BL Oil & Gas History, Economics and Geopolitics OENA8433: Topic 4, Lecture 5: OPEC

1
CRICOS Provider No. 00126G copyright © The University of Western Australia
BL Oil & Gas History, Economics and Geopolitics OENA8433

Topic 4, Lecture 5: OPEC
Dr. Karin Oerlemans
1
Unit Overview
Topic 1: Introduction – The Founders
Topic 2: The Global Struggle
Topic 3: War and Strategy
Topic 4: Oil and Gas Economics
Lecture 1: Fundamentals of Oil and Gas Economics
Lecture 2: Oil Pricing & Petroleum Rents
Lecture 3: Natural Gas Markets & LNG pricing
Lecture 4: Government Revenues and taxation
Lecture 5: OPEC
Topic 5: Oil and Gas Technology in context
Topic 6: The Energy Industry Today
3
Lecture Outcomes
Upon successful completion of this lecture you should be able to:
Describe the history of OPEC’s formation
Describe the peak power of OPEC
Understand its present structure and power
Begin to understand future power possibilities
2
Recommended Reading
Yergin: p519-540, & 748-761, &642-646, 431-449
http://www.opec.org/homepage/frame.htm
Video:
The prize: The epic quest for oil, money and power (video): Episode 6 –
Power to the producers. This episode can be viewed via Google video at
http://video.google.com/videoplay?docid=937395876523762335&hl=en
Lecture Outline
OPEC
History of formation
Fifty/Fifty deal
Setting the scene
OPEC formation
OPEC today
Long term issues facing OPEC
Is OPEC an oligopoly?
6
3
OPEC: History of Formation
Consider the Concession between SOCAL & Saudi Arabia of 1933,
covering an area of 360,000 square miles.
For £55,000
£30,000 Loan
£5,000 1 years advance royalty
Next £20,000 Loan after 18 months
Total loan to be repaid out of forthcoming oil royalties!!!
If Oil discovered
Another loan of £100,000
King Ibn Saud’s short term cash flow problem solved

Oil discovered 5 years later: set off a rush by other companies for
concessions
7

Fast forward to the decades 1950 – 1970
Postwar
Capitalism, consumerism, growth of automobile use, affluence –
drove huge growth in world oil market (demand & supplies)
From 8.7 million bopd to 42 million bopd. (Today?)
Middle East Production

From 1.1 million bopd to 18.2 million bopd
Estimated World Oil Reserves

62 billion barrels to 534 billion barrels
8
4
What were companies getting out of this?
What were producing countries getting?
9

Fifty/Fifty Deal
Chapter 22 p 431-449
Countries wanted more money out of the concessions “to shift the
revenues from the oil companies and the treasuries of the
consuming countries that taxed them to the treasuries of the oil
exporting countries”
How?
Strike better royalty deals?
P432: Bottom paragraph
Host country has sovereignty over the oil beneath its soil.
But has no value until foreign company risks capital & provides
expertise. If oil found, should all increased value go to the
company?
“A rich discovery means a dissatisfied landlord”
10
5
Fifty/Fifty Deal:
First country to work towards a new deal was Venezuela
Royalties & taxes by the host country would be raised to the point at
which the Host Government’s take would about equal the
companies net profits
Deal spread to the Middle East: Saudi Aramco deal of December
1950
What are the company profits?
Companies have control from upstream to downstream
Can write off upstream expenditure & make money downstream
11

Juan Pablo Perez Alfonzo: re-negotiated the 50/50 deal
Government overthrown by military dictatorship 48-1958
Became Minister for Mines & Hydrocarbons in Venezuela in 1958
Believed that oil earnings should be used to advance & develop the
country
Enter Abdullah Tariki in Saudi Arabia “The Red Sheikh”

Head of Directorate of Oil & Mining affairs
An Arab nationalist, a pan-Arab nationalist, a critic of the Saudi Royal
Family
Similar views to Perez Alfonzo
12
6
A 2 price structure had developed in oil markets
An official or posted price (against which royalties were levied)
An unofficial or discounted price as companies sought market share
Therefore companies were hurting, countries getting >50/50
Also, new entrants (Russia)
13

So companies cut the posted price
BP in 1959, Standard Oil followed suit
RESPONSE?
Country sees diminution of revenue

Done without consultation: feel powerless & indignant
14
7
Setting the stage for OPEC
1952 Gamal Abdel Nasser led coup in Egypt
1956 President of the Republic of Egypt
1956 Nasser announced the nationalization of the Suez Canal
1959 Arab Oil Congress met in Cairo
Including Juan Pablo Perez Alfonzo, Minister of Mines and
Hydrocarbons from Venezuela, who wanted a global alliance
Abdullah Tariki, the red sheikh, who wanted control over prices and
production
They met again in Maadi, created a Gentlemen’s Agreement
Would become the Organization of Petroleum Exporting Countries –
OPEC
Juan Pablo Perez Alfonzo Gamal Abdel Nasser Abdullah Tariki

