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Organization of Petroleum Exporting countries

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. Organization 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 OPEC was founded in Baghdad, driven by a 1960 law instituted by American President Dwight Eisenhower that forced quotas on Venezuelan and Persian Gulf oil imports in favor of the Canadian and Mexican oil industries. Eisenhower gave reasons of national security and land access to energy supplies at times of war. When this led to falling prices for oil in these regions, Venezuela's president Romulo Betancourt reacted by seeking a cooperation with oil producing Arab nations as a main strategy to maintain the continued autonomy and profitability of Venezuela's oil resources Thus the Organization of the Petroleum Exporting Countries (OPEC) was formed and now it is a cartel of twelve developing countries. The Organization of Petroleum Exporting countries is a permanent intergovernmental, created at Baghdad conference on September 10-14, 1960 by Iran, Kuwait, Saudi Arabia and Venezuela. The five founding members were later joined by other nine countries Qatar (1961), Indonesia (1962) suspends its membership from January 2009; Libya (1962), United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973) suspended its membership from December 1992 October 2007., Angola (2007), and Gabon (1975-1994). OPEC has its headquarters in Geneva, Switzerland, in the first five years of its existence. This was moved to Vienna, Austria, on September 1, 1965.

History: 1960s: These were OPECs formative years, with the Organization, which had started life as a group of five oil-producing, developing countries, seeking to assert its Member Countries legitimate rights in an international oil market dominated by the Seven Sisters multinational companies. Activities were generally of a low-profile nature, as OPEC set out its objectives, established its Secretariat, which moved from Geneva to Vienna in 1965, adopted resolutions and engaged in negotiations with the companies. Membership grew to ten during the decade.

1970s: OPEC rose to international prominence during this decade, as its Member Countries took control of their domestic petroleum industries and acquired a major say in the pricing of crude oil on world markets. There were two oil pricing crises, triggered by the Arab oil embargo in 1973 and the outbreak of the Iranian Revolution in 1979, but fed by fundamental imbalances in the market; both resulted in oil prices rising steeply. The first Summit of OPEC Sovereigns and Heads of State were held in Algiers in March 1975. OPEC acquired its 11th and final current Member, Nigeria, in 1971.

1980s: Prices peaked at the beginning of the decade, before beginning a dramatic decline, which culminated in a collapse in 1986 the third oil pricing crisis. Prices rallied in the final years of the decade, without approaching the high levels of the early-1980s, as awareness grew of the need for joint action among oil producers if market stability with reasonable prices was to be achieved in the future. Environmental issues began to appear on the international agenda.

1990s: A fourth pricing crisis was averted at the beginning of the decade, on the outbreak of hostilities in the Middle East, when a sudden steep rise in prices on panic-stricken markets was moderated by output increases from OPEC Members. Prices then remained relatively stable until 1998, when there was a collapse, in the wake of the economic downturn in South-East Asia. Collective action by OPEC and some leading non-OPEC producers brought about a recovery. As the decade

ended, there was a spate of mega-mergers among the major international oil companies in an industry that was experiencing major technological advances. For most of the 1990s, the ongoing international climate change negotiations threatened heavy decreases in future oil demand.

2000s: An innovative OPEC oil price band mechanism helped strengthen and stabilize crude prices in the early years of the decade. But a combination of market forces, speculation and other factors transformed the situation in 2004, pushing up prices and increasing volatility ina well-supplied crude market. Oil was used increasingly as an asset class. Prices soared to record levels in mid2008, before collapsing in the emerging global financial turmoil and economic recession. OPEC became prominent in supporting the oil sector, as a part of global efforts to address the economic crisis. OPECs second and third summits in Caracas and Riyadh in 2000 and 2007 established stable energy market, sustainable development and the environment as three guiding themes, and it adopted a comprehensive long-term strategy in 2005. One country joined OPEC, another reactivated its membership and a third suspended it.

Objectives of OPEC: 1. To coordinate & unify the petroleum policies of the member countries and to determine the best mean for safeguarding their individual and collective interests.

2. To seek ways and means of ensuring the stabilization of prices in international oil markets, with a view of eliminating harmful and unnecessary fluctuation; and

3. To provide an efficient, economic and regular supply of crude oil to consuming nations and a fair return on capital to those investing in the petroleum industry.

Functions of OPEC: The OPEC Member Countries coordinate their oil production policies in order to help stabilize the oil market and to help oil producers achieve a reasonable rate of return on their investments. This policy is also designed to ensure that oil consumers continue to receive stable supplies of oil. The Ministers of energy and hydrocarbon affairs meet twice a year to review the status of the international oil market and the forecasts for the future in order to agree upon appropriate actions which will promote stability in the oil market. The Member Countries also hold other meetings at various levels of interest, including meetings of petroleum and economic experts, country representatives and special purpose bodies such as committees to address environmental affairs. Decisions about matching oil production to expected demand are taken at the Meeting of the OPEC Conference. Details of such decisions are communicated in the form of OPEC Press Releases. The OPEC Secretariat is a permanent inter-governmental body. The Secretariat which has been based in Vienna since 1965 provides research and administrative support to the MCs. The Secretariat also disseminates news and information to the World at large. The official language of the Secretariat is English, official Currency is USD per barrel of oil. Additional functions include: Printing publications, Special Events, Communications, Organizing Conferences, Ceremonies and Visitor Functions, Press and Media Relations Press Releases, Press Inquiries, Clearances, Evaluation, Strategic Planning.

