Going for gold

Fifty years ago this month in Baghdad, five oil-producing nations joined forces to create the Organization of the Petroleum Exporting Countries (OPEC) in order to stabilise prices and safeguard supplies. O&G’s Julian Rogers meets Secretary General Abdalla Salem El-Badri to hear about OPEC’s crucial role in meeting future soaring demand.

Venezuelan diplomat, politician and lawyer Juan Pablo Perez Alfonso travelled by bicycle and read by candlelight to save energy. To an untrained eye, this frugal character would seem an unlikely protagonist behind the inception and creation of OPEC in 1960. After all, this was the man who said "oil will bring us ruin" and described this fossil fuel as the "devil's excrement".  But form OPEC he did, mainly in reaction to pricing and production policies of the major oil companies, along with a band of five founding nations - Iran, Iraq, Kuwait, Saudi Arabia and Venezuela - who accounted for two-thirds of global reserves at the time and supplied the market with five million barrels per day (bpd).

Sceptics never even envisaged the OPEC lasting five years, let alone 50, but the cartel has survived through testing times, including wars, oil embargos, extreme swings in oil prices and a proliferation of oil-producing rivals. Today, OPEC, based in Austria, consists of 12 member countries that produce 40 percent of the world's oil output and house almost 80 percent of proven reserves - more than one trillion barrels. Output is currently 29 million bpd and production capacity reached 35 million bpd in 2009. This organisation has certainly come a long way since Alfonso's time.

Coinciding its 50^th anniversary, or 'golden year' as OPEC is trumpeting the occasion, the organisation has moved into new state-of-the-art headquarters in Vienna, which was where the 156^th Meeting of the Conference between OPEC ministers was held in March. It is at OPEC's new 9000-square metre base that O&G is introduced to the softly spoken Abdalla Salem El-Badri, the Secretary General since 2007. Libyan El-Badri, who is very much the figurehead of the organisation, says OPEC has achieved so much since 1960.

"This year, the Organization celebrates its 50th birthday. During the last 50 years, there have been inevitable ups and downs, but our continued commitment to market stability and the welfare of both Member Countries and the global community has been proved time and again." He adds: "We are now 12 strong - our five Founder Members of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela have been joined by Algeria, Angola, Ecuador, the SP Libyan AJ, Nigeria, Qatar and the United Arab Emirates. Today, the Organization is one of the most influential institutions of its type in the world. Our understanding of the oil market continues to grow and as a result the decisions we take as we strive for oil market stability are even more effective," says El-Badri.

"With today's global economic interdependence and increased environmental awareness, we are faced with a new set of challenges. But our 50th anniversary slogan is 'Supporting Stability, Fuelling Prosperity'. Accordingly, in the years ahead OPEC will continue to work hard for harmony and stability in the international oil market for the benefit of producers, consumers, investors and the global economy at large - whatever the challenge, whatever the obstacle."

Since 1960, oil consumption has rocketed, being the primary fuel for vehicles the world over. And with rising wealth in the BRIC countries (Brazil, Russia, India and China) as well as the Middle East and Africa, car ownership is set to soar. In China alone, car ownership stood at 19 million (one in 70 of the population) but analysts predict this to balloon to 300 million (one in five) by 2030. Despite efforts to reduce our reliance upon black gold, the consensus of opinion is that oil demand is set to soar by 2030 and the MENA region will play a key role in securing crude supplies. Indeed, the Middle East alone accounts for 70 percent of proven reserves and OPEC predicts global demand to swell by 40 percent within the next two decades due to factors such as economic growth, expanding populations and higher standards of living.

With demand for oil and gas set to increase markedly in the coming years, despite improvements in energy efficiency, the Arab world, with its considerable reserves, will play a major role in the future energy scene and will be called upon to help meet this increased demand. But El-Badri believes that the MENA region will be in a position to adequately respond.

"OPEC Member Countries and non-OPEC producers have more than enough oil reserves to meet demand for the foreseeable future," he says. "However, just as consumers need a secure supply of oil, producers need to know that there is a demand for their product. For OPEC Member Countries to invest, they need to be sure that future projections of oil demand are realistic. We need consuming countries to be clear about their forecasts and about their energy-related policies, which often serve only to add confusion to energy outlook. Despite this, all Member Countries are investing heavily in new projects, as I have already explained. Combined OPEC Member Country spare capacity already stands at more than 6 million b/d and is expected to reach 7 million b/d by 2014. We are serious about our quest for oil market stability," says El-Badri sternly.