15

OPEC alliance-
The Organization of Petroleum Exporting Countries (OPEC)
Foundation meeting in Baghdad, Sept 1960
Aim: to defend the price of oil, and to control production through
quotas.
Able to do so, as the 5 founding members (Saudi Arabia,
Venezuela, Kuwait, Iraq, Iran) would control over 80% of the world’s
crude oil exports
But new sources were in the wings
16
8
OPEC
The role of OPEC
Its objective is to coordinate and unify petroleum policies among

Member Countries, in order to secure a steady income to the
producing countries; an efficient, economic and regular supply of
petroleum to consuming nations; and a fair return on capital to those
investing in the petroleum industry.
http://www.opec.org
17

THE OIL WEAPON WAS USED IN 1973 against the backdrop of
the Arab/Israeli war
The Arab Oil embargo sent prices from $5.40 to $17 per barrel
18
9
OPEC Today
New sources
Some joined OPEC, others did not
But overall, producing countries obtained more favorable
terms: 50/50 deal was an important deal for all
Today’s OPEC: 13 countries (Algeria, Angola, Ecuador,
Indonesia, the Islamic Republic of Iran, Iraq, Kuwait, the
Socialist People’s Libyan Arab, Jamahiriya, Nigeria, Qatar,
Saudi Arabia, the United Arab Emirates and Venezuela)
The Organization has its headquarters in Vienna, Austria
19
OPEC: Peak Power

OPEC’s Peak Power:
1st Oil Price Shock 1973 (80% of world’s Production)
Earnings by the original 5 countries from $23 billion (1972) to $140
billion (1977)
What was done with the wealth?

See p634,
industrialization, infrastructure, subsidies, services, necessities,
luxuries, weapons, waste, corruption
So the money was spent: good or bad for the World
20
10
OPEC
Saudi Arabia was (& is) the moderate in the pack
No love for Iran
Saudi ‘the swing producer’ :

Able to vary production capacity between 6 to 12 million bopd, to
set price range
Today still the same
Important person was Sheikh Zaki Yamani:

Saudi Arabian Oil Minister
And
Secretary of OPEC
21
Saudi Arabia’s Revenue Needs

The minimum oil price needed by Saudi Arabia, based on expected
expenditures and income in 2003
2003 2002 actual

$bn $bn
Current expenditure 53.3 52.3
Capital expenditure 8.0 7.8
Total expenditure 61.3 60.1
Non-oil income 11.5 11.4

Oil revenues expected 48.3 43.1
Planned deficit -1.5 -5.6
22
11
Saudi Arabia’s Revenue Needs
2003 example:
With Saudi output a 8mbpd (the 2003 average) the minimum

OPEC basket price to cover current expenditure was $22.1/bbl
To cover planned capital expenditure as well needed a basket

price of $27/bbl
Repaying debt at a rate of $2bn per annum needed $27.9/bbl
23
OPEC and Oil Prices: Squaring the Circle

Three considerations:
What Saudi Arabia needs
To pay for essential goods and services and capital expenditure
What consumers need

Global oil demand continues to grow
What is needed to deter non-OPEC producers

OPEC can do very little to shut in existing non-OPEC production,
but it can slow down the discovery and development of new oilfields
to keep the price low
24
12
OPEC’s Vicious Circle
OPEC seeks to
keep prices at its
Higher prices are target level
needed to meet OPEC output is
revenue needs constrained and
because of lower prices rise
output
Oil demand
OPEC loses growth slows and
market share and non-OPEC output
its revenues grows
decline
Oil prices begin to
slip back
25
The Price of OPEC Oil Since 1985
www.abare.gov.au, 2008
www.opec.org, 2008
26
13
Long Term issues facing OPEC
World economic growth expected to slow
Technological improvements to vehicles, such as hybrids and

eventually fuel cells
Increasing competition from natural gas on demand side

(process heat, domestic heating and power source for fuel
cells) and on supply side
Environmental concerns – global warming and pollution
Sustainability – WOO2008
27
Oligopoly or Cartel?
Cartel – a group of firms, suppliers or producers or perhaps even
sovereign states whose goal is to increase their collective profits
by means of an agreement of price fixing, limiting supply with
output quotas or restrictions, bid rigging, market sharing, or other
restrictive practices.
Consumers could be faced with a smaller supply or range of

goods and services at higher prices
OPEC is a registered with the United Nations as an

intergovernmental organisation
28
14
Oligopoly or Cartel?
Oligopoly – situation in which a particular market is controlled
by a small group of firms
The degree of market concentration is very high
Significant entry barriers into the market in the long run which
allows firms to make supernormal profits
Oligopoly firms collaborate to charge the monopoly price and

get monopoly profits
Interdependence – take into account the likely reactions of

other firms in the market when making pricing and investment
decisions
29
In Summary
Question for discussion with your tutor – is OPEC a cartel or an
oligopoly?
15
Lecture Conclusion
This is the end of lecture 1 topic 4
You may now progress to Lecture 2, Topic 4
31
16

BL Oil & Gas History, Economics and Geopolitics OENA8433: Topic 4, Lecture 5: OPEC

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

BL Oil & Gas History, Economics and Geopolitics OENA8433: Topic 4, Lecture 5: OPEC

Uploaded by

Copyright:

Available Formats

1

CRICOS Provider No. 00126G copyright © The University of Western Australia