OPECS Mission: The mission of OPEC is 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 consumers, a steady income to producers and a return on capital to those investing in the petroleum industry.

The Governing Bodies: OPEC Secretariat: The OPEC Secretariat is the executive organ of the Organization of Petroleum Exporting countries, located in Vienna; it also functions as the headquarters of the organization, in accordance with the provisions of OPEC statue. It is responsible for the implementation of all the resources passed by the conference and carries out all the decisions made by the Board of Governors. It also conducts research, the findings of which constitute key inputs in decision making. The secretariat consist of the secretary general who is the organizations chief executive officer, as well as such staff that may be required by the organizations operations. It further consist of the office of the secretary general, the legal office, the research division, and support service division. The research division comprises Data service, petroleum studies, and energy studies department. The support services division includes Public relations & Informations, Finance and Human Resource department, Administration and IT services department. The Secretariat was originally established in 1961, in Geneva, Switzerland. In April 1965, the 8th OPEC conference approved the host agreement with the government of Austria, effectively shifting the organizations headquarters to Vienna on September 1, 1995.

The Secretary general: The secretary general is the legal authorized person of the organization and chief Executive of the Secretariat. In this capacity, he administers the affairs of the organization in accordance with the directions of Board of Governors. The conference appoints the Secretary General for a period of three years, which may be renewed once for the same period. This appointment takes place upon nomination by the member countries. The Secretary General is assisted in the discharge of his duties by a team of officers and staff including two directors responsible for the research division and support services divisions, six heads of department, the General Legal Council, Head of the Office of the Secretary General,

and the internal auditor who independently ascertains weather the ongoing processes for controlling financial and administrative operations at the Secretariat are adequately designed and functioning in an effective manner.

OPEC Organizational Structure: -

Members of OPEC: OPEC has twelve third member countries, six in the Middle East, four in Africa, and two in South America. Current Members: Algeria Angola Ecuador Iran Iraq Kuwait Libya Nigeria Qatar Saudi Arabia United Arab Emirates Venezuela

Former members: Gabon Indonesia

The United States was a de facto member during its formal occupation of Iraq via the Coalition Provisional Authority. Indonesia left OPEC in 2008 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. The country's growing dependence on imports is proving increasingly expensive as global prices soar.

OPECs Crude oil reserves: -

According to current estimates, more than 81% of the world proven oil reserves are located in OPEC member countries, with the bulk of OPEC oil reserves in the Middle East, amounting to 66% of the OPEC total. OPEC member courtiers have made significant additions to their oil reserves in recent years, for example, by adopting best practices in the industry, realizing intensive explorations and enhancing recoveries. As a result, OPECs proven oil reserves currently stand at 1,200.83 billion barrels.

OPECs Crude Basket/ Reference 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 $102.16 a barrel on Monday, April 7, 2014

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OPEC downstream capacity: -

While overcapacity in the refining sector persists globally, the prospect for demand increases in developing countries is attracting investor interest in building new capacity. This is particularly apparent in Asia, followed by the Middle East and Latin America where incentives from demand increases are combined with an emerging trend among crude producers to refine heavier crude domestically. Indeed, a recent review of existing refinery projects indicates that around 7.5 million b/d of new distillation capacity will be added to the global refining sector over the period of 2011-2015, of which almost 50% will materialize in the Asia-Pacific and another 30% in the Middle East and Latin America. A significant number of these new investments will occur in OPEC member countries. By 2015, compared to the refining capacity available at the end of 2010, the assessed investments result in 2 million b/d in condensate plants within the national borders. Thus, by 2015, OPEC member countries have over 11 million b/d of downstream capacity. Moreover, substantial investments are also underway as part of equity shares in refining outside of national borders.

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OPEC Fund for International Development (OFID)

Figure 14: OFID Logo

The OPEC Fund for International Development (OFID) is a financial institution established by the Member States of OPEC in 1976 as a collective channel of aid to the developing countries. OFID works in cooperation with developing country partners and the international donor community to stimulate economic growth and alleviate poverty in all disadvantaged regions of the world. It does this by providing financing to build essential infrastructure, strengthen social services delivery and promote productivity, competitiveness and trade. OFIDs work is people centered, focusing on projects that meet basic needs - such as food, energy, clean water and sanitation, healthcare and education with the aim of encouraging self-reliance and inspiring hope for the future. OFID was conceived at the Conference of the Sovereigns and Heads of State of member countries, held in Algiers, Algeria, in March 1975. In this spirit, OFID was established in January 1976 by the then 13 member countries of OPEC. Initially, it was called The OPEC Special Fund. The idea was that OFIDs resources are additional to those already made available by OPEC states through a number of bilateral and multilateral channels.

