attitude of the Russian President Vladimir Putin towards the fallen Soviet Union — which collapsed, among other things, as a result of the policies pursued by the Saudis — is well-known. It is therefore no wonder that, during the meetings of OPEC+, Mr. Putin seems to be smiling more than others. All the more so that because of this marriage of convenience the role of Saudi Arabia in OPEC+ seems to be much smaller than in OPEC itself.

The entire problem stems from the fact that OPEC failed to convince oil consumers of its standard requirement consisting in obtaining a demand guarantee. The consumers would prefer to see OPEC as a supplier of last resort that would supply the world with additional oil if necessary.

OPEC never wanted to agree to such an arrangement. This wasn’t merely about prestige, but more about economic issues. Being a supplier of last resort is simply very expensive, and the “opportunity cost” of each USD allocated to mining infrastructure was and still is high, especially in light of the efforts of many OPEC members to reduce their dependence on oil prices. Therefore, instead of the desired dialogue between oil producers and consumers, we are dealing with a continuous escalation of tensions.

The excessive arbitrariness of some OPEC member states proved to be extremely detrimental. However, their annihilation turned out to have even worse consequences, as exemplified by Venezuela or Libya.

A sad conclusion comes out from the summary of the past 60 years. It boils down to stating a lack of willingness on the part of both oil consumers and producers to rise above their own particular interests. Therefore, Karin Kneissl will probably be able to claim until the end of her days that the roots of most global conflicts are what the aforementioned Juan Pablo Perez Alfonso at the end of his life called “the Devil’s excrement”.

Paweł Kowalewski is an economist at the Domestic Operations Department of Poland’s central bank, NBP.

The opinions expressed by the author do not represent the official position of NBP.


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