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A Study of

World crude oil reserves and


current issues on crude oil
pricing
A Project report International Economic Organizations

Prepared by

Submitted to

Dhaval Baria (14M48)

Prof. (Dr.) Yogesh. C. Joshi

Akash prajapati (14F41)

GHPIBM

Jagdish Ramm (14M11)


Rahul Chhatrodiya (14F30)
GHPIBM
2014-2016 Batch

Acknowledgement
At outset, we would like to thank G. H. Patel Post Graduate Institute of Business Management
for designing such a curriculum that help us in in-depth understanding of the industry and
providing us opportunity to do this project work.
We would like to extend our gratitude to Dr. (Prof.) Y.C. Joshi under whose guidance the project
was successfully completed. The major part of success should be attributed to the efforts and
direction provided by her who acting as mentors was supportive not only in explaining the
complexities of the project but also to guide and support at all times.
At last but not least we would like to thank all who have directly or indirectly supported us in
successful completion of this project.

Table of Contents
Chapter 1 Introduction ............................................................................................................................ 4
Introduction ........................................................................................................................................ 4
Objectives ........................................................................................................................................... 4
Methodology ....................................................................................................................................... 4
Importance and Significance ................................................................................................................ 4
Chapter 2 History of OPEC ....................................................................................................................... 5
Mission Statement............................................................................................................................... 5
Values ................................................................................................................................................. 5
History................................................................................................................................................. 5
Objectives of OPEC ............................................................................................................................ 10
Member Countries ............................................................................................................................ 11
Functioning of OPEC .......................................................................................................................... 12
Chapter 3 Current Issues ....................................................................................................................... 14
Chapter 4 OPEC and the World A Comparative study .......................................................................... 27
Macro economic indicators................................................................................................................ 28
Oil and Gas Reserves ......................................................................................................................... 31
OPECs benefit to the member country .............................................................................................. 37
OPEC Influence on Economic Growth of the Member Countries ........................................................ 38
OPEC as a Promoter of Sustainable Development .............................................................................. 45
Chapter 5 OPEC & its influence .............................................................................................................. 60
OPEC and history of oil prices ............................................................................................................ 60
Assessment of OPEC in managing oil prices........................................................................................ 62
Setting the target range for oil price .................................................................................................. 63
Managing spare capacity ................................................................................................................... 64
Influence of OPEC on price ................................................................................................................ 66
Impact of Kyoto protocol on OPEC ..................................................................................................... 70
Chapter 6 Challenges to OPEC ............................................................................................................... 71
Conclusion............................................................................................................................................. 75
Bibliography .......................................................................................................................................... 76

Chapter 1 Introduction
Introduction
Oil is the blood of world economy. Out of top 10 Fortune 500 companies list published in July
2010, five are Petroleum companies. Therefore any increase in world oil prices impacts every
sector of the economy causing inflation. The Oil policies form an important part of national
policy making in all oil consuming countries. Some countries provide subsidy on oil and
petroleum products to promote domestic industries and check inflation, whereas some countries
impose tax on oil consumption to check demand and conserve. Economies all over the world
constantly monitor the oil price movements. Organisation of Petroleum Exporting Countries or
OPEC has the largest oil reserves in the world and is responsible for the supply and prices of
petroleum products to major extent.

Objectives
1) To study challenges to OPEC countries
2) To study the reasons of falling of oil prices.
3) To study the impact of price drop of oil globaly .

Methodology
Secondary data collection through OPECs website.

Importance and Significance


This report will provide insights to the management students about the whole Organization

of

Petroleum Exporting Countries. This will help them to understand the current oil supply and
demand by the OPEC and role of OPEC in stabilizing the oil prices world over. They will come
to know about various functions and objectives of OPEC and its significance for oil demand and
supply balance world over.

Chapter 2 History of OPEC


Mission Statement
To coordinate and unify the petroleum policies of its Member Countries and ensure the
stabilization of oil markets in order to secure an efficient, economic and regular supply of
petroleum to consumers, a steady income to producers and a fair return on capital for those
investing in the petroleum industry.

Values
We believe in transparent, honest, and auditable governance procedures.
We are responsive to our Members, stakeholders in trade, and society.

History
Venezuela and Iran were the first countries to move towards the establishment of OPEC by
approaching Iraq, Kuwait and Saudi Arabia in 1949, suggesting that they exchange views and
explore avenues for regular and closer communication among petroleum-producing nations. In
1959, the International Oil Companies (IOCs) reduced the posted price for Venezuelan crude by
5 and then 25 per barrel, and that for Middle Eastern crude by 18 per barrel. The First Arab
Petroleum Congress convened in Cairo, Egypt, where they established an Oil Consultation
Commission to which IOCs should present price change plans to authorities of producing
countries.
In 1014 September 1960, at the initiative of the Venezuelan Mines and Hydrocarbons
minister Juan Pablo Prez Alfonso and the Saudi Arabian Energy and Mines minister Abdullah
al-Tariki, the governments of Iraq, Iran, Kuwait, Saudi Arabia and Venezuela met in Baghdad to
discuss ways to increase the price of the crude oil produced by their respective countries.
Oil exports imports difference
OPEC was founded to unify and coordinate members' petroleum policies. Between 1960 and
1975, the organization expanded to include Qatar (1961), Indonesia (1962), Libya (1962), the
United Arab Emirates (1967), Algeria (1969), and Nigeria (1971). Ecuador and Gabon were
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early members of OPEC, but Ecuador withdrew on 31 December 1992 because it was unwilling
or unable to pay a $2 million membership fee and felt that it needed to produce more oil than it
was allowed to under the OPEC quota, although it rejoined in October 2007. Similar concerns
prompted Gabon to suspend membership in January 1995. Angola joined on the first day of
2007. Norway and Russia have attended OPEC meetings as observers. Indicating that OPEC is
not averse to further expansion, Mohammed Barkindo, OPEC's Secretary General, asked Sudan
to join. Iraq remains a member of OPEC, but Iraqi production has not been a part of any OPEC
quota agreements since March 1998.
1973 oil embargo
In October 1973, OPEC declared an oil embargo in response to the United States' and Western
Europe's support of Israel in the Yom Kippur War of 1973. The result was a rise in oil prices
from $3 per barrel to $12 and the commencement of gas rationing. Other factors in the rise in
gasoline prices included a market and consumer panic reaction, the peak of oil production in the
United States around 1970 and the devaluation of the U.S. dollar. U.S. gas stations put a limit on
the amount of gasoline that could be dispensed, closed on Sundays, and limited the days gasoline
could be purchased based on license plates. Even after the embargo concluded, prices continued
to rise.
The Oil Embargo of 1973 had a lasting effect on the United States. The Federal government got
involved first with President Richard Nixon recommending citizens reduce their speed for the
sake of conservation, and later Congress issuing a 55 mph limit at the end of 1973. Daylight
savings time was extended year round to reduce electrical use in the American home. Smaller,
more fuel efficient cars were manufactured. Nixon also formed the Energy Department as a
cabinet office. People were asked to decrease their thermostats to 65 degrees and factories
changed their main energy supply to coal.
One of the most lasting effects of the 1973 oil embargo was a global economic recession.
Unemployment rose to the highest percentage on record while inflation also spiked. Consumer
interest in large gas guzzling vehicles fell and production dropped. Although the embargo only
lasted a year, during that time oil prices had quadrupled and OPEC nations discovered that their
oil could be used as both a political and economic weapon against other nations.
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1975 hostage incident


On 21 December 1975, Ahmed Zaki Yamani and the other oil ministers of the members of
OPEC were taken hostage in Vienna, Austria, where the ministers were attending a meeting at
the OPEC headquarters. The hostage attack was orchestrated by a six-person team led by
Venezuelan terrorist Carlos the Jackal (which included Gabriele Krcher-Tiedemann and HansJoachim Klein). The self-named "Arm of the Arab Revolution" group called for the liberation of
Palestine. Carlos planned to take over the conference by force and kidnap all eleven oil ministers
in attendance and hold them for ransom, with the exception of Ahmed Zaki Yamani and
Iran's Jamshid Amuzegar, who were to be executed.
The terrorists searched for Ahmed Zaki Yamani and then divided the sixty-three hostages into
groups. Delegates of friendly countries were moved toward the door, 'neutrals' were placed in the
centre of the room and the 'enemies' were placed along the back wall, next to a stack of
explosives. This last group included those from Saudi Arabia, Iran, Qatar and the UAE.
Carlos arranged bus and plane travel for the team and 42 hostages, with stops in Algiers and
Tripoli, with the plan to eventually fly to Aden then Baghdad, where Yamani and Amuzegar
would be killed. All 30 non-Arab hostages were released in Algiers, excluding Amuzegar.
Additional hostages were released at another stop. With only 10 hostages remaining, Carlos held
a phone conversation with Algerian President Houari Boumdienne who informed Carlos that
the oil ministers' deaths would result in an attack on the plane. Boumdienne must also have
offered Carlos asylum at this time and possibly financial compensation for failing to complete
his assignment. Carlos expressed his regret at not being able to murder Yamani and Amuzegar,
then he and his comrades left the plane. Hostages and Carlos and his team walked away from the
situation.
Sometime after the attack it was revealed by Carlos' accomplices that the operation was
commanded by Wadi Haddad, a Palestinian terrorist and founder of the Popular Front for the
Liberation of Palestine. It was also claimed that the idea and funding came from an Arab
president, widely thought to be Muammar al-Gaddafi. In the years following the OPEC
raid, Bassam Abu Sharif and Klein claimed that Carlos had received a large sum of money in
exchange for the safe release of the Arab hostages and had kept it for his personal use. There is
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still some uncertainty regarding the amount that changed hands but it is believed to be between
US$20 million and US$50 million. The source of the money is also uncertain, but, according to
Klein, it was from "an Arab president." Carlos later told his lawyers that the money was paid by
the Saudis on behalf of the Iranians and was, "diverted en route and lost by the Revolution".
The 1980s oil gluts
In response to the high oil prices of the 1970s, industrial nations took steps to reduce dependence
on oil. Utilities switched to using coal, natural gas, or nuclear power while national governments
initiated multi-billion dollar research programs to develop alternatives to oil. Demand for oil
dropped by five million barrels a day while oil production outside of OPEC rose by fourteen
million barrels daily by 1986. During this time, the percentage of oil produced by OPEC fell
from 50% to 29%. The result was a six-year price decline that culminated with a 46 percent price
drop in 1986.
In order to combat falling revenues, Saudi Arabia pushed for production quotas to limit
production and boost prices. When other OPEC nations failed to comply, Saudi Arabia slashed
production from 10 million barrels daily in 1980 to just one-quarter of that level in 1985. When
this proved ineffective, Saudi Arabia reversed course and flooded the market with cheap oil,
causing prices to fall to under ten dollars a barrel. The result was that high price production
zones in areas such as the North Sea became too expensive. Countries in OPEC that had
previously failed to comply to quotas began to limit production in order to shore up prices.
Responding to war and low prices
Leading up to the 199091 Gulf War, The President of Iraq Saddam Hussein recommended that
OPEC should push world oil prices up, helping all OPEC members financially. But the division
of OPEC countries occasioned by the Iraq-Iran War and the Iraqi invasion of Kuwait marked a
low point in the cohesion of OPEC. Once supply disruption fears that accompanied these
conflicts dissipated, oil prices began to slide dramatically.
After oil prices slumped at around $15 a barrel in the late 1990s, joint diplomacy achieved a
slowing down of oil production beginning in 1998. In 2000, Venezuela President Hugo Chvez
hosted the first summit of OPEC in 25 years in Caracas. The next year, however, the September
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11, 2001 attacks against the United States, and the following invasion of Afghanistan, and 2003
invasion of Iraq and subsequent occupation prompted a sharp rise in oil prices to levels far higher
than those targeted by OPEC themselves during the previous period.
On 19 November 2007, global oil prices reacted violently as OPEC members spoke openly about
potentially converting their cash reserves to the euro and away from the US dollar.
In May 2008, Indonesia announced that it would leave OPEC when its membership expired at
the end of that year, having become a net importer of oil and being unable to meet its production
quota. A statement released by OPEC on 10 September 2008 confirmed Indonesia's withdrawal,
noting that it "regretfully accepted the wish of Indonesia to suspend its full Membership in the
Organization and recorded its hope that the Country would be in a position to rejoin the
Organization in the not too distant future." Indonesia is still exporting light, sweet crude oil and
importing heavier, more sour crude oil to take advantage of price differentials (import is greater
than export).
Production disputes
The economic needs of the OPEC member states often affects the internal politics behind OPEC
production quotas. Various members have pushed for reductions in production quotas to increase
the price of oil and thus their own revenues. These demands conflict with Saudi Arabia's stated
long-term strategy of being a partner with the world's economic powers to ensure a steady flow
of oil that would support economic expansion. Part of the basis for this policy is the Saudi
concern that expensive oil or supply uncertainty will drive developed nations to conserve and
develop alternative fuels. To this point, former Saudi Oil Minister Sheikh Yamani famously said
in 1973: "The stone age didn't end because we ran out of stones."
One such production dispute occurred on 10 September 2008, when the Saudis reportedly
walked out of OPEC negotiating session where the organization voted to reduce production.
Although Saudi Arabian OPEC delegates officially endorsed the new quotas, they stated
anonymously that they would not observe them. The New York Times quoted one such
anonymous OPEC delegate as saying Saudi Arabia will meet the markets demand. We will see
what the market requires and we will not leave a customer without oil. The policy has not
changed.
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OPEC aid
OPEC aid dates from well before the 1973/74 oil price explosion. Kuwait has operated a
programme since 1961 (through the Kuwait Fund for Arab Economic Development).
The OPEC Special Fund "was conceived in Algiers, Algeria, in March 1975", and formally
founded early the following year. "A Solemn Declaration 'reaffirmed the natural solidarity which
unites OPEC countries with other developing countries in their struggle to overcome
underdevelopment,' and called for measures to strengthen cooperation between these countries",
operating under a reasoning that the Fund's "resources are additional to those already made
available by OPEC states through a number of bilateral and multilateral channels." The Fund was
later renamed as the OPEC Fund for International Development (OFID).
The Fund became a fully fledged permanent international development agency in May 1980 and
was renamed the OPEC Fund for International Development (OFID), the designation it currently
holds.

Objectives of OPEC

OPEC seeks to ensure the stabilization of oil prices in international oil markets, with a
view to eliminating harmful and unnecessary fluctuations

OPECs role in overseeing an efficient, economic and regular supply of petroleum to


consuming nations.

To ensure a fair return on capital to those investing in the petroleum industry.

To deliver steady supply of oil to deliver steady supply of oil to consumers.


To get oil to people at reasonable and fair prices.

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Member Countries
Current members
OPEC has twelve member countries: six in the Middle East, four in Africa, and two in South
America.