Aims:

To promote cooperation between OPEC Member Countries and other developing countries as an expression of South-South solidarity. To help particularly the poorer, low-income countries in pursuit of their social and economic advancement.

12 OFID RESOURCES: -

OFIDs resources consist of voluntary contributions made by OPEC Member Countries and the accumulated reserves derived from its various operations. At the close of the year 2011, contributions pledged by the OPEC Member Countries totaled $3,435 million, out of which $2,463 million was direct contributions to OFID. The Reserve Account stood at $3,531 million. Vision: To aspire to a world where Sustainable Development, centered on human capacity-building, is a reality for all. Mission: To foster South-South Partnership with fellow developing countries worldwide with the aim of eradicating poverty. Director General: The current Director General of OFID is Mr. Suleiman Jasir Al-Herbish Mr. Suleiman Jasir Al-Herbish, a Saudi national, has been the Director-General and Chief Executive Officer of the OPEC Fund for International Development (OFID) since November 2003. Mr. Al-Herbish is a long-time supporter of people-centered development, a principle he has kept at the heart of OFID throughout his stewardship of the institution. He has been especially vocal on the issue of energy poverty alleviation, a cause he has championed tirelessly at the highest level and one that forms the central pillar of OFIDs latest lending program (201113). Since assuming office, Mr. Al-Herbish has led numerous initiatives to make OFIDs work more relevant and efficient, including the broadening of financing mechanisms and the strengthening of cooperation with other development organizations. In 2010, he oversaw the conclusion of milestone partnership agreements with the World Bank Group, the Andean Development Corporation and the International Fund for Agricultural Development, and in May 2011, with the Asian Development Bank. Mr. Al-Herbish has also driven institutional change at OFID, particularly in the areas of human resource development and corporate communications, the latter with a view to increasing recognition and understanding of OFID in both its Partner and Member Countries as well as within the wider development community. Mr. Al-Herbish holds a BA in Economics and Political Science from the University of Cairo and an MA in Economics from Trinity University, San Antonio, Texas. Prior to his appointment at OFID, he served for 13 years as the Governor of Saudi Arabia at OPEC. He is currently in his second term of office at OFID, having been re-elected unanimously by the institutions highest authority, the Ministerial Council, in June 2008.

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Headquarters: - It has its headquarters at Vienna.

Member countries: 1) Algeria 2) Gabon 3) Indonesia 4) Iran, IR of 5) Iraq 6) Kuwait 7) Libya 8) Nigeria 9) Qatar 10) Saudi Arabia 11) United Arab Emirates 12) Venezuela, BR of

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Adjusting the Production quotas:

Today, after OPEC has experienced a rapid dwindling of oil prices, it can confine its members within production limits and somehow make up for poor prices. However, production cuts in the absence of a price target will prove to be futile. The success of a production adjustment plan is subject to the design of a mechanism that would reconcile production policies and price targets. How can OPEC concentrate its efforts on maintaining control over production and stabilize the market? The response to this question would be possible if one takes a glance at the recent history of this Organization. In its 109th ordinary meeting in March 2000, OPEC unofficially introduced its price band mechanism to the market. Within this mechanism, in the case of the average OPEC Basket crude price falling under $22/B for more than 10 successive working days, OPEC member states would be obligated to cut their daily production by 500,000 b/d, and in the case of the price exceeding $28/B for 20 successive working days, OPEC would increase production by 500,000 b/d. Although OPEC took advantage of this mechanism only once, increasing production by 500,000 b/d beginning on 31 October 2000, and gave up the whole idea in January 2005, introduction of this mechanism affected the market psychologically and stabilized prices during the period that OPEC was not inclined to change prices beyond specific limits. OPEC can revive this mechanism under the present circumstances. Concurrent with OPECs 150th meeting, the President of Venezuela declared that the organization should specify oil prices within the price region of $70/B, $80/B or even $90/B. These statements revealed that at least some OPEC member states are well prepared to utilize this mechanism, which is not intended to rule out market fluctuations; rather it is meant to preserve a price average within a specific band. Should OPEC member states wish to restore a price band mechanism, they are recommended to introduce the following amendments: A price target should be defined by making use of the OPEC Basket price within a band that would make investment in the oil industry attractive. A period of one month should be specified for the calculation of the price average. The production adjustment date should be prior to the regulation of oil loading programs by the member states. The specified price band and production changes should be observed and adhered to by all.

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The scope of price band should not be very extensive; otherwise it would make no sense to implement such a band. Within the mechanism, decision making should be activated automatically and communicated to the member states by the OPEC Secretary General or President.

