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Crude oil plays a vital role in the global commodities market as the fluctuations in its prices have a direct impact on the world economy. Consequently, the countries or entities producing oil exert influence on economies all over the world.
Two major factors impact oil prices: economic events and geopolitical developments. Changes in these factors can lead to shifts in oil supply and demand, which subsequently cause oil price variances. Several historical geopolitical events, including the 1973 Arab oil embargo, the 1980 Iran-Iraq war, the 1990 Gulf War, the 1997 Asian financial crisis, and the 2007-2008 global financial crisis, have significantly influenced oil prices.
Crux points:
The driving force behind oil prices includes numerous factors, with demand and supply being the primary ones. Approximately 40% of the world's crude oil is produced by member nations of the Organization of the Petroleum Exporting Countries (OPEC). It's noteworthy that OPEC's oil exports make up about 60% of the total petroleum traded across the world. OPEC, especially Saudi Arabia, typically has a decisive role in determining oil prices. However, Russia has become a substantial force in the oil market. It remains unclear whether non-OPEC countries have a significant impact on oil prices.
Dynamics of OPEC and Oil Prices
The Organization of the Petroleum Exporting Countries (OPEC) is tasked with setting production targets among its member nations to control oil production. OPEC member countries are responsible for about 40% of the world's oil production, and 60% of the global petroleum trade originates from OPEC, as reported by the United States Energy Information Administration.
Due to this remarkable market share, the actions undertaken by OPEC profoundly impact international oil prices. Above all, Saudi Arabia exerts the most influence, being OPEC's largest oil producer. Typically, oil prices escalate when there are reductions in OPEC's production targets.
The Effect of OPEC and OPEC+ on Oil Prices
There are three major entities that participate in global oil production; these are members of OPEC, non-OPEC nations, and the nations in OPEC+. OPEC+ was created in 2016 when ten non-OPEC nations joined OPEC to gain a more effective handle on the global crude oil market. Therefore, OPEC+ has an even larger influence over the world economy than OPEC.
Responding to the volatile economic and geopolitical environment, these entities make changes to their oil production capacities. These changes then influence oil supply levels and generate oil price volatility.
OPEC's Authority in the Market
About 60% of total petroleum traded globally comes from OPEC's oil exports. The Energy Information Agency reveals that the world's proven crude oil reserves lie within OPEC countries. Almost two-thirds of these reserves were located in the Middle East in 2021.
OPEC member nations have been consistently enhancing technology and exploration efforts to improve their oil production capacities while simultaneously reducing operational costs.
Saudi Arabia's Role
In the OPEC group, Saudi Arabia holds the crown as the world's largest crude oil producer. It's also the leading exporter of crude oil globally. A cut in Saudi oil production usually brings about a sharp increase in oil prices, while an increase in Saudi oil production potentially drops the prices.
Since the 1973 Arab oil embargo, Saudi Arabia has had a commanding role in oil prices through supply control. All significant oil price fluctuations in recent history can be traced back to changes in production levels by Saudi Arabia and other OPEC nations.
OPEC+
OPEC+ controls more than half of the global oil supplies, as highlighted by Tamas Varga, a senior analyst at PVM Oil Associates, in his quote to CNBC. OPEC+ remains a powerful force due to three main reasons:
- No alternative sources match its dominant position.
- There's a dearth of economically viable alternatives to crude oil in the energy sector.
- The relatively low-cost price advantage of OPEC+ against the comparatively high cost of non-OPEC production.
In essence, OPEC+ has the economic capability to either disrupt or enhance oil supply levels at any time, seriously influencing oil prices. For instance, OPEC’s 1973 Arab oil embargo led to a quadrupling of prices from $3 to $12 per barrel. More recently, Saudi Arabia's sudden increase in production in March 2020 led to a sharp decline in oil prices.
The Influence of Non-OPEC Producers on Oil Prices
Non-OPEC oil producers constitute the nations that produce crude oil outside of the OPEC group and also include shale oil producers. Some of these non-OPEC nations are significant oil producers, including the United States, leading the pack, followed by Canada and China.
These non-OPEC nations usually have high consumption levels, limiting their export capacity and making them minimal influencers of oil prices. However, with the discovery of shale oil and gas, non-OPEC oil producers, especially the United States, have experienced increased production and market share.
However, the high upfront costs needed for shale oil technology have acted as a deterrent to shale oil producers. There's still a debate whether non-OPEC producers can substantially affect oil prices. Despite high production levels from non-OPEC members from 2002 to 2004 and in 2010, the prices didn't go down and instead increased. This could be because non-OPEC members didn't have a substantial market share to move the oil market needle. Conversely, high production from 2014 to 2015 did bring about a decline in prices.
OPEC and Non-OPEC Countries Versus Market Dynamics
Oil prices are also influenced by geopolitical events and economic self-interests. In addition, suDDen, unpredictable events, or "black swan" events, can deeply affect the supply/demand ideal.
Such an event occurred in January 2020 when the pandemic rocked the global economy. The sharp drop in oil demand led to a rift in OPEC+, primarily between Saudi Arabia and Russia, the two largest oil exporters. In response, Saudi Arabia increased its production, leading to a sharp fall in the price of WTI, breaking the $20/barrel barrier.
OPEC - An Overview
The Organization of the Petroleum Exporting Countries (OPEC) consists of 13 chief oil-exporting countries. Established in 1960, OPEC's mission is to manage the supply of oil to stabilize market prices and avoid fluctuations that might impact the economies of oil-producing and oil-consuming countries. In late 2016, ten non-OPEC nations formed OPEC+, establishing a wider coalition to exercise greater control over the global oil market.
Factors Affecting Oil Prices
Many variables can impact the price of crude oil significantly. The supply and demand prospects combined with the perceived risk of market disruptions take a considerable portion of this equation. Periods of economic acceleration tend to spike oil demand and boost prices, while economic downturns can lessen oil demand and depress prices. OPEC and OPEC+ also influence oil prices by managing the global supply through production quota negotiations.
Investing in Oil
Various ways can be used to make an investment based on your predictions about the direction of oil prices. These include trading oil futures and options, investing in related exchange-traded funds (ETFs) and exchange-traded notes (ETNs), and buying individual energy stocks.
Final Thoughts
The complexity of the oil economy is undeniable, and oil prices hinge on more than basic supply and demand principles. However, in an operational global market, OPEC+ will likely continue its commanding influence on oil prices. Despite challenges like fracking technology and the discovery of oil in non-OPEC regions, OPEC's extensive share of the global market empowers the organization to manipulate production quotas, continuing its central role in determining oil prices.