Country

Region

Joined
OPEC

Algeria

Africa

1969

Angola

Africa

2007

Ecuador

South America (1973) 2007

Iran

Middle East

1960

Iraq

Middle East

1960

Kuwait

Middle East

1960

Libya

Africa

1962

Nigeria

Africa

1971

Qatar

Middle East

1961

Saudi Arabia

Middle East

1960

United Arab Emirates Middle East

1967

Venezuela

South America 1960

Total

11

Former members
Country

Region

Joined OPEC

Gabon

Africa

1975

Indonesia

South East Asia 1962

Some commentators consider that the United States was a de facto member during its
formal occupation of Iraq due to its leadership of the Coalition Provisional Authority. But this is
not borne out by the minutes of OPEC meetings, as no US representative attended in an official
capacity.
Indonesia left OPEC in 2009 because it ceased to be a net exporter of oil. It could not fulfill the
demand of its own country's needs, as growth in demand outstripped output. The situation was
made worse because of weak legal certainty and corruption that deterred foreign investors from
investing in new reserves in Indonesia. In recent times, the government has increased financial
incentives for foreign firms to invest in exploration and extraction but has found itself forced to
import more supplies from the likes of Iran, Saudi Arabia and Kuwait. Indonesia's departure
from OPEC will not likely affect the amount of oil it produces or imports.

Functioning of OPEC
Representatives of OPEC Member Countries (Heads of Delegation) meet at the OPEC
Conference to co-ordinate and unify their petroleum policies in order to promote stability and
harmony in the oil market. They are supported in this by the OPEC Secretariat, directed by the
Board of Governors and run by the Secretary General, and by various bodies including the
Economic Commission and the Ministerial Monitoring Committee.
The Member Countries consider the current situation and forecasts of market fundamentals, such
as economic growth rates and petroleum demand and supply scenarios. They then consider what,

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if any, changes they might make in their petroleum policies. For example, in previous
Conferences the Member Countries have decided variously to raise or lower their collective oil
production in order to maintain stable prices and steady supplies to consumers in the short,
medium and longer term.

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Chapter 3 Current Issues


Global oil prices have fallen sharply over the past six months, leading to significant revenue
shortfalls in many energy exporting nations, while consumers in many importing countries are
likely to have to pay less to heat their homes or drive their cars.
From 2010 until mid-2014, world oil prices had been fairly stable, at around $110 (68) a barrel.
But since June prices have almost halved. Brent crude oil has fallen below $60 a barrel for the
first time since July 2009 and US crude is below $55 a barrel.
The reasons for this change are twofold - weak demand in many countries due to insipid
economic growth, coupled with surging US production.
Added to this is a determination by the oil cartel Opec that it is not going to prop up prices by
cutting production.

REASONS FOR FALLING OF ALL PRICES


1. The U.S. Oil Boom

Americas oil boom is well documented. Shale oil production has grown by roughly 4
million barrels per day (mbpd) since 2008. Imports from OPEC have been cut in half and
for the first time in 30 years, the U.S. has stopped importing crude from Nigeria.

2. Libya is Back

Because of internal strife, analysts have until recently assumed that Libyas output would
float around 150,000-250,000 thousand barrels per day. It turns out that Libya has sorted
out their disruptions much quicker than anticipated, producing 810,000 barrels per day in
September. Libyan officials told the Wall Street Journal last week that they expect to
produce a million barrels per day by the end of the month and 1.2 million barrels a day by
early next year.

3. OPEC Infighting

There have been numerous reports about the discord between OPEC members, leading
many to believe that OPEC will not be able to reign in production like it has done so in
the past. The Saudis and Kuwaitis have reportedly been in an oil price war, repeatedly
lowering their prices in order to maintain their market share in Asia. John Kingston, the
news director at Platts, believes that the Saudis will not be willing to give up market
share like they have done during previous price drops.
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4. Negative European Economic Outlook

European Central Bank president Mario Draghi has left investors concerned about the
continents slow growth. Germanys exports were down 5.8 percent in August, stoking
the fears of anxious investors that the EUs largest economy had double dipped into
recession last quarter. Across the Eurozone, the IMF again lowered its growth forecast to
0.8 percent in 2014 and 1.3 percent in 2015.

5. Tepid Asian Demand


Beyond slow economic growth and currency depreciation, a number of Asian countries have
begun cutting energy subsidies, resulting in higher fuel costs despite a drop in global oil
prices. In 2012, Asias top spenders on energy subsidies, as a percentage of GDP included:
Indonesia 3 percent; Thailand 2.6 percent; Vietnam 2.5 percent, Malaysia 2.3 percent, and India
2.3 percent. India is a primary example. Between 2008-2012, Indias diesel demand grew
between 6 percent and 11 percent annually. In January 2013, the country started cutting the
subsidies of diesel. Since then, diesel consumption has plateaued.
Why the oil price is falling

Four things are now affecting the picture. Demand is low because of weak economic
activity, increased efficiency, and a growing switch away from oil to other fuels. Second,
turmoil in Iraq and Libyatwo big oil producers with nearly 4m barrels a day
combinedhas not affected their output. The market is more sanguine about geopolitical
risk. Thirdly, America has become the worlds largest oil producer. Though it does not
export crude oil, it now imports much less, creating a lot of spare supply. Finally, the
Saudis and their Gulf allies have decided not to sacrifice their own market share to
restore the price. They could curb production sharply, but the main benefits would go to
countries they detest such as Iran and Russia. Saudi Arabia can tolerate lower oil prices
quite easily. It has $900 billion in reserves. Its own oil costs very little (around $5-6 per
barrel) to get out of the ground.

Cutting Oil Production Will Not Solve OPECs Problems

As oil prices continue to fall, OPEC faces a dilemma at its meeting in Vienna on 27
November. Members must decide between decreasing production that will support the
oil prices but also consequently the U.S. shale oil industry, and maintaining current
levels of production that will lower oil prices at a potential cost for political stability.
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The largest drop in oil prices in the past five years created a stir among the
members of the prestigious energy club. At the moment OPEC controls 40% of the
words oil production, with a daily production of around 30 million barrels.
However, its market position is far from safe.

The surge in the U.S. unconventional oil production, along with stagnating global
demand, has caused an oil glut of 2 million barrels per day and a sudden slump in
oil prices. Since June 2014, prices have dropped by 30% to less than $80 dollars per
barrel of both Brent and WTI crude.

The drop obviously caught the oil producers by surprise, and OPEC members will have
to decide whether to retain the current production levels or significantly cut output. Both
choices carry major risks.

The significant cut of about 500 000 to 1 million barrels would inevitably bring oil prices
close to their pre-June levels, but in the long term would not solve the fundamental
problem of OPEC losing control of the global oil markets.

As a result of the shale revolution, the U.S. is already pumping more than 8 million
barrels of oil per day, compared to five million barrels in 2008. Consequently, the share
of U.S. crude oil imports from the OPEC members has already dropped to a 30 year low,
and with the U.S. oil production still on the rise and the crude oil export ban firmly in
place, the OPECs market share in the U.S. will continue to decline.

An expected increase in prices following potential cuts in OPEC production would give
more incentive for U.S. producers to enhance their production targets and start to bite into
the cartels market share outside North America. The U.S. has already re-started exports
of Alaskan crude oil to South Korea and more U.S. companies are circumventing the
export ban by shipping a lightly processed oil condensate to Asia and Europe, which
could soon reach 1 million barrels per day.

It will be equally difficult for OPEC oil ministers to agree on cuts on 27 November in
Vienna. High oil prices benefited the budgets of oil exporters during the past decade, and
the OPEC countries are no exception.

However, some countries are more dependent on oil incomes than others. Whereas the
rich Gulf countries with high foreign currency reserves can sustain longer periods of low
oil prices, countries like Libya, Venezuela, Iran or Nigeria cannot afford to lose their oil
revenues, and will fight vigorously to cut OPECs overall production but with minimal
cost to their own production quotas, which will put additional pressure on the
organisations informal leader, Saudi Arabia.

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The Gulf kingdom will be careful not to repeat its mistake in the 1980s when a decision
to shrink production resulted in a prolonged period of low oil prices. In addition, the cuts,
along with the price upsurge would only give advantage to U.S. producers. This gives an
indication that Riyadh will not react to the increased cut demands from its OPEC peers.
With low production costs and a secure cash cushion, Saudi Arabia is still in a
comfortable position to cautiously assess its future moves.

Regardless of the outcome of Thursdays meeting, the oil markets are experiencing
significant changes and all players will have to adapt to new circumstances. However, the
immediate collateral victims of the prolonged oil price slump will be the countries that
heavily depend on oil prices to patch their budget holes, which might have a disastrous
effect on their fragile political stability.

Why does oil prices rise and fall?


Of all industries in the world, oil industry is indeed an international business which affects most
countries in the world. As the oil is the most consumed energy, it plays a vital role in daily lives
as well as economy and social development. Also, the oil industry leads to new technology
development both directly and indirectly. It has been deployed as a means for economy and
political negotiation. Nevertheless, crude oil when refined into various petroleum products
having different attributes i.e. gasoline, diesel, aviation fuel, kerosene, and fuel oil, and others, its
value will be maximized. The price of crude oil is thus determined by the type and quality of the
crude oil itself. Once distilled, heavy and light crude oil yield several refined products e.g.
gasoline and diesel to serve demands at different quantities. In addition, sour and sweet crude are
also priced differently.
Forecasting or estimating oil price in the future is sophisticated because oil is the commodity
product which is available globally. Unlike other products, the quality of oil product can be made
different to serve different needs of consumers. As the oil market is mainly regional activities
which are born of cooperation from various countries and parties having different needs and
environments, several factors then involve both directly and indirectly. Nevertheless, the price
can be analyzed at both regional and global levels.

Main factors that affect the oil price

1. Fundamental factor

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The fundamental factor of oil price determination is demand and supply like other type of
products. Demand and supply of oil products change according to situation and circumstances. In
any market situation, imbalance between demand and supply can affect prices. For instance, in
the case of more demand than supply (undersupply), the price is likely to rise. The variables
which result in imbalance between demand and supply include:
Economic growth is the factor that positively corresponds with the price of oil. When the
economy grows, oil demand in our daily lives as well as demand to cope with economy
expansion will increase. If the worlds production is unable to meet the growth, the price of oil is
definitely on a rise. In an opposite vein, the price of oil will decrease if the economy growth is
minimal in the light of oversupply of oil. It is noted that the world economy growth rate in every
region must be taken into consideration.
Weather Seasonal change is another factor which causes the imbalance between oil demand and
production. Especially, the consumption patterns in Europe and the USA are clearly dictated by
the season. That is, in winter, the demand of heating oil (mainly diesel and fuel oil) is higher than
other types of oil. Normally, the oil traders start to increase inventory of heating oil in the fourth
quarter of the year to prepare for the winter at the beginning of the year. As a result, the price of
oil tends to increase during the said period. In addition, the demand is sensitive to the coldness.
The colder it gets, the higher the demand is. Due to the

Fears of the oil shortage, the consumers increase their oil inventories which also results in an
oversupply and may affect the price as well.
Meanwhile, summer is the driving season for the western countries, starting in the third quarter
of the year or around July. Given that the demand of gasoline is higher than other types, its price
tends to increase in the second quarter of the year. In sum, the weather is another fundamental
factor which contributes to the changing demand and supply and the price of oil.
OPECs production capacity If the production is not in line with the demand, the price of oil will
be affected as witnessed by the price skyrocketing during the past world oil crises. Thus the
countries with high reserves and production capacity have strong negotiating power for prices.
Most of the producers are Organization of Petroleum Exporting Countries or OPEC which
currently has 11 members i.e. Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi
Arabia, UAE and Venezuela. OPEC can manage and control production to meet the
consumption. If the production of the member is too high or too low, the price will be
accordingly affected. For instance, the growing and prolonged strike of oil workers in Nigeria
can have consequences in decreasing production and rising prices.
Policy of OPEC The policy set by OPEC also impacts demand and supply of oil market at great
length. As, the worlds largest oil producers and reserves, the OPECs announcement to increase
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or lower the production level, unavoidably triggers the oil price. As a major news, each OPECs
meeting is always in the spotlight.
Oil reserves of worlds major consumers Typically, each country has to reserve oil for energy
stability and security. Large consumer has to maintain the right inventory level just to
sufficiently meet the demand in order to reduce the expense. The sufficient oil inventory will
lessen the worry in the supply shortage. The price is likely to be softened. In the meantime,
when the demand exceeds the forecast, the inventory then decreases as the consumption rises and
results in undersupply. Under such scenario, the price will then adjust upward. As a result, the
large consumer such as the USA or European countries, have paid a particular attention to the oil
inventory.
Alternative energy The discovery and technology development to exploit other alternative
energy sources such as natural gas, coal and nuclear and others to substitute oil at competitive
prices and efficiently meet the consumers need, will decrease the demand and price of oil. As
long as the technology and development is still limited, the price of oil will fluctuate and depend
on the imbalance between demand and supply. Nevertheless, the world oil crisis alerts the people
who suffer from the oil price to accelerate their plan to develop other alternative fuels. If
alternative fuel can be developed to replace oil, the equilibrium between demand and supply will
then take place.
2. Sentimental factors
The oil market is naturally more sensitive to news than other market. The sentiment of oil traders
is the key factor to drive oil price to quickly respond to the news. The political and economy
movement in any region can impact the world oil price. Particularly, in unordinary situation e.g.
major war, the price is quite volatile. The news about the major oil producers and users in the
world especially in the Middle East, North Sea and the USA, etc predominantly impacts oil
market more than the news about other regions. Therefore, monitoring unrest political situation,
strike, coup dtat, assassination of political leaders of OPEC countries or the decision of
international organization which influences international politics, is thus critical. These news all
affect the price adjustment due to the concern and worry despite the fact the production and
export volume still remain unchanged.
3. Technical factor
To trade oil product in the market, apart from monitoring news and movement according to
fundamental factors of oil market, the traders require information, statistic as well as average
price record or history of the oil products to determine the price of today. This information also
affects the decision of oil sale and purchase as well as poses an indirect impact of price level.
Especially, the impact is greater in the future market which has a larger trading volume larger
than the real existing volume in the market. The trading is mostly speculated for profit making.
At present, there are five major future markets: New York Mercantile Exchange (NYMEX),
19

New York, USA; International Petroleum Exchange (IPE), London, UK; Singapore Monetary
Exchange (SGX), Singapore; Tokyo Commodity Exchange (TOCOM), Japan; and Shanghai
Futures Exchange, China.
4. Miscellaneous Factor
Foreign exchange the oil is traded internationally and sold in US dollar. Therefore, the value
change of foreign currency when compared with US dollar, affect the price of oil. When US
dollar devalues, the price of imported crude and finished products will be cheaper when
calculated in local currency. Conversely, the price when calculated in US dollar, will be higher.
The stronger US dollar will also result in lower oil price. Furthermore, the fluctuation of foreign
exchange will make it more difficult for traders to compare the price of oil in each market.
It can be concluded that no one can predict the price of oil in the future with certainty. But we
may estimate the price and direction of oil price by taking into account various aforementioned
factors. The oil price depends on a number of variables or situations occurring during a particular
period. The understanding of price mechanism deems vital and most important for planning and
managing energy utilization effectively and promptly.
However, the analysis of future oil price is complicated and the price is yet constantly
indeterminable due to several factors. The direction of price rests upon designated hypothesis as
of the day of analysis. That is why the analysis of the experts of different organizations may vary
according to their views and hypotheses formed in the forecast.