OPEC Working:

Fossil fuels, such as oil, gas and coal, provide ninety-two percent of the world energy resources with sixty-five percent of the worlds known oil reserves being in the Middle East. Half of that oil in the countries of Saudi Arabia and Kuwait. This is how OPEC works: each member country selects representatives. These representatives choose a governor for their country. These governors go to the two OPEC meetings every year and they also choose the OPEC chairman. All decisions are to be unanimous As stated in the OPEC Statutes, the main objective is to set prices of oil and oil products and keep the price and supply stable with fair returns to the investors To increase the price of oil or oil products, OPEC decreases production. This makes oil harder to find on the market, so countries end up paying more to get the hard to find oil. To decrease the price of oil or oil products OPEC increases production. This makes oil easier to find, so countries end up paying less for the abundant oil. The increase or decreases of oil prices are used for many other things than just making money. The change in oil prices is used for political reasons to get support for the region or for help from larger countries and for elections of public officials. In 1970, Libyas leader, Quadaffi, used OPECs influence to put pressure on the other independent Middle Eastern states by cutting its supplies and thus increasing the asking price per barrel. Even though Libya was not working within the OPEC pact, it did lead to the OPEC decision to press for price increases and raised the tax on oil company incomes. But in the 1990, there was a real oil shortage caused by the Persian Gulf Crisis. Oil production abruptly stopped during the crisis, and once again, oil prices quickly rose. The Persian Gulf Crisis began in, May 1990. Saddam Hussein, President of Iraq, accused Kuwait of reducing the price of oil lower that OPECs agreed price. Hussein also accused Kuwait of secretly drilling into Iraqi oil fields. Husseins troops invaded Kuwait, destroying its oil fields, in the hopes of gaining control of the entire Persian Gulf region. Hussein did not count on the other Arab nations coming to Kuwaits

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defense, but they did, along with the United States, Britain, France, Italy, Egypt and Syria. During Operation Desert Storm, Iraq was bombed steadily for 40 days and then on, February 24, 1991, after a 100 hour ground attack, the Gulf War was over. In response to the crisis, OPEC immediately increased supplies from fields not affected by the Iraq-Kuwait crisis. This resulted in the stabilization of prices. Future trends in OPECs power will depend on three factors; the oil needs of OPEC, the oil usage of the worlds main consumers and the prevalence of alternative energy sources. At the current rate of production and usage, OPEC has approximately eighty years worth of reserves left. Therefore, OPEC will remain a vital part of global energy decisions for the foreseeable future. But the future does hold some bad things for OPEC. This is because renewable energy usage will increase and the world will improve its energy efficiency that will decrease the worlds dependency on Middle Eastern oil. These changes will take many years, so OPEC will be around for a long while longer.

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OPECs position in trading spot and oil future: 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. 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 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 (IEA) of Paris and

US Energy Information Administration (EIA) are also important players. The spot and future trading in these affect the oil prices.

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Even though today OPEC is not entirely responsible for oil prices, OPEC member countries do voluntarily restrain their crude oil 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.

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Impact of OPEC on world Crude oil prices

After the financial crisis in 1998, oil price has kept the rising trends all through. Both developed and developing countries have suffered from it. In response to the oil crisis, many researches were carried on the factors influencing on the oil price. Oil is an exhaustible resource and it is often argued that the price dynamic is affected by scarcity issues. Since OPEC was positioned as an important force in the world oil market for the two oil shocks in 1970s, a lot of studies have dealt with the movements of the oil price which result from an oil market more or less dominated by OPEC. Since the 1973 oil price shock, the history and behavior of the Organization of Petroleum Exporting Countries (OPEC) have received considerable attention both in the academic literature and in the media. Many conflicting theoretical and empirical interpretations about the nature of OPEC and its influence on world oil markets have been proposed. The debate is not centered on whether OPEC restricts output, but the reasons behind these restrictions. Some studies emphasize that production decisions are made with reference to budgetary needs which in turn depend on the absorptive capacity of the domestic economies. Others explain production cuts in the 1970s in terms of the transfer of property rights from international oil companies to governments which tend to have lower discount rates. Others explain output restrictions in terms of coordinated actions of OPEC members. As in any other issue related to OPEC, there are divergent views regarding its pricing power. More importantly, there seem to be switches in perceptions shifting from one end where OPEC is perceived to play no role or a very limited role to the other where it is perceived to be a pricesetter. These switches in perception became very apparent in the events that surrounded the oil price collapse in 1998 and the oil price hike in 2004. In 1998, when the Dubai price approached $10 per barrel, many observers claimed that OPEC had lost its ability to defend oil prices with many observers predicting its demise. This view of an ineffective OPEC was however reversed only a few months later with many observers in the media considering the events of 1997 as inducing great cooperation among members and ushering in a new era. During March 1998 and March 1999, OPEC embarked on two production cuts in an attempt to put an end to the slide in oil prices. These production cuts were implemented with a high level of cohesiveness among members, contradicting the view that OPEC is not able to implement cuts. In the high oil price environment of 2004, there was another switch in perception were doubts re-emerged about OPECs pricing power. But unlike, the events surrounded in 1998, the loss of pricing power was mainly attributed to OPECs loss of excess capacity.

The events of the last few years highlight some important observations that are essential to understanding OPEC behavior. First, OPECs pricing power is not constant, but varies over time. There are many instances in which the organization can lose power to influence oil prices.