However, OPEC is uncertain about pressures on its member countries' supplies, forecasting that as early as 2020, demand for OPEC crude could be as low as 29 million bpd or as high as 37 million bpd. In a speech that El-Badri gave at the 9th Arab Energy Conference, in Doha, Qatar, in May of this year he said that this translates into an uncertainty gap of over US$250 billion in upstream investments. "There is, therefore, the very real possibility of wasting financial resources on unneeded capacity," he noted. "These daunting uncertainties stem in part from consuming countries announcing policies that are geared towards reducing oil demand, subsidising alternatives and putting heavy tax burdens on the use of oil. Inconsistent, unrealistic and wishful-thinking policy announcements can only provide the wrong signals to markets and investors, creating a lack of certainty and predictability that undermines the ability of the oil industry to invest to meet future energy demand."

Macroeconomic activity

OPEC has witnessed the odd recession down the years but the downturn of the past few years has been described as the worst since the Great Depression. With staff layoffs, house repossessions, businesses suffering and consumers tightening their belts, oil consumption was bound to dip. Indeed, global demand fell in 2008 and 2009 - a cumulative drop of 1.8 million barrels. This was the first time this had happened since 1981. It led to a significant rise in unused production capacity, which stood at six million bpd earlier this year. And with some Arab countries' petrodollars accounting for 90 percent of GDP, the economic maelstrom was a hammer blow for export revenues. Although El-Badri says a viable petroleum industry provides important economic stimulus for the region, the downturn left a visible adverse impact on Arab counties.

"OPEC Member Countries have been particularly hard hit by the global economic downturn. Many of our Member Countries had to delay some of their investment projects. They also saw a steep decline in their oil revenues and were forced to cut costs. As oil-exporting, developing countries, their economies do not have the same capacity to weather a storm as more diverse and emerging economies, such as China and India," explains El-Badri.

The low oil prices that accompanied the economic downturn had a profound effect on the region's projects. "Due to falling oil prices as the global economic downturn took hold, OPEC Member Countries had no choice but to delay a number of their scheduled and planned investment projects. At one stage, around 35 projects out of a total of 150 projects had been delayed or stalled," explains El-Badri.

However, by the first quarter of this year, as more realistic oil prices were observed, these projects were resumed. El-Badri points out that this 'stop-go' situation was not exclusively experienced by OPEC alone - all oil producing countries and oil companies faced similar challenges. "The result has been staff cuts throughout the entire industry. We have also witnessed cutbacks in investment and budgetary plans. This is concerning, since the oil industry was already suffering from a lack of skilled personnel, which at the end of the day translates into supply cuts."

With the economy in the region being so reliant on oil, El-Badri highlights a need for Arab nations to diversify their economies. "Hydrocarbons are finite resources. It is important for all countries to have diverse economies. Many of our Member Countries are already taking steps in this direction." The attempts by many countries in the region to invest in tourism and create logistical port hubs serve as proof of this.  El-Badri adds: "OPEC is also a firm believer in the need for diversity in the global energy mix. Indeed, many of our Member Countries are working hard to develop alternative sources of energy. But while alternative forms of energy will grow in importance, we must still recognize that they are starting from a very low base. It is widely accepted that fossil fuels will remain the main source of energy for the foreseeable future."

The crisis and the slow and fragile economic situation is evident in the modest increase in oil demand - around 900,000 bpd for 2010 - but the downturn has underlined the need for Arab states to diversify their economies. However, El-Badri says the risks remain high especially with some OECD countries saddled with eye-watering levels of debt, high unemployment, credit tightness and a fragile financial system.

However, El-Badri says the crisis once again highlights OPEC's importance to world oil and he stresses that the organisation will continue to play an active role in the future. "OPEC will continue to pursue stability in the oil market - something that is critical to support a sustained return to global economic growth. To do this, we will continue to monitor the markets closely and OPEC Member Country ministers will make informed decisions accordingly."

Despite the oil industry faces a multitude of challenges and uncertainties, significant investments are underway in OPEC member countries. In 2009, around 30 projects came onstream, culminating in 1.5 million bpd of net crude and liquids capacity. In the next five years, the completion of another 140 projects is expected to add another 12 million bpd of gross crude and liquids capacity. El-Badri believes that current investments should be enough to satisfy demand for OPEC crude and provide a comfortable cushion of spare capacity - of more than six million barrels a day by 2013. Downstream has seen OPEC countries plough some US$40 billion in order to expand refining capacity by more than two million bpd to more than 10 bpd. Such investments, according to El-Badri, help OPEC support market stability.

Volatile situation

Apart from inflated costs and a lack of qualified personnel, El-Badri singles out extreme crude price volatility as one of the most urgent challenge facing the oil sector. In 2008 oil prices rocketed to US$147 a barrel and some analysts were forecasting it to top US$200. But as the global financial crisis began to bite, crude plummeted to just US$35 a barrel within the space of six months. This rollercoaster ride in prices creates harmful uncertainties with regard to the long-term price of oil, with some questioning why speculators can have so much influence over how much we for crucial commodity, especially at the pumps. A weak dollar and geopolitical factors came into the equation in 2008's spike, but speculators were mainly to blame.