Analysis of the Impact of High Oil Prices on the Global Economy

Oil prices still matter to the health of the world economy. Higher oil prices since 1999 partly
the result of OPEC supply-management policies contributed to the global economic downturn
in 2000-2001 and are dampening the current cyclical upturn: world GDP growth may have been
at least half a percentage point higher in the last two or three years had prices remained at mid2001 levels. Fears of OPEC supply cuts, political tensions in Venezuela and tight stocks have
driven up international crude oil and product prices even further in recent weeks. By March
2004, crude prices were well over $10 per barrel higher than three years before. Current market
conditions are more unstable than normal, in part because of geopolitical uncertainties a0nd
because tight product markets notably for gasoline in the United States are reinforcing
upward pressures on crude prices. Higher prices are contributing to stubbornly high levels of
20

unemployment and exacerbating budget-deficit problems in many OECD and other oil-importing
countries.
The vulnerability of oil-importing countries to higher oil prices varies markedly depending on
the degree to which they are net importers and the oil intensity of their economies. According to
the results of a quantitative exercise carried out by the IEA in collaboration with the OECD
Economics Department and with the assistance of the International Monetary Fund Research
Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the
OECD as a whole losing 0.4% of GDP in the first and second years of higher prices. Inflation
would rise by half a percentage point and unemployment would also increase. The OECD
imported more than half its oil needs in 2003 at a cost of over $260 billion 20% more than in
2001. Euro-zone countries, which are highly dependent on oil imports, would suffer most in the
short term, their GDP dropping by 0.5% and inflation rising by 0.5% in 2004. The United States
would suffer the least, with GDP falling by 0.3%, largely because indigenous production meets a
bigger share of its oil needs. Japans GDP would fall 0.4%, with its relatively low oil intensity
compensating to some extent for its almost total dependence on imported oil. In all OECD
regions, these losses start to diminish in the following three years as global trade in non-oil
goods and services recovers. This analysis assumes constant exchange rates.
The adverse economic impact of higher oil prices on oil-importing developing countries is
generally even more severe than for OECD countries. This is because their economies are more
dependent on imported oil and more energy-intensive, and because energy is used less
efficiently. On average, oil-importing developing countries use more than twice as much oil to
produce a unit of economic output as do OECD countries. Developing countries are also less
able to weather the financial turmoil wrought by higher oil-import costs. India spent $15 billion,
equivalent to 3% of its GDP, on oil imports in 2003. This is 16% higher than its 2001 oil-import
bill. It is estimated that the loss of GDP averages 0.8% in Asia and 1.6% in very poor highly
indebted countries in the year following a $10 oil-price increase. The loss of GDP in the SubSaharan African countries would be more than 3%.
World GDP would be at least half of one percent lower equivalent to $255 billion in the year
following a $10 oil price increase. This is because the economic stimulus provided by higher oilexport earnings in OPEC and other exporting countries would be more than outweighed by the
depressive effect of higher prices on economic activity in the importing countries. The transfer of
income from oil importers to oil exporters in the year following the price increase would alone
amount to roughly $150 billion. A loss of business and consumer confidence, inappropriate
policy responses and higher gas prices would amplify these economic effects in the medium
term. For as long as oil prices remain high and unstable, the economic prosperity of oilimporting countries especially the poorest developing countries will remain at risk.
The impact of higher oil prices on economic growth in OPEC countries would depend on a
variety of factors, particularly how the windfall revenues are spent. In the long term, however,
21

OPEC oil revenues and GDP are likely to be lower, as higher prices would not compensate fully
for lower production. In the IEAs recent World Energy Investment Outlook, cumulative OPEC
revenues are $400 billion lower over the period 2001-2030 under a Restricted Middle East
Investment Scenario, in which policies to limit the growth in production in that region lead to an
average 20% higher prices, compared to the Reference Scenario.

HOW HIGHER OIL PRICES AFFECT THE GLOBAL ECONOMY

Oil prices remain an important determinant of global economic performance. Overall, an oilprice increase leads to a transfer of income from importing to exporting countries through a shift
in the terms of trade. The magnitude of the direct effect of a given price increase depends on the
share of the cost of oil in national income, the degree of dependence on imported oil and the
ability of end-users to reduce their consumption and switch away from oil. It also depends on the
extent to which gas prices rise in response to an oil-price increase, the gas-intensity of the
economy and the impact of higher prices on other forms of energy that compete with or, in the
case of electricity, are generated from oil and gas. Naturally, the bigger the oil-price increase and
the longer higher prices are sustained, the bigger the macroeconomic impact. For net oilexporting countries, a price increase directly increases real national income through higher
export earnings, though part of this gain would be later offset by losses from lower demand for
exports generally due to the economic recession suffered by trading partners.
Adjustment effects, which result from real wage, price and structural rigidities in the economy,
add to the direct income effect. Higher oil prices lead to inflation, increased input costs, reduced
non-oil demand and lower investment in net oil- importing countries. Tax revenues fall and the
budget deficit increases, due to rigidities in government expenditure, which drives interest rates
up. Because of resistance to real declines in wages, an oil price increase typically leads to
upward pressure on nominal wage levels. Wage pressures together with reduced demand tend to
lead to higher unemployment, at least in the short term. These effects are greater the more
sudden and the more pronounced the price increase and are magnified by the impact of higher
prices on consumer and business confidence.
An oil-price increase also changes the balance of trade between countries and exchange rates.
Net oil-importing countries normally experience a deterioration in their balance of payments,
putting downward pressure on exchange rates. As a result, imports become more expensive and
exports less valuable, leading to a drop in real national income. Without a change in central bank
and government monetary policies, the dollar may tend to rise as oil-producing countries
demand for dollar-denominated international reserve assets grow.
The economic and energy-policy response to a combination of higher inflation, higher
unemployment, lower exchange rates and lower real output also affects the overall impact on the
economy over the longer term. Government policy cannot eliminate the adverse impacts
22

described above but it can minimise them. Similarly, inappropriate policies can worsen them.
Overly contractionary monetary and fiscal policies to contain inflationary pressures could
exacerbate the recessionary income and unemployment effects. On the other hand, expansionary
monetary and fiscal policies may simply delay the fall in real income necessitated by the increase
in oil prices, stoke up inflationary pressures and worsen the impact of higher prices in the long
run. While the general mechanism by which oil prices affect economic performance is generally
well understood, the precise dynamics and magnitude of these effects especially the
adjustments to the shift in the terms of trade are uncertain. Quantitative estimates of the overall
macroeconomic damage caused by past oil- price shocks and the gains from the 1986 price
collapse to the economies of oil- importing countries vary substantially.
This is partly due to differences in the models used to examine the issue. Nonetheless, the effects
were certainly significant: economic growth fell sharply in most oil-importing countries in the
two years following the price hikes of 1973/1974 and 1979/1980. Indeed, most of the major
economic downturns in the United States, Europe and the Pacific since the 1970s have been
preceded by sudden increases in the price of crude oil, although other factors were more
important in some cases. Similarly, the boost to economic growth in oil-exporting countries
provided by higher oil prices in the past has always been less than the loss of economic growth in
importing countries, such that the net effect has always been negative. The growth of the world
economy has always fallen sharply in the wake of each major run-up in oil prices, including that
of 1999-2000. This is mainly because the propensity to consume of net importing countries that
lose from higher prices is generally higher than that of the exporting countries. Demand in the
latter countries tends to rise only gradually in response to higher prices and export earnings, so
that net global demand tends to fall in the short term.

QUANTIFYING THE IMPACT ON OECD COUNTRIES

OECD countries remain vulnerable to oil-price increases, despite a drop in the regions net oil
imports and an even more marked decline in oil intensity since the first oil shock. Net imports
fell by 14% while the amount of oil the OECD uses to produce one dollar of real GDP halved
between 1973 and 2002. Nonetheless, the region remains heavily dependent on imports to meet
its oil needs, amounting to 56% in 2002. Only Canada, Denmark, Mexico, Norway and the
United Kingdom are currently net exporting countries. Oil imports are estimated to have cost the
region as a whole over $260 billion in 2003 equivalent to around 1% of GDP. The annual
import bill has increased by about 20 % since 2001.

23

In order to test the vulnerability of the OECD economy to higher oil prices in the medium term,
we carried out a simulation using Interlink,2 the OECDs in-house macro-economic model. In
the OECD base case, oil prices3 are assumed to remain constant at $25 per barrel over the fiveyear projection period from 2004 to 2008. In a sustained higher oil price case, prices are assumed
to be $10 higher at $35 per barrel the level actually reached in early April 2004 for the whole
of the projection period. Crucially, nominal dollar exchange rates are held constant at late-2003
levels in both cases.4 In practice, any change in the value of the dollar would significantly affect
the impact of higher nominal oil prices on the global economy. The fall in the value of the dollar
against the currencies of most other OECD countries in the last two years has dampened the
impact of recent oil-price increases in those countries.
Higher oil prices have a significant adverse impact on OECD economic performance in the short
term in this case, though their impact in the longer term is more limited. The impact on the rate
of GDP growth is felt mostly in the first two years as the deterioration in the terms of trade
drives down income, which immediately undermines domestic consumption and investment.
OECD GDP is 0.4% lower in 2004 and 2005 compared to the base case. In all OECD regions,
these losses start to diminish in the following years as global trade in non-oil goods and services
recovers. Throughout the whole five-year projection period, GDP is 0.3% lower on average than
in the base case. 5
The impact of higher oil prices on the rate of inflation is more marked. The consumer price index
is on average 0.5% higher than in the base case over the five- year projection period. The impact
on the rate of inflation is felt mostly in 2005 the second year of higher prices. Recent trends
show a clear correlation between oil- price movements and short-term changes in the inflation
rate.

QUANTIFYING THE IMPACT


TRANSITION ECONOMIES

ON

DEVELOPING

COUNTRIES

AND

The adverse economic impact of higher oil prices on oil-importing developing countries is
generally more pronounced than for OECD countries. The economic impact on the poorest and
most indebted countries is most severe. On the basis of IMF estimates, the reduction in GDP in
the sustained $10 oil-price increase case would amount to more than 1.5% after one year in those
countries (Table 2). The Sub-Saharan African countries within this grouping, with more oil24

intensive and fragile economies, would suffer an even bigger loss of GDP, of more than 3%. As
with OECD countries, dollar exchange rates are assumed to be the same as in the base case.
Asia as a whole, which imports the bulk of its oil, would experience a 0.8% fall in economic
output and a one percentage point deterioration in its current account balance (expressed as a
share of GDP) one year after the price increase. Some countries would suffer much more: the
Philippines would lose 1.6% of its GDP in the year following the price increase, and India 1%.
Chinas GDP would drop 0.8% and its current account surplus, which amounted to around $35
billion in 2002, would decline by $6 billion in the first year.6 Other Asian countries would see a
deterioration in their aggregate current account balance of more than $8 billion. Asia would also
experience the largest increase in inflation in the first year, on the assumption that the increase in
international oil price would be quickly passed through into domestic prices. The inflation rate in
China and Thailand would increase by almost one percentage point in 2004.
Table 2: Oil-Importing Developing Country Macro-economic Indicators in Sustained Higher Oil
Price Case after One Year by Region/Country (Deviation from base case, in percentage points
unless otherwise stated) Real GDP Inflation Trade Balance (% of GDP)

Country
Asia
China
India
Malaysia
Philippines
Thailand
Latin America*
Argentina
Brazil
Chile
Highly
indebted
poor
developing
countries7 -1.6 n.a.
n.a.

Real GDP
-0.8
-0.8
-1.0
-0.4
-1.6
-1.8
-0.2
-0.4
-0.4
-0.4
-0.8

Inflation
1.4
0.8
2.6
2.0
1.6
0.8
1.2
0.2
2.0
2.0
1.4

Trade balance
1.0
0.6
1.2
0.0
2.0
3.0
0.0
0.2
0.4
1.4
1.0

Latin America in general would suffer less from the increase in oil prices than Asia because net
oil imports into the region are much smaller. Economic growth in Latin America would be
reduced by only 0.2 percentage points. The GDP of transition economies and Africa in aggregate
would increase by 0.2 percentage points, as they are net oil-exporting countries.
The economies of oil-importing developing countries in Asia and Africa would suffer most from
higher oil prices because their economies are more dependent on imported oil. In addition,
energy-intensive manufacturing generally accounts for a larger share of their GDP and energy is
25

used less efficiently. On average, oil- importing developing countries use more than twice as
much oil to produce one unit of economic output as do developed countries.

NET IMPACT ON THE GLOBAL ECONOMY

The results of the sustained higher oil price simulation for both the OECD and non- OECD
countries suggest that, as has always been the case in the past, the net effect on the global
economy would be negative. That is, the economic stimulus provided by higher oil (and gas)
export earnings in OPEC and other exporting countries would be outweighed by the depressive
effect of higher prices on economic activity in the importing countries, at least in the first year or
two following the price rise. Combining the results of all world regions yields a net fall of around
0.5% in global GDP equivalent to $ 255 billion - in the first year of higher prices. The loss of
GDP would diminish somewhat by 2008 as increased demand from oil-exporting countries
boosts the exports and GDP of oil-importing countries. The transfer of income from oil importers
to oil exporters in the year following the $10 price increase would amount to roughly $150
billion.
The main determinant of the size of the initial net loss of global GDP is how OPEC and other
oil-exporting countries spend their windfall oil revenues. The greater the marginal propensity of
oil-producing countries to save those revenues, the greater the initial loss of GDP. Both the IMF
and OECD simulations assume that oil exporters would spend around 75% of their additional
revenues on imported goods and services within three years, which is in line with historical
averages. However, this assumption may be too high, given the current state of fiscal balances
and external reserves in many oil-exporting countries. In practice, those countries might take
advantage of a sharp price increase now to rebuild reserves and reduce foreign and domestic
debt. In this case, the adverse impact of higher prices on global economic growth would be more
severe.
Higher oil prices, by affecting economic activity, corporate earnings and inflation, would also
have major implications for financial markets notably equity values, exchange rates and
government financing even, as assumed here, if there are no changes in monetary policies:
International capital market valuations of equity and debt in oil-importing countries would be
revised downwards and those in oil-exporting countriesupwards. To the extent that the
creditworthiness of some importing countries that are already running large current account
deficits is called into question, there would be upward pressure on interest rates. Tighter
monetary policies to contain inflation would add to this pressure.
Currencies would adjust to changes in trade balances. Higher oil prices would lead to a rise in
the value of the US dollar, to the extent that oil exporters invest part of their windfall earnings in
US dollar dominated assets and that transactions demand for dollars, in which oil is priced,
increases. A stronger dollar would raise the cost of servicing the external debt of oil-importing
developing countries, as that debt is usually denominated in dollars, exacerbating the economic
26

damage caused by higher oil prices. It would also amplify the impact of higher oil prices in
pushing up the oil-import bill at least in the short-term, given the relatively low price-elasticity of
oil demand. Past oil shocks provoked debt-management crisis in many developing countries.
Fiscal imbalances in oil-importing countries caused by lower income would be exacerbated in
those developing countries, like India and Indonesia that continue to provide direct subsidies on
oil products to protect poor households and domestic industry. The burden of subsidies tends to
grow as international prices rise, adding to the pressure on government budgets and increasing
political and social tensions.
It is important to bear in mind the limitations of the simulations reported on above. In particular,
the results do not take into account the secondary effects of higher oil prices on consumer and
business confidence or possible changes in fiscal and monetary policies. The loss of business and
consumer confidence resulting from an oil shock could lead to significant shifts in levels and
patterns of investment, savings and spending. A loss of confidence and inappropriate policy
responses, especially in the oil-importing countries, could amplify the economic effects in the
medium term. In addition, neither the OECDs estimates for member countries nor the IMFs
estimates for the developing countries and transition economies take explicit account of the
direct impact of higher oil prices on natural gas prices and the secondary impact on electricity
prices, other than through the general rate of inflation. Higher oil prices would undoubtedly drive
up the prices of other fuels, magnifying the overall macroeconomic impact. Rising gas use
worldwide will increase this impact. Nor does this analysis take into account the macroeconomic
damage caused by more volatile oil prices. Short-term price volatility, which has worsened in
recent years, complicates economic management and reduces the efficiency of capital
allocation.10 despite these factors; the results of the analysis presented here give an order-ofmagnitude indication of the likely minimum economic repercussions of a sustained period of
higher oil prices.

