What is the Organization of the Petroleum Exporting Countries (OPEC)?

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Definition:

The Organization of the Petroleum Exporting Countries (OPEC) is a 14-member international organization of countries that export oil.

🤔 Understanding OPEC

In 1960, five of the world’s largest oil-producing countries came together to form the Organization of the Petroleum Exporting Countries (OPEC). Since then, the organization has grown to include 13 member countries (as of January 2020), all of whom are significant exporters of oil. OPEC seeks to unify the member countries and control the world’s supply of oil, thus setting petroleum prices. For its first five years, OPEC held its headquarters in Geneva, Switzerland. It has since moved them to Vienna, Austria. While OPEC consists of many of the world’s largest oil producers, not all are members. For example, the United States is one of the largest producers and is not a member of OPEC.

Example

OPEC affects your life every time you pay for gas. By attempting to control the world’s supply of oil, OPEC has a significant impact on the prices consumers pay at the pump — or the price airlines pay for jet fuel, and thus what you pay for an airline ticket.

Takeaway

OPEC is like a special club for oil-producers…

Not just anyone can join. When OPEC gets together for its “club” meetings, they talk about issues that are important to the member countries, including the price of petroleum. They also look out for each other and come to each other’s aid if need be — often at the expense of nations and consumers whose economies depend on oil.

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What is the history of OPEC?

The Organization of the Petroleum Exporting Countries (OPEC) came to life in September 1960. The five founding countries — Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela — created the organization at the Baghdad Conference. The conference was an opportunity for the countries to meet to discuss the price of crude oil and other issues of interest to oil-producing countries.

The headquarters of OPEC was initially in Geneva, Switzerland. During the five years that it had its headquarters there, three other countries joined: Qatar, Indonesia, and Libya. In 1965, the member countries decided to move the headquarters to Vienna, Austria, which is where it remains today.

The founding countries formed OPEC during a decade when the world’s political landscape was changing, and they wanted to ensure they had ultimate ownership over the natural resources their countries were home to. By the 1970s, OPEC has risen to international prominence and took more control of the price of crude oil around the world.

OPEC has seen a lot of changes since its formation in 1960. Over the decades, there has been volatility in the price of crude oil. Some decades saw drastic price increases, while others saw price decreases. OPEC also struggled as other oil producers entered the market, and OPEC’s share of the market decreased.

The organization has also seen its membership change over the years. Several countries joined, left, and rejoined OPEC. Today the organization has 13 members: Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Libya, the United Arab Emirates, Algeria, Nigeria, Gabon, Angola, Equatorial Guinea, and Congo.

The member countries of OPEC produce 60% of the world’s oil, but some major oil-producing countries are not members of OPEC. Seven of the fifteen largest oil producers in the world have not joined: The United States, Russia, China, Mexico, Canada, Norway, and Brazil.

One of the critical benefits of OPEC is that it allows oil-producing countries with similar interests to gather and discuss ways to further those interests. On the other hand, not joining OPEC allows countries to have more say over their oil pricing and production — They have the freedom to focus on interests that differ from the member countries of OPEC.

What is the purpose of OPEC?

The purpose of the Organization of the Petroleum Exporting Countries (OPEC) is to unify the member countries and allow them to coordinate the stable prices of petroleum. They help to connect oil consumers with oil producers and ensure that each of their member countries has a steady income from oil.

According to the OPEC statute (its governing document), the organization works to safeguard the interests, both individual and collective, of the member countries.

OPEC has three primary goals. The first goal is price stability — OPEC wants to ensure all of the members can get a reasonable price for their oil. The members usually aim for $70 to $80 per barrel.

Setting the prices together helps OPEC countries to get more money for their oil. In a traditionally competitive market, each country would have the goal of out-earning other sellers. But, to do this, they may lower their prices to make their product more competitive. Others in the market would do the same.

