Briefing: OPEC and the soaring cost of oil

As the price of oil hit an all-time high of $139 a barrel last week, some government officials pointed the finger at OPEC, the international oil cartel. Is OPEC the main culprit?

Is it fair to blame OPEC for the high price of oil?

To a degree. After all, the Organization of Petroleum Exporting Countries—a 13-nation body dominated by Saudi Arabia, Kuwait, and other Middle Eastern countries—was created with the express purpose of influencing prices. In the 1970s, it did in fact hold the world ransom by restricting supply. (See below.) The U.S. and other oil-consuming nations maintain that the cartel is once again driving up prices by limiting production, even though OPEC now controls only 40 percent of the world oil market, down from 70 percent in 1973. The U.S. House of Representatives has even called for the Justice Department to pursue antitrust and price-fixing charges against OPEC.

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What does OPEC say in its defense?

OPEC members claim that most of them couldn’t supply more oil even if they wanted to, because they are already pumping at or near capacity. Only Saudi Arabia has substantial surplus capacity; yet when the Saudis, at President Bush’s behest, agreed recently to produce 300,000 extra barrels a day, global oil prices were barely affected. Last week, the Saudis agreed to an additional 200,000-barrel increase. In any case, OPEC insists that it’s not in its own interest to let oil prices rise uncontrollably.

How could that be?

OPEC has been burned before. The price rise it engineered in the 1970s led to a global recession, a slump in demand, and a drive by other countries to find new sources of supply. This was disastrous for most of the cartel’s oil-rich states, which are rich in little else. Since then, OPEC has aimed for long-term price stability. In 2000, it adopted a policy of cutting production if the price went below $22 per barrel and raising production if it passed $28. However, after 9/11 and the U.S. invasion of Iraq, prices skyrocketed. So OPEC has abandoned official price targets.

So what’s behind the recent price explosion?

OPEC points to the U.S. Federal Reserve. To prop up domestic banks, the Fed has slashed interest rates and expanded the money supply, severely weakening the dollar in the process. Since oil is bought in dollars, it now takes a lot more of them to buy a barrel of oil. The problem has been exacerbated by speculators, OPEC says. When economies slow, investors tend to move into commodities such as food, gold, and oil. Commodity prices have recently reached historic highs, and anticipating additional price increases, investors are piling into oil futures—driving prices even higher.

What does this mean for the oil market?

Whatever the immediate causes of the price hike, it’s clear that the long-term trend is deeply affected by the huge rise in demand for oil from India, Russia, the Middle East, and, above all, China. Together, they now consume 20.7 million barrels of oil a day, compared with 20.3 million barrels a day in the U.S. And global demand will prove increasingly difficult to meet. “Eighty-five million barrels of oil per day is all the world can produce, and the demand is 87 million,” said Texas oil mogul T. Boone Pickens. “It’s as simple as that.” OPEC claims daily supply is in fact 88.75 million barrels, but even if there is enough to meet today’s demand, the big concern is about the future.

What’s the problem?

Oil production is decreasing in 54 of the world’s top 60 oil-producing nations—including the U.S., which produces 5 million barrels a day, down from 11 million in 1970. The overall amount of oil discovered has been falling for 40 years; easily reached oil fields are being depleted, while untapped reserves are often small and hard to exploit. Many experts expect non-OPEC production to peak around 2010; outside the cartel, the best new source of oil is said to lie under the Arctic. But reserves there are believed to be relatively limited, and the conditions are extremely hostile.

But doesn’t OPEC have huge reserves?

In theory. Until recently, Saudi officials routinely claimed that the kingdom, which produces 13 percent of the world’s exported oil, had an almost bottomless well. But some analysts fear its reserves aren’t as plentiful or easily available as suggested. Sadad al-Husseini, a former top executive at the state-owned oil company Saudi Aramco, says that Saudi production has already reached a peak and will begin dropping in 15 years or less.

So will global production soon reach a peak?

Again, that’s contested. The Association for the Study of Peak Oil thinks global crude supplies will top out at 87 million barrels per day at the end of this decade and then decline. But the more authoritative International Energy Agency, which advises 27 industrial nations, believes we won’t hit a peak until around 2040, when supply will be at 100 million barrels a day. The real problem right now, the IEA argues, is posed by the “above-ground hindrances” in the major oil-producing nations.

What are these hindrances?

The threat of violence from armed militias severely hampers production in Iraq and Nigeria. The nationalist autocrats of Russia, Venezuela, and Iran are reluctant to let Western oil giants fully exploit their resources. In the U.S., environmentalists vehemently oppose efforts to expand offshore drilling or to allow exploration of Alaska’s Arctic National Wildlife Refuge. For their part, the Saudis could spend more to increase production and bring down oil prices. But why would they want to do that?

When OPEC got greedy

OPEC was a relatively benign force in world affairs until 1973, when it decided to halt all oil shipments to countries that backed Israel in the Yom Kippur War. The oil embargo resulted in a quadrupling of the cost of a barrel of oil and sparked global economic mayhem, perhaps best symbolized by the miles-long lines at gas stations. But OPEC then began to fragment, as each member, trying to cash in on the high price created by their collective action, surreptitiously sought to exceed their agreed-upon quotas. Soon enough, supply and demand began to even out. By 1980, the reduced demand from a battered world economy, coupled with overproduction, led to a drop in prices, which remained low throughout most of the 1980s and 1990s. Most analysts now say that because of the growth in oil production in non-OPEC countries as diverse as Russia, Norway, and Mexico, OPEC has never been able to reassert the market control it once enjoyed.