El-Badri says OPEC has been warning since 2007 that wild price swings were detached from supply and demand fundamentals, but these concerns fell on deaf ears. However, there is now dialogue within the International Energy Forum (IEF) to mitigate volatility and proposals by the Commodities Futures Trading Commission (CTFC) in the US to limit excessive speculation in the futures and over-the-counter markets.

"OPEC has time and again stressed that the extreme oil prices witnessed in 2008 were not due to oil market fundamentals. It is now widely accepted that oil was being used as an asset class and that speculation was driving the extreme volatility we saw. We are now seeing some moves to improve regulation in this respect," explains El-Badri.

"OPEC is currently engaged in a collaborative joint work programme with the International Energy Agency (IEA) and the International Energy Forum (IEF) to better understand exactly how the physical market for crude oil and the financial markets interact as well as the potential of improved regulation."

 The oil price graph has remained fairly stable in the past 12 months, bobbing up and down between US$67 and US$82. El-Badri says that OPEC does not have a target price, but he believes that the current oi price of close to US$80 a barrel is an acceptable level for both producers and consumers.

"These prices are not in any way hampering the global economic recovery, but they are enabling producers to push forward with their much-needed investment programmes," he says. "Of course, there are huge uncertainties on the economic front and the outlook for oil demand remains unclear. At OPEC, we remain very cautious. Oil inventories remain extremely high and this could put downward pressure on oil prices. But as we have seen in recent years, other factors such as the financial markets are now also driving oil prices."  

He is also keen to emphasis that nobody wants to see a repeat of the spike and fall in prices of 2008 - neither producers or consumers. With a fluctuating dollar having a profound effect on crude prices, there has long been talk of ditching the greenback for a basket of currencies. But El-Badri does not see this happening any time soon. "With regards to the dollar, it remains the currency with which oil is priced. I do not foresee any change in this respect. However, it is up to MCs to decide."

But with OPEC's influence over oil output on the world market, it is little surprise that the organisation has its fair share of opponents down the years. After all, it was the Arab oil producing nations of OPEC who cut supplies in 1973, leading to oil rationing and bringing the global economy to its knees (see box out). Critics see also see little unity within OPEC, except when it comes to member countries setting production limits to their advantage. OPEC, however, says it is there to intervene when threats to supplies could prevent oil from reaching the market. For instance, when capacity fell from Iraq and Kuwait in 1990 before the Gulf War, OPEC members ramped up production to make up the shortfall. Similarly between 2003 and 2006 after the US invasion of Iraq, OPEC responded to the disruptions in supplies by flooding the market with another five million barrels a day.

Keeping the market supplied today and into the future is about dialogue, suggests El-Badri. He believes that genuine dialogue and cooperation between energy producers and consumers is the key to ensuring a stable and predictable energy scene.

Of course, one day OPEC's significance will fade along with oil supplies as the world is forced to focus on alternatives. Question marks still hang over whether or not we have passed Peak Oil - even the experts don't know definitively how much crude is still lying under the ground and beneath sea beds. Gas is being touted as the hydrocarbon of the 21^st century, while unconventional oil reserves will play a greater role in the energy mix. Renewable energy will play a greater role in the energy mix. But for the foreseeable future though, oil is king.

OPEC's mission

In accordance with its Statute, the goal of the OPEC is to coordinate and unify the petroleum policies of its member countries and ensure the stabilisation of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry.

Arab OPEC nations impact on crude oil prices came to the fore after Syria and Egypt attacked Israel (the 18-day Yom Kippur War) in 1973. The US and a host of other nations sided with Israel so several Arab OPEC members placed an embargo on them and cut production by five million barrels per day. The oil crisis of 1973, as it became known, led to many people, especially the Americans, to reassess energy security and how reliant they were on Middle East oil supplies. Oil couldn't just be thoughtless consumed, which was underlined by philosopher E.F. Schumacher when he said: "The party is over."

The embargo's impact on crude prices was profound - quadrupling from US$3 a barrel in 1973 to US$12 in 1974. It also led to gasoline rationing and queues of two to three hours at petrol stations. Odd-even rationing was rolled out, meaning drivers of vehicles with licence plates with an odd number as the last digit were permitted to refill their tanks on odd days of the month, and vice versa for motorists with even number digits. Consumption in the US, the world's largest consumer of oil, dropped by 20 percent while inflation jumped to jumped to 10 percent and interest rates hit the high teens. Daylight saving time was issued year round with the aim of conserving electrical use and speed limits on roads were also slashed in some counties. 

Those countries affected by the embargo refocused their efforts on the development of alternative energy resources and reducing their reliance on fossil fuels. When the embargo ended in 1974, Arab nations began shipping oil again but at inflated prices. The long-term result of the crisis was a global recession and a change in attitude as people and governments realised just how much they relied upon oil.