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Second, this change in pricing power is induced by market conditions and can occur both in weak and tight market conditions. This does not imply that market participants can afford to ignore OPEC. In fact, OPEC has succeeded in many instances in implementing production cuts to prevent declines in oil prices. Also OPEC (and, more specifically, Saudi Arabia) has succeeded in offsetting the impact of sudden disruptions of supply and in moderating the rise in oil prices. Third, pursuing output polices has become more complicated with the growing importance of the futures market in the process of oil price discovery. The effectiveness of any policy depends to a large extent on the ability of OPEC to influence participants expectations in the futures market (Fattouh, 2006). Finally, long-term investment plans can have important implications for OPECs continuing pricing power. Many international organizations such as the International Energy Agency (IEA) and Energy Information Administration (EIA) project greater reliance on Middle Eastern oil in the next two decades and hence they predict a distinct increase in the market share of Middle Eastern oil exporters. This is seen to have the effect of automatically increasing OPECs market power. However, we argue that OPEC may not have the incentive to invest. Even if member countries decide to invest, there are serious bottlenecks that may prevent this investment from taking place. Finally, even if the investment does materialize and OPEC market share rises markedly, its ability to influence prices does not automatically follow. At first sight, it may seem that OPEC plays a very limited role in the formation of oil prices. OPEC countries, like other oil exporters, just take the marker price from the spot market (and, more recently, from the futures market) and plug it in the pricing formula to arrive at the price at which they sell their oil. But this simple description does not provide a realistic portrayal of OPECs role in price formation. By changing production quotas, the organization and its dominant player Saudi Arabia are bound to have an influence on oil prices. OPEC sets production quotas based on its assessment of the markets call on its supply. Oil prices fluctuate in part according to how well OPEC performs this calculation. Through the process of adjusting its production quotas, OPEC can only hope to influence price movements towards a target level or target zone. In a supply demand framework, the oil price is determined by OPEC and non-OPEC supplies as well as oil arriving to the market from OPEC members who do not abide by the assigned quotas. Since these supplies cannot be predicted with accuracy and are influenced by factors other than prices, OPEC can only hope that the resulting oil price is close to its preferred price.

From a very different perspective which emphasizes the bureaucratic nature of OPEC, Smith (2005) argues that OPEC acts a bureaucratic cartel; i.e. a cooperative enterprise weighed down by the cost of forging consensus among members and therefore partially impaired in pursuit of the common good. Achieving the desired price level to acquire more revenues has become more difficult in the current context in which prices are increasingly being determined in

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the futures market. OPECs influence on prices is now dependent on the expectations of participants in the futures markets. In principle, quota decisions can be viewed as signals to the market about OPECs preferred range of prices. It is important to stress that this signaling mechanism may or may not succeed, depending on how the market interprets these signals. Specifically, the effectiveness of the signal will depend on whether the market believes that OPEC is able to undertake the necessary output adjustment in different market conditions. Although OPEC has on many occasions succeeded in defending the oil price, adjusting output downward has sometimes proven to be unsuccessful. If global demand for oil falls, non-OPEC suppliers will continue to produce at their maximum potential. In their attempt to defend a target price, OPEC members would call for production cuts. However, because of the different features, needs and bargaining power and the divergent interests of member countries, OPEC cannot usually reach agreements on allocation of production cuts. Even when agreements are reached, each member has the incentive to go against these decisions. Because of the absence of a monitoring mechanism, these violations are not usually detected and even if they are, the organization does not have the power to punish and force member countries to abide by the agreed production cuts. These problems become more acute when the required cuts are significant as the small OPEC members usually find it difficult to reduce their production on a pro-rata basis: the usual system adopted by OPEC over the years. In these circumstances, market participants would doubt the credibility of OPECs decision to cut production and may decide to ignore the signal. This is particularly true if there are deep divisions and political rivalries among member countries which will jeopardize the success of any coordination efforts. Lack of transparency about the decision-making processes and lack of information about production and investment reduces the credibility of the signal.

The Dependence on Middle Eastern oil and the Pricing Power Many international organizations such as the IEA and EIA projected that most of the increase in global demand for oil would be met by OPEC, especially Middle Eastern producers within OPEC which implies greater reliance on Middle Eastern oil. This would require that oil exporters increase their investment outlays or open their oil and gas sectors to foreign investment. In an exercise which focuses on Middle East and North Africa (MENA) oil and gas resources, the IEA (2010) projects in the reference scenario a rise in MENA oil production from the 2004 level of 29 mbd to 33 mbd in 2010 and 50 mbd in 2030. In this scenario, Saudi Arabia will remain the largest supplier increasing its output from 10.4 mbd in 2004 to 11.9 mbd in 2010 and over 18 mbd in 2030. A second important player would be Iraq, which is expected to witness the second fastest production growth after Saudi Arabia. The IEA envisages that MENAs share of world oil production would increase from 35% in 2004 to 44% in 2030 with four countries (Iraq, Kuwait, the UAE and Libya) increasing their share. However, the IEA warns that this requires doubling of annual upstream investment in MENA which it is not certain will take place because MENA governments could choose deliberately to develop production capacity more slowlyor external factors such as capital shortages could prevent producers from investing as much in expanding capacity as they would like. The IEA claims that MENA producers would lose out by not making these investment commitments because higher revenues owing to a rise in oil prices would not compensate for the loss in revenue owing to lower export volumes.