Chapter 4 OPEC and the World A Comparative study


In this chapter we will compare OPEC with the rest of the world. Macroeconomic indicators, oil
and gas reserves, production capacity, import and export from the OPEC is described in the
following section and it was find out that where the OPEC stands and the role of OPEC for
maintaining the demand and supply balance of crude oil.
27

Macro economic indicators

On observing and analyzing macroeconomic factors for OPEC and Non-OPEC countries it is
clear that real GDP growth rate of OPEC countries was high in year 2012 compared to non
OPEC countries, however in year it declined drastically by 50% of the previous year though
there was decline in GDP growth rate observed in case of non opec countries also it was very
low compared to opec countries. Value of imports was very much less compared to non opec
countries and crude production was also very high when it was compared with non opec
countries.

Table 2 OPEC members value of export

28

Table 3 OPEC members value of Petroleum exports (m$)

29

From the table 2 and table 3 it was observed that export from the OPEC countries was increasing
from year 2009 to 2012 however, slightly decline in the export was observed in the year 2013.
Same was the case with export of the oil from these countries. It was observed that export of the
petroleum products was about 70% of the total exports.
Table 4 OPEC members value of import

Import by the OPEC member countries was increased from year 2009 to 2013 however it was
quite lower compared to the total exports. Out of all the member countries UAE and Saudi
Arabia were the countries that had maximum import and Kuwait had the minimum imports
compared to all other OPEC member countries.

30

Oil and Gas Reserves


Table 5 world proven oil reserves by country

31

32

33

34

35

36

If we observe the above tables and analyze it is observed that maximum oil and gas reserves are
in OPEC countries which is 81% and 42% respectively followed by Russia. However, the
production of the oil and gas is little less compared to United States of America and Russia. The
production of oil and natural gas from the OPEC is about 40% and 20% respectively.

OPECs benefit to the member country


Energy resources due to their specific nature are key product and strategic commodity in todays
international society. Industry worldwide is dependent on the resources for survival and their
cost will always affect the price of the finished product, thereby controlling energy supply is a
powerful tool in todays international market. The member states of Organisation of Petroleum
Exporting Countries had an early understanding of this new international economic system.
Furthermore, the member states realise their potential to shift the balance of power from the
West. OPEC is a permanent, intergovernmental Organization, created at the Baghdad Conference
on September 1014, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. The five
Founding Members were later joined by nine other Members: Qatar (1961); Indonesia (1962)
suspended its membership from January 2009; Socialist Peoples Libyan Arab Jamahiriya
(1962); United Arab Emirates (1967); Algeria (1969); Nigeria (1971); Ecuador (1973)
suspended its membership from December 1992-October 2007; Angola (2007) and Gabon
(19751994). OPEC is one of the oldest organizations founded by developing countries, having
survived half a century since its establishment. According to data from official web page of
OPEC, in 2009, this organization possessed 79.3% of global proven crude oil reserves and was
responsible for 60.3% of the worlds crude oil exports.
This organization has been known as an international organization rather than a regional or
intergovernmental one. In fact, OPECs decisions about levels of production have a global effect,
as international oil markets are inter-related and oil can be transferred from one market to
another. Moreover, by building more and more sophisticated refineries, crude oil is becoming
more like a homogenous commodity, so that the supply and demand of a specific type of a crude
in one corner of the global oil market will affect the fundamentals of other crudes in another part
of the global oil market.

37

Moreover, OPEC can easily affect on oil price and its supply. Nowadays in case of OPEC
scholars mainly look at the oil production its reserves, price monopoly and impact of OPECs
quotas on world oil market (see Loderer 1985, Griffin and Xiong 1997,); they test OPECs
behavior and its impact on the oil prices as well as market (see James 1999, Noguera J. and
Pecchecnino R. 2006) and its role in providing sustainable development. However, there are a
few studies that test whether there is any benefit for the oil producing countries to be the member
of organization of petroleum exporting countries and what are they.
As Noguera J. and Pecchecnino R. (2006) has emphasis in their studies there two economic goals
of being member of OPEC. One is macroeconomic reaching low oil market volatility, and
second one microeconomic is to promote economic development of the country. Since oil
revenues are vital for the economic development of the OPEC nations, they aim to bring stability
and harmony to the oil market by adjusting their oil output to help ensure a balance between
supply and demand. Also some scholars as Morrison (2004) argues that because of the high level
of oil dependence, the oil sector must perform well in these nations both to maintain current and
ensure future living standards. On the other hand, oil sector and overall economic productivity in
the OPEC economies has declined, and today less rather than more is being produced with the
same resources. Taking in to account that OPEC is one of international organisation with long
history, permanent members and huge impact on world energy supply and market. Also,
considering fact that completely all members of OPEC are developing countries it would be
interesting to know how OPEC is beneficial for the member countries despite the quotas for oil
producing. Taking in to account this circumstance in the paper I also want to see what kind of
and in which spheres the member countries get benefits.

OPEC Influence on Economic Growth of the Member Countries


OPEC is commonly described as Cartel, which is intergovernmental organization. However,
according to the statue of OPEC, it define itself as an international organization with aim to
influence and maintain the price of oil through the control of production levels and to generate
revenue, which goes towards meeting the development needs of its members.
However, OPECs influence on the oil markets has significantly diminished compared to the
1970s OPEC is still the key player of world energy market. Nowadays the organisation supplies
38

about 60% of world oil output and more than 75% of world petroleum reserves are located
within OPEC nations; and OPEC policy instruments have consistently beenconfined to fiscal and
pricing measures (Logman 1982).
Former Acting OPEC Secretary-General, Fadhil Al-Chalabi has emphasized that OPEC's
objective is to co-ordinate and unify petroleum policies among the member countries, in order to
secure fair and stable prices for petroleum producers, member countries, as well as, efficient
economic growth for the member states, and regular supply of petroleum to consuming nations
(World oil outlook 2010). Many scholars argue that OPEC has evolved over the years and has
become a market phenomenon. Since the early 1970s, a significant degree of re-integration has
been achieved in the world oil industry, between OPEC minor and major member countries
(Yang 2004), member countries and the biggest oil-producing companies. Moreover, OPEC
influence on the growth and promote economic growth of its member countries through fair
return of capital, that is mentioned in OPEC statue, to those member countries who investing in
their industries that would lead to economic development of the member countries (OPEC statue
article 1-2).
OPECs influence on the economy of the member countries is great, since most member
countries derive more than 80% of their foreign-exchange earnings, as well as huge share of
GDP, from oil and gas exports. In turn, receipts from the oil and gas sector account for at least 70
% of government revenue. (Appendix Table 1 and 2)

39

Unsurprisingly, the performance of the member countries national economies is closely linked
to the fortunes of the domestic oil and gas sector. Investment in oil and gas determines the
potential for the sector to provide either leverage financial resources for economy-wide
development or diverse it through reinvesting. Judged by a number of measures, OPEC member
countries have made varying degrees of economic and social progress over the past 30 years.
Perhaps less debatable and doubtful is the idea that it is now time to review the existing sources
of development finance and the modalities for it in OPEC member countries.
As I have already mentioned OPEC member countries is divided in to two minor and major
countries. Scholars made this diversification according to the hydrocarbons reserve and number
of population. Most minor OPEC countries are those that have large populations and smaller oil
reserves (such as Algeria, Indonesia and Nigeria). Major OPEC countries are those countries that
have larger hydrocarbons reserves and smaller population.
I assume that for describing economic influence of OPEC on the member countries growth I
should narrow down my observation to one country. However, Indonesia nowadays is a former
member it would be appropriate example to demonstrate economic influence of OPEC even on
minor country. While Indonesia was member of OPEC, since 1962, it has a relatively diverse its
economy by reinvesting, as it was already mentioned, from the oil industry toward other sectors.
Despite the fact that, Indonesia was not well develop country, even within the OPEC countries,
with a large external debt. Indonesia was able to divers it economy from oil based economy to
manufacture. As evidence we can observe that in 2005 Indonesia became a net oil importer for
the first time in decades (EIA, 2004) this had implications for its membership of OPEC.
Therefore nowadays Indonesia is not heavily dependents on oil export. That diversification was
done with help of the reinvesting the income from the revenues obtained by Indonesia within
OPEC (table 2). According the data from World Bank for 2005, the services sector in Indonesia
is the largest sector of economy, nowadays, and accounts for 45.3% of GDP (2005). This is
followed by industry (40.7%) and agriculture (14.0%). However, agriculture employs more
people than other sectors, accounting for 44.3% of the 95 million-strong workforce. The service
sector of economy is followed by the services sector (36.9%) and industry (18.8%).Major
industries include petroleum and natural gas, textiles, apparel, and mining however, the share of

40

petroleum industry in Indonesian GDP has decreased over last years. (Indonesia in a Glance
2006).

The UAE, Saudi Arabia are another examples of OPEC major countries that have larger oil
reserve and smaller population and that countries slightly diversify their economy, moving
increasingly towards services (tourism, banking, re-exports, and information technology) (EIA,
2009). Kuwait and the UAE are the only two Gulf States, which are relatively independent from
oil prices because of the structure of their finances and economy; the other Gulf States will
continue to need higher oil prices to fund their increased levels of expenditure (Barnett J. 2008
citied from Kohl, 2002).
Additionally, as it mentioned in the human development report by UNDP (2003) Saudi Arabia is
the worlds largest crude oil producer, a leader in OPECs production quota decisions and
certainly the most active member of OPEC. However, Saudi Arabia has diverse its economy oil
dependence continues to dominate the in Saudi economy (appendix Table 1). Income in Saudi
Arabia remains low from non-oil sources. (Inter-American Development Bank Office of the
Chief Economist Working Paper 312) As a result, the governments budget is highly vulnerable
to oil price volatility. Improving OPEC member countries economies is absolutely essential for
OPEC, since it is one of the aims of organisation. Thus, it is significant for the organisation to
continue and increase investment in their member countries economy in the coming years. Oil
export revenues dominate the economies of these countries. Although this revenue will continue
to increase in the future, there is a point where oil will run out, and all the money that is
41

generated by oil will disappear with it. That is why these investments need to be implemented
immediately. Investments made into oil and gas projects that stretch beyond maintenance and
production expansion would significantly benefit these natural resource heavy economies. Of
equal importance is investment in social capital; education, transportation, telecommunications,
healthcare, etc and the investments toward economic diversification. If these investments are
made while oil revenues are steadily increasing, OPEC member countries will benefit socially
and economically in the future.
Nonetheless, as it is emphasized in the statue OPEC, as an international organisation has proved
to have a very strong economic character. It has shown this by targeting the development of its
member states as a goal to achieving the highest GDP growth possible.
OPECs Benefits to the Member Countries
OPEC members benefits from it in several ways. Mainly they could be divided in to two as
follow: economical that we have already seen in previous part; and political. In this part of my
paper, I am going to look at other than economical benefits of being OPEC member.
Additionally, in this part of my paper I would like to examine whether OPEC member countries
make large benefit by exporting oil within OPEC despite the existing quotas on oil producing for
the member countries.
Among all international trade organisations, OPEC has proved to be a good example of an
alternative international political economy with an undisputed amount of bargaining power and
one of the few powerful organisations not controlled by the West (Farhan Al-Farhan 2003). This
gathering brings great benefits in both economic and political sense for oil exporting countries.
One of the benefits for the member countries can be identified regarding to the primary purpose
of OPEC, which is to secure its member countries fair shares of the value of their oil resources,
for the purpose of accelerating economic development and improving the welfare of people of
the member countries (Iz Osayimwese 1999). Another non-economical benefit for the members
of the organisation, is that OPEC protects its member countries interest, within the oil market
and the global arena. (BB Alizadeh MEES 9 febrary, 7 December 2009) Also the fact the
organization provide and willing to increase its development assistance to the minor member
countries is another advantage; since this will lead to divers economy, reduce external debts
42

create new work places, reduce poverty and malnutrition. Despite those benefits, it is also
important for the member countries that the organization provides opportunity to influence on
Western countries as most of them depends on the OPEC oil, as well as paying key role in the
global oil market/ industry. This also includes the murky international politics synonymous with
the oil industry. As we know OPEC emerge in time when the cold war has just end, and
international attention was focused on the tense situation between the Eastern Block and the
Western powers. AL-Otaibas (former Minister of Petroleum and Mineral Resources of the
United Arab Emirates under the Presidency of H.H Sheikh Zayed bin Sultan al Nahayn)
argument that he provides can be interpreted as OPEC countries had the opportunity to be
considered as a serious power within the new international system and should use that rationally
in order to achieve their own countries goals. The classical definition of power is the ability
to get people to do what you want them to do (Krasner p.3). The power of OPEC can be viewed
in relation to the rational aspect and absolute role when it used the right strategies and policies to
achieve its member countries goals. Another way that the union is beneficial for the member
countries is that the countries which located in the East are secure in terms of wars and other
conflicts (OPEC working paper 2003) but I have doubt on this statement (the two Iraq wars). The
benefit from OPEC to non-OPEC counties is that OPEC focuses its activities on ensuring order
and stability in the international oil market with reasonable prices.
The declaration reiterated that OPEC would go ahead in its efforts to accelerate economic
development in the developing countries through its aid programs; The International OPEC
Development Fund and the International Fund for Agricultural Development. It is urged the
industrial countries to contribute positively to these efforts and to work towards the reduction of
debts of the developing countries. Regarding to the more real benefits gained directly from oil
export, OPEC in its long term strategy, has emphasized that unstable prices cause difficulties
in the interpretation of signals sent by market. It makes no difference whether such signals are
indicative of the markets structural change or is resulting from a temporary phenomenon.
Therefore, it is difficult to support long-term market stability only by one supplier, if prices
remain unstable. (OPEC long-term strategy:4)
Thus, I think it can be argued that being OPEC member is beneficial as the member countries by
establishing and joining to OPEC make themselves free from dealing with this kind of issues
43

furthermore get larger economical benefits by playing together. Besides, OPEC in its long term
strategy, has also stipulated when the market is tight, very high prices may influence
economic growth, especially in developing countries, threatening future demand growth for oil.
Meanwhile, very low prices could also limit the trend of economic development and social
welfare of OPEC member countriesThus, avoidance of a market faced with excess of supply or
shortage of supply is necessary. The presence of more members in OPEC would increase the
organizations ability to stabilize the market. (OPEC long-term strategy:7)
As it was already mentioned, OPEC countries manly drive their main revenues to the GDP from
oil export (OPEC annual reports 2000-2009). I think it is obvious that the OPEC provide
economic growth to the member countries thought the revenues from oil trade. Thus, it is
significant to underline role of OPEC in oil market and pricing. Moreover, understand how the
member countries are making large benefit from oil export despite the existing quotas on oil
production settled by OPEC.
The aim of OPEC is to provide stabile prices on oil for the member countries by controlling the
prices through quotas. OPEC provides equilibrium and sustainability between such market
phenomena as consumers demand on crude oil and supply of the producers, by using the tool of
quotas on oil producing. OPEC implement the main rule of market is that is, when the there is
larger supply of goods and services the prices go down and when there is larger demand the
prices go up, within its member countries by using the quotas. That helps it to control the prices
on oil. As, the member countries of OPEC are the larger producers of oil, its decisions regarding
the quotas, directly affect on the world prices on oil.
Thus, it can be argued that the quotas are providing to the OPEC countries opportunity to make
larger benefits. Despite the fact that it is commonly argued, that the quotas are the barriers for the
member countries to make larger benefit. It is obvious that the quotas are the main tool that let to
maintain preferable by the suppliers, OPEC countries, prices on oil in the market and keep the
prices beneficial for both consumers and suppliers. Furthermore, according to the OPEC statue
following to the quotas in oil production volume is not mandatory.

