Sep 16, 2011|
OPEC: The Oil Supremacy
In the previous article, we discussed the categories of Oil producing companies and their emergence. In this article, we talk about Organization of Petroleum Exporting Countries (OPEC) and its function.
What is OPEC?
OPEC was created in 1960s with an objective to co-ordinate the petroleum policies for its member nations and to thereby achieve fair and stable prices for oil producers. It is an inter-governmental body consisting of 12 crude oil reserve rich countries. The list includes Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Nigeria, and Libya among others.
How does OPEC work?
To achieve its motive, OPEC attempts to regulate the supply and achieve fair return on capital for its members. The members collectively agree on the supply that is required to balance the demand in the market. To decide on the supply levels, the Energy ministers from each member nations meet biannually and consider various factors like inventories, expected demand, and price among others. Once the overall supply is decided, each member nation is allocated a production quota based on its own oil reserves. To reach to this conclusion, the members must agree unanimously on the supply and production quota. This means that Saudi with maximum reserves cannot overrule other country with lower reserve.
Why is it so influential?
Around 80% of world’s oil reserves belong to OPEC countries. One-third of world’s oil demand is fulfilled by the production from OPEC countries. The remaining is contributed by non-OPEC countries. However, it is important to note that non-OPEC countries are already operating at full capacity, while the OPEC countries often have spare capacity. The biggest spare capacity resides with Saudi Arabia.
In effect, OPEC’s decision to supply oil has a significant impact on oil prices. One other parameter that also plays a role in determining the supply of oil is the level of spare capacity with the OPEC countries. Higher spare capacity will create a negative bias on the crude price.
OPEC always intends to maximize profits for the OPEC countries by adopting proper pricing policies. In 1991, OPEC targeted the oil prices between US$ 22 to US$ 28 per barrel. This was increased to US$ 55 per barrel in 2006 and again revised to US$ 60 per barrel in 2008. After the recovery of Oil prices from the lows of 2009, OPEC has indicated that it will be comfortable to see the Oil price at US$ 70 per barrel.
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