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Such developments would have important implications for oil prices and OPECs pricing power. First, low investment in OPEC, especially in the large Middle Eastern exporters within OPEC, can lead to sharp rises and more volatile oil prices. Second, these scenarios predict that the OPECs share in the global oil market would rise drastically. Third, the above implies a reduction in the elasticity of supply outside core producers such that there will be a smaller supply response from non-OPEC to rises in oil prices. The last two factors may have important implications on pricing power depending on the OPEC model used. For instance, in the dominant firm model, OPECs power depends on the elasticity of world demand for oil, the elasticity of the supply of the competitive fringe and OPECs share in the world market. With predictions of increasing market share, lower non-OPEC supply elasticity and more inelastic global oil demand, the model implies a greater OPEC pricing power.

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The Role of Saudi Arabia (The Biggest OPEC Player)

Some observers anticipated that the re-emergence of Russia and Iraq as significant oil exporters would undermine Saudi Arabias prominent role in the oil markets. These views, however, proved premature and there is little doubt nowadays that Saudi Arabia is likely to remain a prominent player within OPEC and in the oil market at least for the foreseeable future. Furthermore, Saudi Aramco, Saudi Arabias national oil company, has been investing heavily in upstream oil with the aim of increasing the Kingdoms capacity. In 2004, Saudi Arabia completed two mega projects, Qatif and Safah, with estimated gross production of 500,000 bd and 150,000 bd in 2004. In 2006, Saudi Aramco brought on stream its Haradah III crude oil project two months ahead of schedule. The project is expected to produce around 300,000 bd of Arab light crude at its peak. This expansion push is likely to continue for the next few years. Saudi Aramco has started an on stream project the AFK project in 2007 with an estimated gross production of 500,000 bd of Arab light. In 2008, the Shaybah (Phase 1) and Nuayyim fields had been started and the projects will come on stream with an estimated gross addition of 250,000 bd and 100,000 bd respectively. The largest increment of production is expected to come from the Khurais field, scheduled for completion in 2009. The gross addition from Khurais is estimated to reach massive 1.2 mbd. According to Saudi Arabias official oil policy, the reasons for embarking on such rapid expansion are twofold: to maintain a back-up capacity and to enhance the stability of the world oil market. Regarding the latter objective, it is important to note that stabilizing the world oil market (the fourth pillar of Saudi Arabias oil policy) does not mean that Saudi Arabia prefers or wants low oil prices. In this respect, it is important to make a distinction between price takers and price makers within OPEC. The price taker is a small producer with little influence on price while the latter has market power and can influence the price by individual actions. As argued by Mabro (2003), the role of the price maker is to set the price not to express, in an unconstrained manner, views about its level. The view he is obliged to take will have much to do with what can be achieved, not with what one can dream about in an idealized world divorced from reality. We have, therefore, on the one hand the price-takers, who have the freedom to dream and no power to act, and the price-maker who has the unenviable task to bring the dream within the confines of real economic and political conditions. The feasible price, in most circumstances, is likely to be lower than the one price-takers talk about and would like to have. In these situations the price-maker will always appear to be a moderate. This does not necessarily characterize his ideal preferences it does certainly not mean that low prices are an objective of policy. The aim of maintaining back up capacity is to preserve Saudi Arabias leadership in international oil markets. This leadership depends on managing and maintaining excess capacity without which it ceases to become a price maker. A widely held view in the literature is that Saudi Arabia has assumed the role of a swing producer in many occasions. Because of its excess capacity, Saudi Arabia can swing its production depending on the residual demand it faces which in turn depends on global demand for oil and the supply of the fringe producers. In fact, Libecap

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and Smith (2004) consider that it is this special role of Saudi Arabia that has kept OPEC afloat all these years. Saudi Arabia has played the role of a discipliner who, from time to time, punishes members exceeding their quotas by flooding the oil market and reducing the price (Griffen and Neilson, 1994; Soligo and Jaffe, 2006). For instance, Griffin and Neilson (1994) find evidence that Saudi opted for a tit-for-tat strategy that punishes some members and rewards others. Specifically, as long as Saudi Arabia earns more than Cournot profits, it will be willing to tolerate deviations. However, if cheating goes too far, the swing producer will punish the cheaters by increasing its production until everybody gets Cournot profits. The adherents of this view refer to two examples from recent years: in 1985 when Saudi Arabia boosted its supply in an attempt to increase market share and in 1998 when Venezuela embarked on a policy of increasing production and rapid capacity expansion. In both cases, it is argued that Saudi Arabia played the role of discipliner, important to maintain the cohesiveness of OPEC especially in the absence of a formal disciplinary mechanism within the organization. Regardless of the nature of its role, given the Kingdoms dominant position in reserves, production and excess capacity, Saudi Arabias actions are bound to influence oil prices. However, it is important to stress the following points. First, in a slack market, Saudi Arabia could be left with a huge surplus capacity, a situation which it tries to avoid but cannot escape if concerned about the price level. Second, although the target set by Saudi Arabia could be achieved, the planned spare capacity of 2 mbd is very thin for a system as big and complex as the world petroleum system. In any case, the rise in capacity may be absorbed by rising demand and falling supply outside Saudi Arabia. Thus, unexpected events can cause an erosion of excess capacity in which case Saudi Arabia will cease to act as a price maker. Third, the notion that Saudi Arabia will always have the incentive to maintain spare capacity should be critically examined. Recently, Saudi Arabia has been raising the issue of whether it should bear on its own the costs of maintaining spare capacity. It is obvious that the international oil order where nonOPEC supplies much of the incremental global oil demand and Saudi Arabia provides the capacity cushion may no longer be viable in the future.