44

OPEC as a Promoter of Sustainable Development


In this part of the paper I am going to see the OPECs activity toward promoting sustainable
development for the member countries, as well as for other developing countries. OPECs aid
organisations were noted as good examples to the developing countries in the early 1970s. OPEC
member states, acting in partnership, decided in the 1970s to join forces to achieve greater
effectiveness and relevance in the field of development assistance delivery. The aim from the
idea was to have greater impact and to better manage official aid resources, which were
increasing in both volume and significance.
In 1975, OPEC also called industrialized developing countries to come together to solve the
problems poor countries are facing and to look for ways of establishing a better economic system
by allowing increased trade and exchange of knowledge (OPEC review vol. 3.2 1979). OPEC
established the OPEC Fund for International Development (OFID) in January 1976 (originally
called the OPEC Special Fund) to promote cooperation between OPEC Member Countries and
other developing states. In particular, OFID aims to help poorer, low-income non-OPEC 15
countries in their pursuit of social and economic advancement. OFID is active in many regions,
including Africa, Asia, Europe and Latin America.
It has supported a wide range of projects, from providing clean water and energy to remote
communities, to building schools, hospitals and roads and developing industries, farming and
trade opportunities. Since its establishment, it has made commitments totaling nearly US $10.1
billion, two-thirds of which have already been disbursed. The Third Summit of OPEC Heads of
State and Government in 2007 reaffirmed OPECs commitment to energy for sustainable
development. The concluding Riyadh Declaration stated that energy was essential for poverty
eradication, sustainable development and the achievement of the Millennium Development
Goals (OPEC annual report 2007). It associated Member Countries with all global efforts aimed
at bridging the development gap and making energy accessible to the worlds poor.
Over the last three decades, some experts have highlighted the vital importance that OPEC has
played in the socio-economic development and the huge growth of the member states. OPEC
participates in development financing at two levels. First, individual member countries finance
domestic capital investment from a combination of domestic savings and external borrowing and

45

aid. Second, as a group, OPEC countries provide concessional finance for development projects
in non-OPEC developing countries (Note1). OPECs development assistance is provided through
the OPEC Fund for International Development, established in 1976 as a multilateral agency with
a mandate that combines some elements of the activities of both the World Bank and the IMF.
The financing of oil and gas projects is a paradigm for development financing in the member
countries economies. OPEC countries are still far from achieving the goal of transforming their
enormous hydrocarbon wealth into human and physical capital for sustainable economic
development. To achieve their goal, member countries need to invest massively in oil and gas
projects, beyond just maintaining and expanding production capacity. Practically all members
countries are financially strained. All of them face, in varying degrees, undue geopolitical risks
that limit their access to external financial resources, under the existing international financial
infrastructure. Moreover, all OPEC countries have experienced the Dutch disease at some time
in the past, and one member country suffers an extreme form of the disease (Note 2).This being a
regional epidemic, the Dutch disease deserves appropriate response from the custodians of
international financial health.
Since 1971 OPEC member states, acting individually and concerned by the difficult economic
circumstances of neighboring countries, had provided assistance to their neighbors (Ibrahim F.I.
Shihata 1982 p 47-59). At the multilateral level, the objective has been to cooperate and
coordinate to make the total aid effort more effective. OPEC has successfully managed, over the
years, to establish a set of international aid bodies. These are:
The Arab Authority for Agricultural Investment and Development (AAAID) is an investment
organisation consisting of 15 Arab states aimed at improving food security in Arab countries. Its
objective is to develop agricultural resources in the member states by investing in all forms of
agricultural production and related activities. Particular areas of involvement include: land
reclamation; plant, animal and fish production; pastures and forestry creation; the transportation,
storage, marketing, processing and exporting of agricultural produce; and, all inputs necessary
for agricultural production.
Arab Gulf Program for United Nations Development Organizations (AGFund) Seven Arab Gulf
countries (Bahrain, Iraq, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates)
46

contribute to the resources of the AGFund, an organisation that provides grant assistance to UN
agencies and Arab NGOs in support of humanitarian projects. The type of projects supported by
the AGFund is in the fields of health, nutrition, water and sanitation, education, the disabled and
the environment. The main beneficiaries of this fund are mothers and children.
Arab Monetary Fund (AMF) was established by Arab countries with the objectives of laying the
monetary foundations of Arab economic integration, accelerating the process of economic
development in all Arab nations, and promoting trade amongst them. The main activity of the
AMF is the provision of loans in support of economic adjustment programs.
Arab Fund for Economic and Social Development (Arab Fund) finances projects for economic
and social development in Arab countries. With a membership comprising all 22 members of the
League of Arab States, it extends concessional loans to governments as well as to public and
private organisations. Preference is given to projects that are of vital importance to the Arab
world and to joint ventures involving Arab cooperation Arab Trade Financing Program (ATFP)
is a specialised financial institution launched by the Arab Monetary Fund in 1989. Its objective is
to develop and promote trade between Arab countries and enhance the competitive ability of
Arab exporters. The ATFP functions as an autonomous body and operates through designated
national agencies.
Arab Bank for Economic Development in Africa (BADEA) seeks to promote economic, financial,
and technical cooperation between African and Arab countries. Funded by Arab governments, it
finances economic development in African countries, stimulates the contribution of Arab capital
to African development, and provides technical assistance.
Islamic Development Bank (IsDB) is to foster economic development and social progress in
member countries and in Muslim communities in accordance with the principles of Islamic
Shariah. Its membership consists of 52 countries, which are also members of the Organization of
the Islamic Conference. IsDB has the authority to extend financing and raise funds in many ways
and to establish special funds for specific purposes.
Providing assistance to these countries to diversify their economy, technology transfer, and
capacity building can be cited as being among these commitments from the figure bellow we can
see how the founds are divided between the sectors. That the main share, are transportation,
47

energy, agriculture and agro industry education, water supply, and other. In providing
assistance it agricultural and agro industrial sectors OPEC cooperate with IFAD, together they
provide

assistance

mainly

to

the

southern

African

and

eastern

countries

(www.ifad.org/pub/index.htm).

OPECs efforts to establish cooperation with the World Trade Organization (WTO) is yet
another example that can be mentioned in this regard. Based on OPECs long term strategy,
implementing an active role by OPEC in commerce has great significance, especially as far as
developing countries are concerned. OPEC member countries continue to consolidate and
promote economic growth and social development using the relative advantage resulting from
their natural resources. The collective interests of member countries lie in pursuing such policies.
Thus, any other country becoming an OPEC member can also benefit from the outcomes and the
effects of the organizations policies.

REGIONAL PERSPECTIVES ON TRENDS IN GLOBAL OIL


MARKETS
48

The average price of oil fell to a six-year low in early 2015 after declining by 50% over the
course of just one year. Although prices have continued to fluctuate, the overall trend of cheaper
oil has had profound implications for the Asia-Pacific, which consumes well over half of the
worlds oil. The region is also home to four of the five top oil-producing countries, and oil
exports continue to play a key role in many economies.
For some countries, lower oil prices have been embraced as an opportunity to enact muchneeded policy reforms and improve trade balances; for others, lower prices have had profoundly
negative economic ramifications.
Worldwide, falling oil prices have spurred shifts in policy, consumer behaviour, and industry
projections, and as the current centre of global energy demand, the Asia-Pacific has dramatic
effects on worldwide energy security.
The Impact of low oil prices on CHINA
Like many other Asian countries, China has been affected by recent dramatic changes in global
oil prices. In the view of FACTS Global Energy (FGE), the shift occurring in the global oil
market is structural, and we have entered an era of lower oil price ranges that is likely to last for
years. As such, the impact of low oil prices on China will not end anytime soon. This policy brief
assesses the impact of low oil prices on China in several areas, ranging from the economy and
the environment to energy security and regional cooperation on market instability.
Economic Impact
The implications of sustained low oil prices may be wide-ranging for the Chinese economy. On
the positive side, low oil prices have resulted in the following changes:

Lower imports of oil in dollar amounts will increase Chinas current account surpluses.
Using crude oil as an example, in 2014 China imported a total of 6.2 million barrels per
day of crude oil at a cost of $228 billion (at an average oil price of around $101 per
barrel). Crude oil accounted for 12% of Chinas total merchandise imports. For 2015,
FGE projects that China is likely to import 6.5 million barrels per day of crude oil. If
average Brent crude prices are in the range of $55$60 per barrel for the year as a whole,
total imports will be valued at $130$142 billion. The share of oil in Chinas total
merchandise imports is thus forecast to decline to 7%.
Low oil prices are expected to stimulate growth of Chinas GDP. Estimates vary, but the
impact appears to be positive.
This trend should facilitate efforts by the Chinese government to reform the countrys tax
and fiscal systems.
A negative implication, however, is that low oil prices have enhanced the fear of deflation. If
deflation indeed occurs, the consequences could be grave, considering that China has surplus
capacities in many energy-related industrial sectors. Meanwhile, investment in domestic energy
supplies, particularly oil and gas production, is likely to be negatively affected by low prices,
leading to lower contributions from these sectors to Chinas GDP growth.

49

Impact on environmental and energy

security

Low oil prices impose a challenge for the Chinese government to achieve some of its
environmental policies and targets. The impact may vary from fuel to fuel.
Natural gas:
Following the collapse of oil prices, the Chinese government has been slow in adjusting natural
gas prices. During 2014, gas demand growth was already negatively affected due to the increase
of government-regulated prices. With lower prices in place for oil, natural gas demand may be
further affected. For instance, natural gas competes mainly with diesel and liquefied petroleum
gas (LPG), among major oil products. Now that diesel has become cheaper, promoting liquefied
natural gas (LNG) cars and other gas vehicles has become increasingly difficult. When oil prices
were high, LPG could not compete with natural gas for residential use in most places, but now
the formers competitiveness has inched up.
Coal:
The bulk of coal consumptionpower generationwill not be affected immediately because
China has few oil-fired plants. Instead, coal-based chemicals have been affected the most. Coalto-liquid projects have been hit because of lower prices for gasoline and diesel, though the
pressure has been alleviated somewhat due to the fall of coal prices. Coal-to-gas projects will be
affected too, followed by other coal-based chemicals.
Renewable energy and biofuels
Renewable energy generally competes with coal, so the immediate impact of lower oil prices is
minimal. In the long run, however, it is generally challenging to promote the use of renewable
energy if oil prices stay low. Development of Chinas biofuels had already been slow because of
poor economies of scale. Biofuels now face new challenges with low oil prices.
As far as energy security is concerned, low oil prices present a few challenges to the Chinese
government. On the one hand, domestic oil production has been hit hard by low prices. On the
other hand, oil imports will be stimulated because it is cheaper to import oil and lower prices
though muted somewhat by the hike of consumption taxes on gasoline and dieselhave
increased demand. As a result, net oil imports will rise and may jeopardize the governments
effort to mitigate dependence on imported energy, particularly oil.
One major advantage of low oil prices in terms of energy security, however, is the opportunity
for China to fill up its strategic petroleum reserves (SPR). Indeed, the construction speed of
phase-2 SPR sites in China, which had been slow for a couple of years, has accelerated since the
second half of 2014.
The Impact of low oil prices on INDIA

50

Crude oil prices in India followed a similar trajectory to leading global crude oil benchmarks,
which in early 2015 fell to their lowest levels since April 2009. According to the Ministry of
Petroleum and Natural Gas, the Indian Basket price of crude oil declined sharply from $110.42 a
barrel in mid-June 2014 to $43.36 a barrel on January 14, 2015.
This slump in global crude oil prices offered the Indian government an opportunity to be
steadfast in its economic reforms by addressing both current account and fiscal deficits. While
the price decline allowed the government to fill up its strategic petroleum reserves (SPR) and
deregulate its downstream sector to reduce subsidy burdens, lower prices also stalled upstream
investments needed for augmenting domestic production of hydrocarbons. This brief assesses the
impact on India of recent oil price volatility and draws policy implications.
ECONOMIC IMPACT
The recent drop in crude oil prices could not have come at a better time for India. In May 2014,
Indian citizens gave the newly elected Modi government the mandate to press forward on badly
needed reforms to revive the economy and improve energy security. The biggest benefit of fallen
crude prices for India, as one of the worlds largest oil importers, has been foreign exchange
savings to the tune of $3 billion per month, even as the country continues to import 3.2 million
barrels of oil a day. Low oil prices have also helped reduce inflation to levels below 6%, as
targeted by the Reserve Bank of India, which could bring Indias current account deficit to 1% of
GDP, while reducing the fiscal deficit through fuel subsidies.
Given these trends, the current government has received a rare opportunity to kick-start its
subsidy reform process by deregulating the diesel price, which for the first time since January
2009 was cut by 3.37 Indian rupees a litre. Indias public sector oil marketing companies have
been some of the biggest beneficiaries of reforms. They have witnessed a sharp fall in underrecoveries of 50% during 201415, as well as lower working capital and interest costs.
IMPACT ON ENVIRONMENTAL AND ENERGY SECURITY
Although the fall in the crude price has brought a new hope for the economic development of oilconsuming countries, it is worth considering the environmental implications of this trend for
India. The proliferation of SUVs and other privately owned vehicles, which run on fuels like
diesel and petrol, could significantly increase emissions. On the other hand, changing
technologies and tightening environmental constraints will lead to low oil-intensive growth,
significantly reducing energy-intensity levels. A case in point is Indias planned increase in solar
energy capacity by fivefold to 100 gigawatts by 2020. These efforts are part of a deliberate
attempt by the Indian government to provide a cleaner atmosphere and healthier environment.
The Impact of low oil prices on INDONESIA
The average crude oil price has fallen due to the increase of the United States daily production
of crude oil and the decision of OPEC to maintain its production while European and Chinese
economies are slowing down. The general decline in oil prices has a positive impact for many
states, but whether a country is a net oil importer or exporter is an important factor to determine
51

