(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON Jan 23 OPEC's influence on oil prices is
very visible in the short run, but it is less certain that its
pricing power can be maintained in the long term, according to a
thoughtful review published by Bassam Fattouh and Lavan Mahadeva
of the Oxford Institute for Energy Studies.
Fattouh and Mahadeva examine how the cartel's strategy and
power over oil prices have varied over time depending on market
conditions and the interaction among OPEC members ("OPEC: What
Difference Has it Made?" Jan 2013).
It is a superb review of the cartel's history and operations
since it was founded in 1960 with the aim of securing "fair and
stable prices" for petroleum producers.
But the more important question is how the cartel will
operate in the next decade, and whether it can sustain the
current price level of $110 per barrel.
Past experience suggests it will struggle.
Fattouh and Mahadeva argue OPEC's response to oil price
movements is asymmetric: "A key objective of OPEC is to avoid
oil prices falling below some level deemed acceptable by its
members, rather than to prevent oil prices from rising above
certain levels or to set a price ceiling."
Others have likened OPEC to a tea bag: it works best in hot
water, when prices are falling and members are in trouble. When
prices are high, members struggle to agree on price targets and
sharing output, relegating OPEC to the sidelines.
"In a rising market, OPEC tends to satisfy demand at the
available market-determined prices by adjusting its production;
it does not attempt to discount its spare capacity to bring
prices down," Fattouh and Mahadeva explain (here).
"OPEC countries have been protected by strong barriers to
entry, which stem from ownership and control of the bulk of the
low-cost oil reserves. By limiting investment in their oil
sector, OPEC members can control the future flow of oil supplies
into the market. They also shift the burden of meeting the
demand for the marginal barrel onto high cost producers."
LONG TERM COMPETITION
OPEC secured huge price increases in the 1970s and early
1980s by limiting production and shuttering excess capacity. But
the result was a surge in competing supplies, a huge increase in
conservation in the consumer countries, and mounting discord
among OPEC members themselves about how to share out their
dwindling share of the market.
Between 1973 and 1985, the cartel's share of world
production fell from 51 percent to just 28 percent. Saudi
Arabia's attempts to defend prices saw the kingdom cut output
from 10.2 million barrels per day in 1980 to just 3.6 million
barrels per day in 1985 (and exports were less than 2 million
barrels per day).
The cartel's share was cut by rising production from Mexico,
Alaska and the North Sea, the rest of the United States, and the
former Soviet Union. "The increase in non-OPEC output was a
shocking surprise," according to former MIT Professor Morris
Adelman ("Genie out of the bottle" 1995).
Crude demand fell even as supplies rose, as the United
States, Europe and Japan made determined efforts to boost energy
efficiency and promote alternative fuels.
The question is whether history is about to repeat itself.
Following the dramatic escalation in oil prices since 2002,
output is rising rapidly in the United States, and oil firms are
prospecting intensively for additional supplies across Latin
America, Africa, the Arctic and Asia.
The United States and the EU have enacted laws that will
result in deep cuts to gasoline and diesel consumption by 2025.
Even in transport, their core market, the role of oil-based
fuels is coming under growing pressure from cheap natural gas.
"Taxation, climate change and energy security policies aimed
at reducing the share of oil in the energy mix can erode OPEC's
position in the long term, resulting in lower revenue streams,"
according to Fattouh and Mahadeva.
"This represents a real challenge for OPEC and lies at the
heart of a core of the oil market: the rent distribution
question. The way in which OPEC confronts this challenge will
determine both its future evolution and its position in the oil
SUSTAINABLE PRICE LEVEL
In the 1970s, OPEC's Long-Term Price Policy Committee aimed
to push prices up to the point where they were just under the
cost of producing synthetic liquid fuels from coal, which it put
around $60 per barrel in contemporary money.
But since 2010, prices have remained far above the cost of
competing supplies, such as producing oil from shale ($50-75),
tar sands ($55-85), natural gas ($70), or coal ($90) let alone
deepwater fields. The financial incentive to develop new
supplies outside OPEC is overwhelming.
It seems unlikely OPEC will be able to defend the current
price level without accepting a substantial reduction in its
"Between 1973 and 1985, OPEC exercised the ultimate market
power by setting the marker price," Fattouh and Mahadeva
conclude. However "by fixing price, OPEC had to live with
variable volumes of production. With the continued decline for
its oil ... OPEC saw its market share in the world's oil
In the 1980s and 1990s, cartel members were hit by the
double blow of falling market share and falling prices. As
revenues came under pressure, the organisation was divided by
fierce disputes about how to share out production cuts and shut
ins among its members to try to prevent prices falling further.
OPEC's production share eventually recovered to 43 percent
in 2011. But the increased market share was bought back by two
painful decades of low prices after 1985 which curbed the growth
of high cost supplies outside the cartel, while wars, corruption
and sanctions helped limit the growth in production among member
After enjoying an enormous run up in oil prices and revenues
since 2002, OPEC members must ask whether current price levels
are sustainable, or the prelude to another period of low pricing
needed to shut down the development of alternatives.
(Editing by Alison Birrane)