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Impact of IRAN on world Oil prices

Oil reserves in Iran, according to its government, rank third largest in the world at approximately 150 billion barrels as of 2007. This is roughly 10% of the world's total proven petroleum reserves. Iran is the world's fourth largest oil producer and is OPEC's second-largest producer after Saudi Arabia. As of 2009 it was producing an estimated 4.172 million barrels per day of crude oil. At 2006 rates of production, Iran's oil reserves would last 98 years if no new oil was found. Iran has more than a century of history in exploration and production activities; the first successful exploration well was Masjid Suleiman-1 on May 26, 1908. Since then, based on the latest oil and gas reports, 145 hydrocarbon fields and 297 oil and gas reservoirs have been discovered in Iran, with many fields having multiple pay zones. A total of 102 fields are oil and the remaining 43 are gas, and there are 205 oil reservoirs and 92 natural gas reservoirs. According to Iran Energy Balance Sheet (2009, in Persian), 78 of these fields are currently active, with 62 onshore and 16 offshore, leaving 67 fields inactive at present. Some 23 hydrocarbon fields lie in border areas and are shared between Iran and adjacent countries, including Kuwait, Iraq, Qatar, Bahrain, UAE, Saudi Arabia and Turkmenistan. According to Oil & Gas Journal, as of January 2011, Iran has an estimated 137 billion barrels of proven oil reserves, 9.3 percent of the world's total reserves and over 12 percent of OPEC reserves. In July 2011, OPEC released its 2010 Annual Statistical Bulletin which raised Iran's proven reserves to more than 151 billion barrels of crude. Some analysts are skeptical of this estimate, however, as Iran revised its reserves a week after Iraq had revised its own, leading some to speculate the move was political. Over 50 percent of reserves are confined to six supergiant fields. Of those onshore reserves, 85 percent are located in the southwestern Khuzestan Basin near the Iraqi border. Iran's crude oil is generally medium in sulfur content and in the 28-35 API range. Iran faces continued depletion of its production capacity, as its fields have relatively high natural decline rates (8-13 percent), coupled with an already low recovery rate of around 20-30 percent. Sanctions and prohibitive contractual terms have impeded the necessary investment to halt this decline. In 1979 and 1980, events in Iran and Iraq led to another round of crude oil price increases. The Iranian revolution resulted in the loss of 2.0-2.5 million barrels per day of oil production between November 1978 and June 1979. At one point production almost halted. The Iranian revolution was the proximate cause of the highest price in post-WWII history. However, revolution's impact on prices would have been limited and of relatively short duration had it not been for subsequent events. In fact, shortly after the revolution, Iranian production was up to four million barrels per day. In September 1980, Iran already weakened by the revolution was invaded by Iraq. By November, the combined production of both countries was only a million barrels per day. It was down 6.5 million

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barrels per day from a year before. As a consequence, worldwide crude oil production was 10 percent lower than in 1979. The loss of production from the combined effects of the Iranian revolution and the Iraq-Iran War caused crude oil prices to more than double. The nominal price went from $14 in 1978 to $35 per barrel in 1981. Over three decades later Iran's production is only two-thirds of the level reached under the government of Reza Pahlavi, the former Shah of Iran. Iraq's production is now increasing, but remains a million barrels below its peak before the Iraq-Iran War. In 2010, Iran exported approximately 2.2 million bbl/d of crude oil. Iranian Heavy Crude Oil is Iran's largest crude export followed by Iranian Light. In 2010, Iran's net oil export revenues amounted to approximately $73 billion. Oil exports provide half of Iran's government revenues, while crude oil and its derivatives account for nearly 80 percent of Iran's total exports.

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Impact of Kuwait on crude oil prices