whether it benefits or suffers losses from the oil price decline. In this case, Indonesia, which
imported 106 million kilolitres of crude oil and 179 million kilolitres of fuel in 2014, is overall
benefiting from the decrease in oil prices, despite declines in estimated nontax revenue from oil
and gas.
ECONOMIC IMPACT
Decreased oil prices will result in lost potential revenue of almost 253 trillion Indonesian
rupiahs, or $20.24 billion, in the 2015 state income projection. However, the lowered state
projection for oil and gas production of 8% also accounted for this loss. In addition, the low price
of crude oil will cause a decrease in Indonesias export commodity prices. This trend will
suppress revenue from Indonesian exports, as about 60% of Indonesian exports are in the form of
commodities.
However, the decrease of oil prices will encourage the improvement of Indonesias current
account deficit. A Ministry of Trade press release on March 17 stated that the export total for
the month of February 2015 reached USD 12.3 billion while imports reached USD 11.6 billion.
Therefore, a USD 738.3 million was achieved. The current account for oil and gas itself is in a
surplus condition caused by the 18.7% decrease (month to month) of oil and gas imports, as oil
and gas exports only decreased 8.8% (month to month).
The fall in world oil prices encouraged the Indonesian government to recalculate the amount of
subsidized fuel prices. In its new policy, the government revoked the fuel subsidy for premium
fuel and provided a subsidy fixed at 1,000 rupiahs per liter for diesel fuel. This policy is
considered a win-win option for the government and the public. With the reduction in fuel
subsidies, the government can maximize its spending on productive sectors. On the other hand,
the public can enjoy lower fuel prices, which move in accordance with the market price. In the
future, the government will set a new fuel price each month based on the results of calculations
from various factors, including exchange rate and oil prices in the previous month. Thus, this
policy will comply with the Indonesian constitutions mandate that the state set the fuel price.
With the revocation of the premium fuel subsidy, the reduction in diesel fuel subsidy, and the fall
of oil prices, the projection of government spending on fuel subsidies in 2015 is down to a mere
88 trillion rupiahs ($7 billion) from a 2014 level of 276 trillion rupiahs ($22.08 billion). With
savings of 188 trillion rupiahs ($15 billion), the most important consideration now is how the
government allocates the savings from fuel subsidies (consumption expenditure) to a productive
expenditure (a pro-growth, pro-jobs, and pro-poor) government budget. With sizeable fiscal
room, infrastructure development needs to be realized soon, particularly in the energy sector via
the construction of refineries and gas pipelines to ensure energy security and even distribution of
gas within the country.
IMPACT ON ENVIRONMENTAL AND ENERGY SECURITY
Even amid falling oil prices, Indonesia has to reduce its dependence on imported fuels by
diversifying its energy supply and developing a non-carbon-based fuel portfolio that can improve
Indonesias energy security. While renewable energy development is vitally important, it will
52

take decades for Indonesia to scale up to meet the challenge. Thus, optimizing the potential
benefits of natural gas can provide a near-term, affordable, and cleaner bridge fuel until clean
alternatives such as nuclear, hydroelectric, solar, and wind power become larger-scale.
The Impact of low oil prices on JAPAN
The recent lower oil prices will have limited impact on Japans oil demand and energy policy
direction. Oil demand will maintain its downward trend, due to demographic factors as well as
improving fuel efficiency. Even before the Fukushima incident, the government already had
developed a firm plan to reduce the countrys dependence on oil. In fact, the volatility of oil
prices does not bode well for Japans energy security. The countrys long-term energy policy
will continue to focus on nuclear energy and encourage the increasing use of nuclear energy as
well as renewables to mitigate climate change and move away from oil. The government also
wants to reduce Japans dependence on liquefied natural gas (LNG), which accounts for nearly
50% of the total power-generation mix despite the fact that LNG is not defined as a base-load
fuel.
THE ECONOMIC IMPACT OF LOWER OIL PRICES
Recent lower oil prices, together with the depreciation of the Japanese yen, are expected to help
increase Japans GDP growth by a range of 0.8%1.0% annually. In fiscal year (FY) 2014, GDP
growth was negative (-0.5%) mainly because of the adverse impact on consumer spending of the
consumption tax increase from 5% to 8% (implemented in April 2014). However, the Japanese
Cabinet Office forecasts GDP growth to be 1.5% in FY2015. It also forecasts that the trade
deficit will halve in 2015, primarily because of low oil and LNG prices, although this trend will
be partly offset by a weak yen.
The key factor for sustainable economic recovery, however, is stimulating consumer spending,
which accounts for 60% of GDP. To achieve this goal, an increase in individual income is
necessary. Although large corporations have mostly announced that they will increase salaries
and wages this year, this policy has not yet been adopted by small- and medium-sized
companies, which employ almost 70% of the total workforce.
THE EFFECTS OF LOWER OIL PRICES ON OIL DEMAND
Lower oil prices, meanwhile, have not yet stimulated Japanese oil demand. Despite pump prices
plunging by 25% for the July 2014January 2015 period, gasoline sales have not increased.
FACTS Global Energy (FGE) forecasts gasoline demand to improve only slightly this year, after
having declined by a sharp 3% in 2014. Believing that their income will not increase anytime
soon, consumers remain cautious about spending and continue to drive less.
In the long term, Japans oil demand will maintain its downward trend, even if macroeconomic
issues improve, due to demographic factors (in particular, Japans aging and shrinking
population) as well as improving fuel efficiency. Furthermore, post-Fukushima power saving and
energy conservation have become a habit for consumers.

53

The Impact of low oil prices on RUSSIA


ECONOMIC IMPACT
The impact of falling global oil prices on the Russian economy cannot be seen apart from the
impact of a worsening geopolitical situation and the introduction of economic sanctions on
Russia in 2014. Altogether these factors have led to increasing uncertainty, a rapid economic
decline, and a deterioration of the conditions for further economic growth.
According to the estimates by the Russian Ministry of Economic Development, in 2015 annual
GDP could contract by 4%5% if oil prices remain low at around $45$55 per barrel. In 2016
17, according to the Energy Research Institute of the Russian Academy of Sciences, economic
growth will remain negative at around -0.5%1.5%, even if oil prices recover to $80 per barrel.
According to our estimates, the Russian economy could only achieve positive growth if the oil
price were to rise above $90 per barrel.
This situation yields high risks for the 2015 national budget, which the government initially set
given an oil price of $96 per barrel. According to the head of the Accounts Chamber of the
Russian Federation, by the end of 2015 the state budget deficit could reach 17% of budget
incomes ($45 billion). In response to this situation, the government plans to make significant cuts
to the budget, primarily to salaries in the public sector. This policy could create social tension,
given the potential reduction in household income and the rate of employment.
The government had to provide state support to the companies affected by falling oil prices by
taking assets out of the National Welfare Fund (NWF), which has created additional risks for the
Russian budget. In July 2014 the total allocation of funds to reduce the impact of the economic
crisis increased to 60% of the overall reserves within the NWF. Energy companies are among the
major recipients of this state aid: as of April 2015, the Yamal LNG project run by Novatek has
received 150 billion rubles from the NWF. Rosatom, which is implementing its Hanhikivi-1
nuclear power plant project in Finland, received similar state support (5% of NWF reserves).
The largest application for state support comes from Rosneft, which requested 1.5 trillion rubles
(or 30% of NWF reserves).
ENERGY SECURITY IMPACT
Low oil prices are not expected to have any serious impact on the energy security of Russian
consumers. A large proportion of investment in refineries was made prior to the oil price decline,
and these plants will enable Russia to provide an uninterrupted supply of oil to its domestic
market.
However, the issue of ensuring demand security for external supplies prompts serious concerns.
Given stagnating demand in the European market, Russia faces a serious issue of organizing
construction of large export infrastructure projects in the eastern direction, while there is an
increasing lack of investment due to the Russian energy companies and governmental revenue
decline. For example, by 2022 Russia plans to extend the Eastern SiberiaPacific Ocean (ESPO)
pipeline capacity from the current level of 50 million tonnes annually to 80 million tonnes
54

annually. To provide financing for these projects, the top management of Rosneft uses long-term
contracts to hedge large risks. As of 2015, around
30 million tonnes of oil (60% of the total volume supplied via ESPO) have been contracted to
China.
The Impact of low oil prices on SOUTH KOREA
South Korea is a major oil and LNG importer in Northeast Asia, most of which comes from the
Middle East. In the face of the U.S. shale revolution, South Korea has pursued supplier
diversification and regional energy trade collaboration. This brief examines the impact of low oil
prices on both South Koreas domestic energy policy and regional energy trade dynamics and
discusses how low oil prices have become an issue of regional cooperation for oil market
stability. The recent plunge in oil prices is likely to reverse energy and other infrastructural
projects between South Korea and Russia and prolong South Koreas oil and LNG dependence
on the Middle East and the Persian Gulf. This will lead Seoul to strive to diversify oil and LNG
supply sources beyond this region to include North America and East Africa.
ECONOMIC IMPACT
As the worlds second-largest importer of liquefied natural gas (LNG), South Korea stands to
gain from the current low cost of oil. The price of LNG is tied to the price per barrel of oil, and
as the cost of oil falls, South Korea is better able to negotiate strong terms for long-term
purchasing contracts. This trend can already been seen in deals such as the one between Chevron
and SK LNG Trading, which will see an average of 4.15 million tons of LNG (830,000 tons per
annum) from the Gorgon project delivered per annum from 2017 to 2021.
Many end users in South Korea are also making deals with importers, which is an interesting
shift from the more traditional means of long-term contract buying. This leads to more
competitive terms and essentially cuts out the middle supplierstate-owned Korean Gas
Corporation (KOGAS), known as the largest purchaser of LNG worldwide. South Koreas LNG
demand is forecast to rise 2.6% year on year to 42.14 million tons in 2015 before falling steadily.
Demand is expected to decline 0.5% to 41.95 million tons in 2016, 2.9% further to 40.74 million
tons in 2017, and another 2.3% to 39.81 million tons in 2018. In 2014, KOGAS sold 27.6 million
tons of LNG from January to October, down 9.6% year on year (201314). Economically this
shift could benefit South Korea. Although end users pay a higher price for imports, they receive
a net gain because their mark-up is reduced from the direct transaction. How this will affect
KOGAS is still to be seen. Many believe that the company will need to tighten its margins and
be more aggressive in contract negotiations to maintain its position as the largest buyer of LNG
in the world.
Low prices for oil and LNG allow South Korea to bolster its economy, particularly within the
major industries related to oil and gas, such as shipbuilding. Although South Korea is the worlds
largest shipbuilding nation, with a world market share of 32%, the industry has been suffering
due to the economic slowdown and high oil prices since 2008. This situation is changing,
however. Foreign investment in maritime vessels is on the rise, and the potential increase in

55

exports from the U.S. shale revolution is yielding a positive outlook for the Korean shipbuilding
industry.
On the other hand, GS Caltex has experienced losses since the rise of U.S. shale, largely because
U.S. shale is mainly light tight oil and does not require the type of refinement offered by Caltex.
Another potential blow for the company is the Keystone XL pipeline. If finished, the pipeline
will transport Canadian tar sands production to the Gulf of Mexico to be refined in the United
States. Coupled with low oil prices and increased volatility in the market, this project has caused
many in the South Korean energy industry to become concerned about future security and begin
searching for long-term stability.
Lower oil prices will boost the competitiveness of South Korean exports, but not all industries
will benefit. The petrochemical industry and heavy industry, for example, will be less profitable.
If oil prices are also being affected by the sluggish growth of the global economy, then the
positive impact on the South Korean economy will be limited.
IMPACT ON REGIONAL ENERGY TRADE DYNAMICS
In addition to affecting South Koreas domestic energy policies, the recent oil price collapse has
introduced a new dynamic into the East Asian energy equation that forces China, Japan, and
South Korea to reconsider their options, policies, and relationships with the United States and
other players in the context of a severely diminished Russian presence. East Asia has been the
great hope of the Russian government and energy sector. Though Russia has discussed largescale oil and gas sales to East Asia for over twenty years, the results to date are not much to brag
about, even considering the recent gas deal between Russia and China. Gas deals with Japan and
South Korea have stagnated, and China is essentially paying for Russian gas at cost.
The only relatively positive area in Russian energy sales to Asia before the gas deal of May 2014
was oil sales to China. However, Russia won those contracts only at the price of accepting huge
Chinese loans of $25$30 billion as infusions of cash to Rosneft and agreeing to facilitate
Sinopecs acquisition of oil and gas assets in Russia. This lopsided energy policy emerges clearly
when compared with Russian energy relations with Japan and South Korea. At present, there is
no direct oil pipeline from Russia to Japan or South Korea. Thus, Chinas monopoly on Russian
energy investments in the Far East stokes fears of Russia becoming ever more in the thrall of
China due to Russias failure to diversify its customer base.
Long-standing Russian plans for a trans-Korean gas pipeline connected to the East Siberian gas
fields have gone nowhere. President Park Geun-hye announced in October 2013 a plan to expand
economic cooperation with Eurasian countries for more trade opportunities. Called the Eurasian
Initiative, the policy is centered on the idea that exchanges between South Korea and Eurasian
nations, especially Russia, will help induce an opening up in reclusive North Korea, thus allaying
the long-running military and diplomatic tensions on the Korean Peninsula.
However, the recent oil price collapse will further reverse energy and other infrastructural
projects between South Korea and Russia. Low prices have dashed for the time being the high
hopes for the realization of long-standing Russian plans for a trans-Korean gas pipeline
56

connected to East Siberian gas fields and the Russian Arctic. Absent Pyongyangs assent, any
gas pipeline from Russia to South Korea would have to traverse China, because Beijing already
long ago vetoed any alternatives through Mongolia. A pipeline to South Korea through North
Korea could bypass China; thereby reducing the latters leverage on Russia. This pipeline would
provide alternative consumers for Russian energy exports and thus allow Russia to better
negotiate a higher price with China.
The most important consequence of the recent oil price collapse is the precipitation of this new
debate about energy security and energy trade. A new energy security architecture involving
China, Japan, and South Korea will be needed, and South Korea is a good candidate for strong
involvement in this emerging global and regional energy architecture. Amid shifting dynamics in
global energy markets, it is important to move from bilateral to broader regional and global
approaches to energy trade.
The Impact of low oil prices on NORTH AMERICA
For nations that both produce and consume large volumes of oil, a significant (and sustained)
price drop necessarily presents a mixed bag, carrying both positive and negative implications.
Some of these impacts are evident immediately, while others take a bit longer to manifest
themselves. Such is the case for countries in North America, which are all substantial oil
producers and consumers, importers and exporters.
THE UNITED STATES
In the last several years, the United States has been the largest source of incremental global oil
supply growth. Although rig counts and price remain substantially below levels of a year ago, oil
and gas production has so far remained remarkably resilient. Largely as a result of investments
made in previous years and the refocusing/high grading of drilling efforts to the most productive
basins, well productivity has continued to grow even as rig counts have declined. The desire to
maintain income streams and contract terms that require leases to be held by production continue
to spur ongoing development, albeit at a slower pace. According to statistics published by the
U.S. Energy Information Administration (EIA), March production in the United States averaged
some 9.32 million barrels per day (mmbd), the highest level in 40 years.
At issue, however, are the questions of how low prices can fall and, more importantly, how long
they are likely to remain at depressed levels. The duration of the price trough has severe
implications for future investment and output in the second half of 2015 and beyond, given the
steep decline rates associated with unconventional production. In recognition of cash flow
concerns, drilling budgets have been slashed, expenditures have been curtailed, and the drilling
of research wells, which had become a common practice to better understand the reservoir
dynamics of unconventional basins, has all but been eliminated.
In March 2015, the U.S. economy added 126,000 jobsthe lowest monthly increase since
December 2013 and substantially below economists expectations. So far this year, employment
in mining, the category covering the oil and gas sector, is off some 30,000 jobs. In contrast, the
sector added over 40,000 jobs in 2014, mostly in service-related positions, which are typically
57