The law of demand says that as the price goes down, demand would go up. This increase in demand would result in oil-producing countries using up their most valuable resource more quickly and getting a lower price for it. By setting prices together and coordinating production levels, member countries can slightly slow the use of oil and ensure they get a high price for it.

OPEC’s other goals are to reduce the volatility of oil prices and to adjust the world’s oil supply. These goals go hand in hand. Often the way member countries can reduce price volatility is by increasing or decreasing the oil supply. If prices spike, they can produce more oil to reduce the cost. If prices get too low, they can reduce the supply to increase the price.

Another reason for adjusting the oil supply is to address oil shortages. If there is an oil shortage as a result of the current events in one of the member countries, others may increase their supply to keep the overall supply stable.

How does OPEC work?

OPEC’s founding members created a statute that governs the organization. Per the statute, the conference is the supreme authority of OPEC. The conference consists of delegates representing each of the member countries.

The major decisions of the organization occur at its semi-annual conference, where delegates from all member countries attend. The statute requires a quorum of three-quarters of member countries. Each member country gets one vote when the organization makes decisions, and most decisions have to be unanimous.

OPEC is open to any country that has a substantial net export of crude petroleum, and that has fundamentally similar interests to the other member countries. Before new countries can join, they have to get the approval of three-quarters of the current members, and they need the unanimous consent of all five founding members.

How does OPEC affect the world?

One of the regular practices of OPEC’s member countries is to set oil prices and supply. And because of the percentage of oil that OPEC and its member countries control, it has a substantial impact on determining the global price of oil.

While it does not directly set the price of gasoline that you pay at the gas pump, its policies have a direct impact on those prices. For example, suppose OPEC’s member countries are not happy with the price they are getting for their petroleum. OPEC could vote to reduce the supply of oil available, therefore increasing the cost.

OPEC doesn’t just affect the price of gasoline. The prices of many other products are dependent on gas prices as well. In the United States, for example, companies require a large amount of fuel to move their product around the country. When the price of gas goes up, companies increase the cost of their products to prevent shrinking profit margins. So while OPEC can have an impact on the price you pay for gas at the gas station, the organization can also impact the price you pay for other everyday products.

OPEC isn’t the only decision-maker in the world when it comes to oil prices. The United States has historically been one of the largest oil producers. Though it doesn’t control nearly the same amount of oil as OPEC’s combined member countries, it is one of the two largest suppliers — Saudi Arabia is the other. As the United States reduces its reliance on OPEC member countries through reduced fuel consumption and the production of its own oil, the United States could have an increasing impact on oil prices globally.

Oil prices aren’t the only reason the United States wants to reduce its reliance on OPEC’s oil supply. There are political factors that come into play, as well. Because of its control of the majority of the world’s oil reserves, OPEC has significant political power as well. This political power has only increased as Russia — one of the world’s superpowers — has formed a stronger relationship with OPEC.

What happened at the last OPEC summits?

At recent summits, OPEC members have decided to reduce the supply of available oil. They did this in response to decreasing returns and reserves. In 2016, OPEC members agreed to reduce supply by one million barrels per day.

At subsequent summits, OPEC agreed to extend the cut of oil production, mainly at the urging of Saudi Arabia. Most recently, in December 2019, member countries agreed to reduce oil output once again, down an additional 500,000 barrels per day for the first three months of 2020. Cuts over the past few years have also been in coordination with major oil-producing countries who are not members of OPEC — namely Russa.

It’s important to note that there’s plenty of historical evidence to suggest that OPEC members are inclined to cheat on the deals they make, often failing to stick to the production cuts they agree to.

OPEC met again in March 2020 to decide on the next steps for oil production, their plans to meet unknowingly coinciding with the outbreak of COVID-19. Not only did the pandemic decrease production of oil as many workers became infected in the region, but 2020 also saw a sharp decrease globally in the demand for oil with the institution of travel restrictions and quarantines, prompting many individuals to work from home instead of taking transportation to a business or office. The price of oil collapsed in March of 2020, threatening profitability for OPEC countries.

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