Kuwait is a member of the Organization of Petroleum Exporting Countries (OPEC), exporting the fourth largest volume of oil among the group in 2010. At the same time, Kuwait's economy is one heavily dependent on petroleum export revenues, which account for half of its overall gross domestic product (GDP), 95 percent of total export earnings, and 95 percent of government revenues. Kuwait has an active sovereign-wealth fund, the Kuwait Investment Authority, which oversees all state expenditures and international investments. Kuwait also allocates 10 percent of its state revenues into the Reserve Fund for Future Generations (RFFG), for the day when oil income starts to decline. According to Oil & Gas Journal, as of January 2011, Kuwait's territorial boundaries contained an estimated 101.5 billion barrels (bbl) of proven oil reserves, roughly 7 percent of the world total. Additional reserves are held in the Partitioned Neutral Zone (aka Divided Zone), which Kuwait shares on a 50-50 basis with Saudi Arabia. The Neutral Zone holds an additional 5 billion barrels of proven reserves, bringing Kuwait's total oil reserves to 104 billion barrels. These reserve estimates have been openly questioned by some analysts and a number of Kuwaiti parliamentarians, with some putting reserves as low as 48 billion barrels. Kuwaiti exports of total oil amounted to some 1.8 million bbl/d, of which 1.7 million bbl/d was crude oil. Most Kuwaiti crude oil is sold on term contracts. Kuwait's crude exports are all a single blend of all its crude types. The largest proportion is the lighter Burgan crude, which is blended with heavier, sourer crude from northern fields, as well as marginal amounts from Minagish and Umm Gudair. Kuwait's single export blend ("Kuwait Export") has a specific gravity of 31.4API (a typical medium Mideast crude), and is generally considered sour, with 2.52 percent sulfur content. In 2010, the Asia-Pacific region received approximately 1.4 million bbl/d, while exports to the United States totaled 196,000 bbl/d, and Western Europe received around 100,000 bbl/d. With the majority of its export volumes headed to Asian markets, the most significant benchmark for Kuwaiti exports is the Oman-Dubai, to which it sells at a slight discount. As of the beginning of 2010, the price of Kuwaiti crude oil for American customers was tied to the Argus Sour Crude Index (ASCI), a weighted average of various North American medium, sour crudes. European buyers purchase from a benchmark linked between a Brent weighted-average and Saudi Arab Medium. Mina al-Ahmadi is the country's main port for the export of crude oil. Kuwait also has operational oil export terminals at Mina Abdullah, Shuaiba, and at Mina Saud, otherwise known as Mina al-Zour. To handle increased production generated by Iraq and the northern fields, a new terminal is planned for construction on Bubiyan Island.

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Kuwait consumes only a small portion of its total petroleum production. The country consumed a total of 3, 25,000bbl/d in 2010, leaving the vast majority of its production available for exports. While domestic consumption has been steadily increasing, partly as a result of increased petroleum-fired electricity consumption, about 87 percent was slated for exports last year and forecasts indicate that this trend will continue in the near term.

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Impact of Iraq on crude oil prices

Iraq was the worlds 12th largest oil producer in 2009, and has the worlds fourth largest proven petroleum reserves after Saudi Arabia, Canada, and Iran. Just a fraction of Iraqs known fields are in development, and Iraq may be one of the few places left where vast reserves, proven and unknown, have barely been exploited. Iraqs energy sector is heavily based upon oil, with approximately 94 percent of its energy needs met with petroleum. In addition, crude oil export revenues accounted for over two-thirds of GDP in 2009. Iraqs oil sector has suffered over the past several decades from sanctions and wars, and its oil infrastructure is in need of modernization and investment. As of June 30, 2010, the United States had allocated$2.05 billion to the Iraqi oil and gas sector to begin this modernization, but ended its direct involvement as of the first quarter of 2008. According to reports by various U.S. government agencies, multilateral institutions and other international organizations, long-term Iraq reconstruction costs could reach $100 billion or higher. The proposed Hydrocarbons Law, which governs oil contracting and regulation, has been under review in the Council of Ministers since October 26, 2008, but has not received final passage. According to the Oil and Gas Journal, Iraqs proven oil reserves are 115 billion barrels, although these statistics have not been revised since 2001 and are largely based on 2-D seismic data from nearly three decades ago. Geologists and consultants have estimated that relatively unexplored territory in the western and southern deserts may contain an estimated additional 45 to 100 billion barrels (bbls) of recoverable oil. Iraqi Oil Minister Hussain al-Shahristani said that Iraq is re-evaluating its estimate of proven oil reserves, and expects to revise them upwards. A major challenge to Iraqs development of the oil sector is that resources are not evenly divided across sectarian-demographic lines. Most known hydrocarbon resources are concentrated in the Shiite areas of the south and the ethnically Kurdish north, with few resources in control of the Sunni minority. The majority of the known oil and gas reserves in Iraq form a belt that runs along the eastern edge of the country. Iraq has 9 fields that are considered super giants (over 5 billion bbls) as well as 22 known giant fields (over 1 billion bbls). According to independent consultants, the cluster of super-giant fields of southeastern Iraq forms the largest known concentration of such fields in the world and accounts for 70 to 80 percent of the countrys proven oil reserves. An estimated 20 percent of oil reserves are in the north of Iraq, near Kirkuk, Mosul and Khanaqin. Iraq exported 1.8 million bbl/d of crude oil in 2009. About 1.5 million bbl/d of this came from Iraqs Persian Gulf ports, with the rest exported via the Iraq-Turkey pipeline in the north. The majority of Iraqi oil exports go to refineries in Asia, especially China, India, and South Korea

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Thus, OPEC has been influencing the price of crude oil to a large extent from past many years. It acts an agency that monitors the world crude oil prices by increasing or decreasing the crude oil production by its member countries. OPEC sets production quotas based on its assessment of the crude oil supply.