the easiest and first for companies to cut when prices, income, and profits decline. According to
the U.S. Bureau of Labor Statistics, since December 2014, oil and gas firms have announced
91,000 energy-related job cuts, and state and regional impacts are uneven.
The prospects for reversal anytime soon are not bright. Absent a major supply disruption or
political upheavalan eventuality that is not out of the question given insurgency in Yemen,
distress in Nigeria and Venezuela, and continued instability in Iraq, Syria, and Libyaor a
resurgent rise in economic growth and oil demand, the second half of 2015 looks equally bleak
for producers. Add to that the likelihood of incremental new supplies coming online from Iraq
and Iran, as well as quick-cycle U.S wells, and you have the makings for a persistent price slump
while we work off the current surplus.
On the demand side of the ledger, the EIA now forecasts stronger economic growth in 201516
than that experienced in 201314, in no small part due to reductions in energy costs. Average
household expenditures are projected to fall by some 17% in 2015. Lower global oil prices also
mean reduced prices paid for imports. (The United States still imports approximately 7 mmbd of
crude and an additional 2 mmbd of refined products.) Estimates suggest that lower oil prices will
translate into energy and fuel cost savings of $750$1,000 for the average American household,
although so far these savings have not translated into increased consumer spending elsewhere.
CANADA
The assessment for Canada is similarly mixed. In testimony before the House of Commons
Finance Committee in February, Rhys Mendes, an economist at the Central Bank of Canada,
told members that the rapid fall in oil prices will have both positive and negative effects on
different sectors of the Canadian economy. He noted that even though real GDP grew by 2.4%
in the fourth quarter of 2014, the real incomes of Canadians contracted because the value of an
important Canadian export (oil) had also declined. Mendess testimony also emphasized the
regional impacts and relationship of energy- related supply chains, noting that 30% of all goods
supporting the Alberta oil sands come from other provinces.
MEXICO
For Mexico, a significant but smaller producer and consumer, the impact of low oil prices is
more complex. In the midst of widespread economic and energy reform, the precipitous
downturn in prices was both inopportune from a timing perspective and also unwelcome in terms
of prospective revenue streams. On the positive side, imports of lower-priced oil and gas from
the United States into the Mexican economy can also be beneficial. On a macro level, Canada
and Mexico both benefit from U.S. economic growth. The bigger energy-related issue for all
three countries is the duration of the price trough and the manner in which prices rise on the back
end.
ENERGY AND ENVIRONMENTAL SECURITY OUTLOOKS
From an environmental and energy security perspective, the discussion of low oil prices is more
nuanced. Depending on demand elasticity, lower oil (and gas) prices should in theory stimulate
58

additional oil demand, while at the same time reducing the economic attractiveness of higherpriced but less polluting forms of energy, like nuclear and renewables. This is not a good
outcome from an environmental perspective. Additionally, lower gasoline prices tend to make
the purchase of hybrid, gas-powered, or electric ehicles less attractive. While public policy
choicese.g., mandates, tax incentives, and HOV-lane accessibilitycan be used to partially
offset this economic advantage, the opportunity to displace or replace liquid petroleum fuels in
transportation is likely to be delayed. Further, with low oil prices the economics of expensive
liquefied natural gas (LNG) projects also come into question.
On a foreign policy, national security, and energy security basis, lower oil prices tend to reward
low-cost producers, the bulk of which remain the conventional oil producers in the Middle East.
Lower U.S. and Canadian production volumes reduce the proportion of output from secure
nations, increase reliance on suppliers located in less stable areas, and increase the likelihood of
future disruptions and underinvestment, thus leading to price increases going forward.
Some foreign policy enthusiasts have opined that increasing U.S. oil production would
substantially enhance the United States leverage in dealing with allies as well as competitors
and adversaries. Proponents of this view argue that U.S. supplies could replace those of the
Middle East or Russia. I tend to view that perspective more as attractive political rhetoric than
substantive fact. For while the United States is now the worlds largest oil and gas producer, it is
still a significant oil importer, and is likely to remain so for the foreseeable future. Security
comes in many forms, not the least of which include having a robust global market, strategic
stocks from which to draw prompt barrels in times of significant shortfalls, and policies that
support balancing prudent and timely development of indigenous (fossil and renewable) energy
resources with environmental stewardship, economic improvement, strong trade ties, and a
future-oriented outlook (as the energy landscape continues to change).
Policies aimed at supporting those objectives would include the elimination of consumer
subsidies, the promotion of R&D and the adoption of more resilient and sustainable energy
forms, the timely approval and construction of needed delivery infrastructure, the dissemination
of continued best practices, elimination of barriers to exports, assistance to foreign governments
in designing and realizing free-market regulations, and prompt recognition of the desirability of
putting meaningful prices on carbon and water, just for starters.
The rise in unconventional oil and gas has expanded the opportunity pool of future supply, added
more nations to the mix of prospective and potential producers, and already altered global energy
flows. This will likely extend the life of fossil fuels, and for a time lower prices to the benefit of
consumers everywhere. As with all delectable resources, however, underinvestment now is likely
to bring unpleasant consequences in the future. We are still in the very early stages of this
development, and multiple outcomesnot all desirablehave yet to be identified. Historical
energy supply-demand relationships between nations will inevitably continue to shift,
intraregional trade may expand at the expense of longer-haul trade, and geopolitical alliances
may be altered as a consequence.

59

Chapter 5 OPEC & its influence


OPEC and history of oil prices
The volatility of oil prices has been a major topic amongst researchers in the global oil market
since the first oil shock in 1973. Prior to the founding of OPEC, Standard Oil3, Texas Railroad
Commission4 and the Seven Sisters5 in that order, have impacted significantly on supply oil
prices since 1861. In Fig 1.1 below, it can be seen that following the shark spikes in oil prices
between 1861 and 1878, real oil price stayed relatively stable from that period which was largely
controlled by the seven sisters till the shocks that characterized the 1970s and 1980s.

Nominal prices, sometimes called current dollar prices, measure the dollar value of a product at
the time it was produces. Real price was adjusted for general price level changes over time i.e
inflation or deflation.
Since the founding of OPEC, besides the six day war in 1967 when 2.0mb/d of oil supply was
lost, the global economy did not witness any significant shocks in the price of crude oil till 1973
when an embargo was placed on Netherland and the United States by OPEC for supporting Israel
in the Yom Kippur war. According to the BP Statistical Review of World Energy 20106, real oil
prices went up from $15.89 in 1973 to $50.41 in 1974 which in nominal terms, represents a
400% increase. This was seen as the first attempt by OPEC to control the price of oil by reducing
supply and as a result, panic buying, inventory demand and speculation further contributed in
60

driving up spot prices beyond competitive levels. It is also important to note that between 1965
and 1973, world oil demand grew on average at 7.7% annually (Stephens 1995), which coincided
with cut in oil supply by OPEC of approximately 4.3mb/d (EIA).
Between 1978 and 1982, the second oil crisis occurred due to the Iranian revolution which
caused real oil prices to double from $46.13 in 1978 to $93.41 in 1979 while also leading to a 5.6
mb/d loss in oil supply. The revolution and the invasion of Iran by Iraq had led to a cumulative
loss of 9.7mb/d by 1981. This period represents the first attempt by OPEC to officially influence
world oil markets. OPEC decided to set price differentials for every OPEC crude relative to the
official Saudi Marker crude price to enable it share the burden amongst member countries in the
event of a crash in prices. However, as many researchers have discovered, OPECs inability to
get its member countries to cooperate and agree on a quotas and price level led to the collapse of
the agreement in 19818.
Between 1982 and 1986, oil prices reduced sharply due to a global decrease in oil demand and
the increase in oil production from Non-OPEC countries. OPEC lost its market share, and they
introduced a new system of controlling production known as the loose quota system (Alhajji,
2004) with Saudi Arabia given the swing producer role9. This model was however violated by
several OPEC members who cheated on their quota leading to a reduction in Saudi Arabias
output7 to about 2mb/d. OPEC also dropped the Arabian Light as the official crude price to
favour the netback pricing mechanism, a decision that further led to the crash of nominal oil
prices to $14.92. Netback pricing was again abandoned by OPEC by 1988 in favor of a pricing
formula that linked OPEC crude prices to market prices.

61

Besides the invasion of Kuwait by Iraq in the gulf war which led to a loss of output to the tune of
4.3mb/d from 1990 to 1991, nominal oil prices averaged between $17 and $18 from 1988 to
1997 before it crashed again in 1998 as shown in Fig 1.2 above due to a demand shock which
was characterized majorly by the Asian financial crisis and rapid increase in non-OPEC supply.
The events of the oil price crash in 1998 from $19.09 to $12.72 in nominal terms, led OPEC and
non-OPEC oil producers to reduce output by 2.104mb/d. As expected, this led to a price increase
the following year to $17.97 and OPEC sought to control the rapid increase by raising output. In
the summer of year 2000, OPEC introduced the witnessed the price band11 system to check the
volatility of oil prices, a mechanism that was later suspended in 2005 due to its perceived failure
by members of the organization. The 2001 attacks on the United States, the Iraq invasion by
United States the economic recession that followed and the resulting price hike in 2008 have
impacted strongly on world economies and behaviour of OPEC.

Assessment of OPEC in managing oil prices


According to economics literature, market power exists when a group of producers collude to
maximize profit by reducing output while charging high prices. The behaviour of OPEC as a
wealth maximizing cartel is an example of an imperfect market condition where some degree of
market power is exercised by producers with a reasonable degree of market share. Although the
62

market share of OPEC is still below 40%, its influence on oil prices over the years is significant.
More so, the marginal cost of producing oil in the core OPEC regions is relatively low and as a
result of its position as a key oil supplier, the elasticity of demand for OPECs oil is relatively
low in the short run.
In controlling the price of oil, OPEC needs to stay consistent and totally cooperative in its
policies (Horn 2004), this has however not been the case as literature and data have shown that
OPEC have struggled to get its members to commit13 to a output policy agreements without
cheating on their respective quotas. Dibooglu and AlGudhea (2007) concluded in their
assessment of cheating within OPEC that members have reacted in response to rising oil prices
than falling prices and they occasionally have to be cautioned by Saudi Arabia when cheating
starts reducing its market share. More so, the divided interests14 amongst OPEC members have
led to a series of fluctuations and inconsistency in its behaviour and they have been mostly been
reactive rather than proactive in assessing the oil market conditions in the past. Its failure to
predict the oil price crash in 1986, 1998 and 2009 is a point of note and also, the instability of its
pricing mechanisms due to politics and cheating cast a doubt on OPECs reliability to manage oil
price.

Setting the target range for oil price


In providing guidance on how to set a target range oil prices, it is important to note that even
though one of the aims of OPEC besides stabilizing the price of oil is to make high revenue from
high oil price, OPEC is more concerned about the impact of a global demand shock and fall in
demand for OPEC crude which leads to low prices, on its economies. Santis (2003) concluded
that Saudi Arabia as a dominant firm does not have any incentive to alter oil prices due to
welfare concerns, this also can be further explained by the impact of the past oil price crash on
state budgets and fiscal stability. It is however critical to take cautious approach in setting a
target range for oil price due to the mistakes made in the past.

63

Managing spare capacity


The ability of OPEC to manage its spare capacity is important when considering setting a target
range for its oil price. Adequate spare capacity will enable OPEC to stabilize the market by
increasing supply in the event of disruptions caused by low demand for OPEC oil due to an
increase in exploration and production outside OPEC and the subsequent increase in non- OPEC
supply. If this happens, oil prices will crash its effect on the economies of OPEC countries is
always negative as earlier explained. When there is low capacity, OPEC appears lose control in
the oil market any longer as the market will lose confidence in OPECs ability to stabilize the
market in the event of supply disruptions. This will however lead to stock piling which will lead
to a crash in oil prices. Most OPEC countries (besides Saudi Arabia who had excess capacity to
the tune of 1.95mb/d in 2000) do not have adequate space capacity to respond to increase in
demand which makes them gain little during output increases (Kolh, 2002). Although expanding
capacity is a long term project due to high cost and technical expertise, it is critical to the long
term relevance of the OPEC group in the oil market.
Consumption patterns of oil consuming countries
The consumption patterns of major oil consuming countries in the OECD and non OECD
countries need to be considered. According to the EIA, the United States (US), being the worlds
largest oil consumer, consumed 18,771,000 barrels/day and 5,954,000 barrels/day (31%) was
64

imported from OPEC in 2009. It is reasonable to suggest that a fall in the demand for OPEC
crude by the US could have a significant impact on oil prices if not well managed. The EIA also
projects that the increase in U.S. crude oil production in the Gulf of Mexico and elsewhere,
combined with increasing bio fuel and coal-to-liquids (CTL) production and decreasing
petroleum-derived fuel demand, is expected to reduce the need for imports in the long run. U.S.
petroleum import dependence falls from 51% in 2009 to 45% by 2035 in EIA's reference case
projection. With this in mind, setting the price of oil close or equal to marginal cost is crucial for
the future demand of OPECs crude oil.
According to the BP Statistical Review of World Energy 2010, as OPEC production fell by 2.5
million b/d, production outside OPEC rose by 450,000b/d, due to an increase of 460,000b/d in
the United States. The rapid industrialization on China and India caused disruptions in the oil
market in 2008 as lack of spare capacity was inadequate to meet the rising demand. And as we
have seen so far, the resulting effort by OPEC to get oil prices to recover has always led to them
over supply the market in most cases to send prices crashing again. Calls by China and India on
OPEC to reduce oil price recently due to its damaging effect on their economies is a reference
point, if this is not examined, conservation, fuel switching and increase in oil exploration by
these oil consuming industrialized economies could also have a negative impact on oil prices.
Better information management
As explained earlier, the price band mechanism failed due to the power it gave to market
speculators to increase oil stock which is inversely related to oil price (IEA Monthly Oil Market
Report, 2000). The more recent method of sending signals to the market though speeches and
press releases is a better way of managing information and staying unpredictable. More so, as
OPEC got more used to operating as a cartel, it realized that regular meetings and monitoring of
market dynamics is better for its management of spare capacity which is important for the
sustainability of its market share.
Stringent measures to prevent cheating
Saudi Arabia as the dominant oil supplier in OPEC is known to suffer the most when there is a
collapse in oil prices. This has led it to react strongly when cheating by member countries on
their quotas lead to a fall in oil prices which reduces the market share and revenue of the oil
65

dependent country. More disciplined approaches to compliance on the quota system needs to be
enforced to enable any price agreements by OPEC achieve its objective.

Influence of OPEC on price


OPEC's influence on the market has been widely criticized, since it became effective in
determining production and prices. Arab members of OPEC alarmed the developed world when
they used the oil weapon during the Yom Kippur War by implementing oil embargoes and
initiating the 1973 oil crisis. Although largely political explanations for the timing and extent of
the OPEC price increases are also valid, from OPECs point of view, these changes were
triggered largely by previous unilateral changes in the world financial system and the ensuing
period of high inflation in both the developed and developing world. This explanation
encompasses OPEC actions both before and after the outbreak of hostilities in October 1973, and
concludes that OPEC countries were only 'staying even' by dramatically raising the dollar price
of oil.
Oil Economics
OPEC is a swing producer and its decisions have had considerable influence on international oil
prices. For example, in the 1973 energy crisis OPEC refused to ship oil to western countries that
had supported Israel in the Yom Kippur War or 6 Day War, which Israel had fought against
Egypt and Syria. This refusal caused a fourfold increase in the price of oil, which lasted five
months, starting on October 17, 1973, and ending on March 18, 1974. OPEC nations then
agreed, on January 7, 1975, to raise crude oil prices by 10%. At that time, OPEC nations,
including many whom had recently nationalized their oil industries, joined the call for a new
international economic order to be initiated by coalitions of primary producers. Concluding the
First OPEC Summit in Algiers they called for stable and just commodity prices, an international
food and agriculture program, technology transfer from North to South, and the democratization
of the economic system. Overall, the evidence suggests that OPEC did act as a cartel, when it
adopted output rationing in order to maintain price.
Since currently worldwide oil sales are denominated in U.S. dollars, changes in the value of the
dollar against other world currencies affect OPEC's decisions on how much oil to produce. For
example, when the dollar falls relative to the other currencies, OPEC-member states receive
66

smaller revenues in other currencies for their oil, causing substantial cuts in their purchasing
power. After the introduction of the Euro, pre-invasion Iraq decided it wanted to be paid for its
oil in Euros instead of US dollars causing OPEC to consider changing its oil exchange currency
8 OPEC & its influence on Price of Oil
to Euros, although after Iraq's invasion, the interim government reversed this policy, and the
subsequent Iraq governments stuck to the US dollar. Member states Iran and Venezuela have
undergone similar shifts from the dollar to the Euro.
OPEC Basket
OPEC basket is a weighted average of oil prices collected from various oil producing countries.
This average is determined according to the production and exports of each country and is used
as a reference point by OPEC to monitor worldwide oil market conditions. The new OPEC
Reference Basket (ORB) Introduced on 16 June 2005, is currently made up of the following:
Saharan Blend (Algeria), Girassol (Angola), Oriente (Ecuador), Iran Heavy (Islamic Republic of
Iran), Basra Light (Iraq), Kuwait Export (Kuwait), Es Sider (Libya), Bonny Light (Nigeria),
Qatar Marine (Qatar), Arab Light (Saudi Arabia), Murban (UAE) and Merey (Venezuela). OPEC
daily basket price stood at $93.96 a barrel on Thursday 13th January 2011
Production Allocation
OPEC allocates quotas to its member countries every few months. The most popular view is that
these nations agree to increase global demand by restrict its production but as stated earlier Saudi
Arabia takes a different stand. The recent allocation data has no distributions allocated from
November 2007
OPEC Reserves
OPEC's ability to control the price of oil has diminished somewhat since the Gulf War due to the
subsequent discovery and development of large oil reserves in Alaska, the North Sea, Canada,
the Gulf of Mexico, the opening up of Russia, and market modernization. As of November 2010,
OPEC members collectively hold 79% of world crude oil reserves and 44% of the worlds crude
oil production, affording them considerable control over the global market. The next largest
group of producers, members of the OECD and the Post-Soviet states produced only 23.8% and
67

14.8%, respectively, of the world's total oil production. As early as 2003, concerns that OPEC
members had little excess pumping capacity sparked speculation that their influence on crude oil
prices would begin to slip. 9 OPEC & its influence on Price of Oil
Who gets What - by OPEC
Although the popular view is that OPEC is responsible for all the volatility of crude oil prices
globally, the research division of OPEC contradicts this view by regularly analyzing and
publishing the Who gets What from a litre of imported oil of the G7 countries. The latest
report published in November 2010 states the following.

The crude basket price of OPEC may fluctuate widely but OPEC claims its percentage share of
cost per litre of oil has remained steady.
OPECs position in trading Spot & Oil Futures
Most of the oil futures of different blends produced by OPEC traded at The Dubai Mercantile
Exchange. The DME is the premier energy-focused commodities exchange in the East of Suez.
The DME was launched in June 2007 with the goal of bringing fair and transparent price
discovery and efficient risk management to the East of Suez (Asia Pacific and Middle East), the
worlds fastest growing commodities market and already the largest crude oil supply/demand
corridor in the world. 10 OPEC & its influence on Price of Oil
The DME lists the Oman Crude Oil Futures Contract (DME Oman) as its flagship contract,
providing the most fair and transparent crude oil benchmark in the East of Suez. Today, DME
68

Oman is the explicit and sole benchmark for Oman and Dubai crude oil Official Selling Prices
the historically established markers for Middle East crude oil exports to Asia. The DME is
regulated by the Dubai Financial Services Authority (DFSA) and all trades executed on the
exchange are cleared through and guaranteed by the New York Mercantile Exchange (NYMEX),
a member of the CME Group, which is regulated by the U.S. Commodity Futures Trading
Commission (CFTC) and is a Recognized Body by the DFSA. The DME is recognized by over
20 international regulatory bodies across Europe and Asia, further cementing its position as truly
global and well-regulated marketplace. Another fact that significantly strengthens the OPECs
position is the fact that among the entire worlds oil producing countries only OPEC nations
have a significant spare oil production capacity. They can expand oil production when demand
increases. OPEC member countries respond to market fundamentals and forecast developments
by co-coordinating their petroleum policies. If demand grows or some producers are producing
less oil, OPEC can increase its oil production in order to prevent a sudden rise in prices. It can
also reduce production in response to market conditions. But increasing oil production is not a
simple procedure. In order to expand their output the member countries need to be sure that the
oil industry will continue to be profitable. Oil producers invest billions of dollars in explorations
and infrastructures. A new field can take 3 to 10 years to locate and develop. Sometimes when it
is not used or used less than capacity for a long period, the plant may suffer irreparable damage.
It is also difficult and a colossal loss if a plant in the middle of the ocean has to be shut due to
lack of demand. If oil producers do not invest enough money and do it far enough in advance,
then the world could face a shortage of oil supplies in future.
From the early 1970s to the mid 1980s, the OPEC did set crude oil prices. It is not so today. The
price of crude oil is affected by movements of three major international petroleum exchanges
the New York Mercantile Exchange (NYMEX), the International Petroleum Exchange in
London (IPE) and the Singapore International Monetary Exchange (SIMEX). International
Energy Agency 11
OPEC & ITS INFLUENCE ON PRICE OF OIL
(IEA) of Paris and US Energy Information Administration (EIA) are also important players. The
spot and future trading in these affect the oil prices. Even though today OPEC is not entirely
responsible for oil prices, OPEC member countries do voluntarily restrain their crude oil
69

production in order to stabilize the oil market. Sometimes it does so to maintain profits so as to
maintain the member countries economic growth. This may happen when these countries,
whose sole earning is from oil exports, suffer losses due to sluggish demand caused by
restrictions like taxes on oil import & consumption. Security of oil supplies relies on security of
oil demand. The year 2008-09 were the first time since 1981 when global oil demand declined in
two successive years due to global recession. Demand fell by 1.8 million barrels per day and the
price of a barrel of crude lost almost 100 $ in less than 6 months from mid 2008, resulting in
unused production capacity.

Impact of Kyoto protocol on OPEC


Environmental concerns have forced mankind to diversify into alternate sources of energy. The
possible losses that OPEC countries may incur due to threat by these Non- Conventional sources
have triggered a debate on the green paradox (Sinn 2008). This paradox is based on the
assumption that suppliers of oil feel threatened by a decline of future prices due to gradual
reduction of oil consumption in abating countries. If this reduction reduces the discounted value
of the oil price in the future more than at present, the oil producing countries will expand
production in the short run which will increase oil consumption and thus accelerate global
warming. OPEC stated that its Nations are dependent on oil exports and hence need to be
compensated for the adverse impacts arising due to KYOTO Protocol.

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Chapter 6 Challenges to OPEC


OPEC was organized in the early 1960s by Saudi Arabia, Iran, Iraq, Kuwait and Venezuela with
the primary goal of unifying the five countries oil export policies and hopefully dictating a
high price for their oil. The five countries certainly possessed that power when the cartel was
initially formed, and while the cartel still produces about 40 percent of the worlds oil, OPECs
dominance has declined over the years. Today, only Saudi Arabia and to a certain extent the
United Arab Emirates, Qatar and Kuwait retain the ability to voluntarily adjust production levels.
OPECs other members Libya, Algeria, Nigeria, Ecuador and Angola must maintain
production to finance their national budgets. Effectively, this means that OPEC wields nowhere
near the power it once did. Even a producer of Saudi Arabias size is barely able to change the
price of oil through boosting or cutting production.
A new wave of oil production outside the cartel has already hit. Production in the United
States has increased to an estimated 8 million barrels per day the highest level since the
1980s. Elsewhere, production is set to take off in Canada and potentially Brazil. At the same
time, increased production outside OPEC is dwarfed by the ambitious expansion plans put
forward by OPEC members Iraq and Iran. While production outside the cartel is manageable,
together with Iraq and Irans plans it could represent a significant threat to oil prices in the latter
half of the decade.
Iraqs energy sector has been revitalized after the past five years and is now producing nearly 3.5
million barrels per day. Its oil ministry has set several ambitious goals, including production
hitting 9 million to 10 million barrels per day by 2020. Iran, too, sees prospects for boosted
production on the horizon. Complementing the negotiations with the United States on a possible
long-term rapprochement, Iranian President Hassan Rouhani has started a significant reform
campaign hoping to bring oil production back to the pre-sanction level of 4.2 million barrels per
day within six months and increase it to the pre-revolution level of 6 million barrels per day
within 18 months. To be clear, both goals are not attainable within their respective time frames,
but significant increases are possible.
The amount of production that comes online in Iraq will largely depend on two factors. First, the
political system and violence will shape the pace of investment and regulatory procedures, such
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as issuing contracts and permits. Second and more important, there are logistical limitations to
bringing online that level of production in such a short period of time. Some of these limitations
can be overcome with proper coordination between international oil companies, oil services
providers, the Shia surrounding the Basra region and the various political interest groups in
Baghdad. Adroit cooperation between all of these parties is unlikely, meaning Iraq will fall short
of Baghdads lofty goals, but Iraq can reach about 5 million to 6 million barrels per day by 2020,
and closer to 6 million to 6.5 million barrels per day within a decade.
For Iran, the challenge is somewhat simpler, since its limitations are largely caused by external
sanctions. As seen in other countries, typically when oil production has been interrupted
following regime change, sanctions and other causes, production levels rarely reach the level
achieved prior to the disruption. However, should sanctions be removed, Iran could quickly
revive about half of its offline production within 12 to 18 months about 500,000 to 750,000
barrels per day. In the longer term, there are some reasons to believe that Iran could buck the
trend and increase its production back to previously achieved levels, and perhaps even increase
it, but the time frame would be measured in years, not months. All of this, of course, is subject to
geopolitical events that could slow the process down or stop it entirely such as internal
backlash in Iran and a slow timetable for negotiating with Washington. After bringing shut-in
production back online, Iran (like Iraq) is more likely to slowly increase its daily oil production
by about 250,000 to 300,000 barrels per year, pushing Rouhanis goals to after 2020.
OPEC Going Forward
OPEC is facing short-term and long-term challenges. In the near term, rising production in the
United States and Canada has been unexpectedly quick increasing by 1 million barrels per
day in each of the past two years. Although most of the U.S. increase has been offset by
production taken offline due to instability in Libya, added U.S. exports have already forced
Saudi Arabia to reduce production levels at times to maintain prices. U.S. production is set to
grow by another 1 million barrels in 2014, potentially straining OPECs preferential price points.
In the longer term, Iran and Iraqs production is the key issue. Should Iran and Iraq together
boost production to a reasonably achievable level of 11 million barrels per day by 2020, that
would represent an increase of 5 million-6 million barrels per day above present levels. OPECs
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export quotas have already been a source of tension among its members, but producers have
always found ways to skirt around them. That may no longer be possible. While Irans domestic
consumption will increase significantly, the potential export increases are still too high for Saudi
Arabia to offset. This will cause stress within the organization among regional rivals Iran, Iraq
and Saudi Arabia. Saudi Arabia may ask Iran and Iraq to voluntarily limit export growth, but
without other incentives there is no reason to believe they would do so when it is in their shortterm economic interest to boost exports as much as possible.
Increased exports by Iran and Iraq also play into the broader rivalry between Saudi Arabia and
Iran over issues such as the Syrian civil war and Iranian influence in Saudi Arabias border
regions as well as its oil-producing Shiite-dominated Eastern Province. Historically, Saudi
Arabia has argued for increased production from the cartel to preserve OPECs market share,
since high prices have helped encourage alternative energy development elsewhere, whereas Iran
and Iraq have argued for moderate production levels and strong prices. Additionally, while Saudi
Arabia can afford to sell oil at $85 per barrel, many of the governments surrounding it need
prices at or above $100 per barrel, and Riyadh does not want to see its neighbors engulfed in
even more turmoil than they already are due to lower oil revenue. Iran and Iraq are pursuing this
boost for their long-term production and believe they can do so without reducing prices by
relying on increased demand from developing Asian markets.
Asia is now the worlds biggest net importing region bigger than Europe and North America
combined. Naturally, this has led to increased codependence between OPEC and developing
Asian countries, principally India and China. Indeed, China has massive projects with Saudi
Arabia, Iraq and Iran. Chinas footprint has expanded dramatically in Venezuela and it imports
about 15 percent of its oil from OPEC member Angola. India has also deepened its connections
to OPEC countries and has emerged as Nigerias biggest customer.
As OPECs biggest customer, Asia will continue its strong demand in the near future, and so
stress on OPEC will not necessarily mean lower oil prices. The impact on long-term prices is less
certain, however; the price will be determined not only by the size of Asian growth in the future,
but by global oil supplies in non-OPEC countries as well. While OPEC historically has been
used as a political tool to increase oil prices or place an embargo on exports, as can be seen from
the 2008 price spike, OPECs modern challenge is more concerned with keeping oil prices
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reasonably low, not artificially raising them or embargoing oil. In order to preserve its long-term
health, OPEC will need to preserve relatively low oil prices, both to ensure that developing
markets in Asia can afford to keep buying the oil and to prevent alternatives such as shale oil,
electric cars or natural gas-to-liquids technology from becoming more economically
feasible. Furthermore, tempered oil prices for consumers in Asia will only reinforce the regions
economic growth, contributing to increased demand for OPECs oil.
Few other challenges that OPEC is facing are:

Uncertainty in Global Demand, Structural shift in demand from developed world to


developing world.

Non-OPEC oil-producing nations (Russia , Norway, Canada, Mexico etc.)often increase


production when OPEC cuts it.

Russia overtook Saudi Arabia as the worlds biggest crude supplier in 2009.

OPECs share of production has gone down from around 51% in the mid-1970s to just
over 40% now.

Problem of Member Cohesion within OPEC nations:

Maintaining quota discipline within the cartel.

Existence of factions within OPEC, which are generally classified into three groups:
1. The group led by Saudi Arabia, the UAE and Kuwait, who are in favour of increased
supplies and moderate pricing,
2. The group led by Libya, Iran and Algeria, who are insistent on decreasing output for
higher prices,

The in-between group including Nigeria, Venezuela, Indonesia who have been known to
take sides depending on their own economic/political agenda.

Middle-Eastern Strife & Political instability in OPEC oil-producing countries - Mostly


authoritarian states that use oil money as a means of sustaining

political power.

Future technological developments in areas of renewable energy sources - According to


IEA (International Energy Agency), the increase in renewable usage will far outstrip
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annual growth in energy liquids(crude oil and natural gas) as a source of the world's
power Crude oil, OPEC will become less important in the energy equation.

Conclusion
1. OPEC Still Exists today and still has considerable influence in determining the price per
barrel of petroleum by setting quotas, but their best days are behind them. The cartel
seems to understand that raising prices is easier in short run than in long run.
2. Non-OPEC nations such as Russia, Canada and Mexico have stripped the cartel of its
power to single-handedly manipulate the petroleum market
3. The World has benefited from the increased production of petroleum by Non-OPEC
nations and thus reduced their annual imports from the OPEC countries in recent years

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