THE FUTURE OF THE ORGANIZAtion of Petroleum Exporting Countries was the subject of much speculation among the analysts and decision-makers of the world oil industry as the end of the millennium approached.
Some observers in 1998 were already fashioning a post-mortem for OPEC, which was struggling to avoid relinquishing any more market share in a down market while trying to adhere to production cuts to keep the brakes on skidding oil prices.
The thinking along these lines focused on the recent departures of Ecuador and Gabon from the group, the maverick bent displayed by OPEC stalwart Venezuela, the recurring squabbles over quotas, and the domestic upheaval in a number of the key OPEC nations. Beneath those conflicts lay the acrimony, and occasional state of war, that existed among several of the key members. The conventional wisdom held that OPEC was a dinosaur, unable to cope with the dizzying complications of the modern global oil market, and was thus headed for extinction.
A contrary view suggested that OPEC was merely the temporary victim of its own over-reaching-with higher quotas at the end of 1997-and the economic distress that started in Asia and spread. In this line of thought, OPEC could simply be restored to its dominance over markets by ratcheting back supply until a reviving global economy spurred a resurgence in demand that not only revived oil prices but-withcompetingsuppliesin decline-recaptured much of the group`s market share.
A scenario more likely than either of these was that there would still be an OPEC in the 21st century, one still at the pivot point of oil markets-albeit not as dominant as in the 1970s and 1980s-but also an organization greatly transformed from the one the industry saw in the late 1990s.
There were clouds on OPEC`s horizon, far beyond the price cycles inevitable with any commodity. The most ominous ones were geopolitical, environmental, and economic in nature, and they were certain to persist well beyond the vagaries of oil prices and production quotas that obsessed OPEC-watchers in 1998.
The group`s final meeting in 1998 did little to dissuade the naysayers over OPEC`s future. OPEC closed its November 1998 meeting without an agreement even to extend the group`s pledged production cuts through the end of 1999, and analysts were predicting oil prices would drop to less than $10/bbl in the near term.
At that meeting, OPEC ministers agreed only to meet again in Vienna in March 1999-instead of the regularly scheduled ministerial meeting in June-and take stock of prices and markets at that time before extending cuts or negotiating further cuts.
By not taking steps to cut production further in 1999, OPEC`s last meeting inspired another swan-song chorus from some observers pointing to the group`s helplessness in the face of plunging oil prices and seeming irrelevance to the market.
But, in fact, it may have been the only viable option for preserving the group`s market share in the years to come. And, coupled with signs of new flexibility on foreign investment among the most critical members and new ideas about how to weather the supply-demand rollercoaster, it may have helped set the stage for a new OPEC to return to center stage of the global energy scene in the new century.
Greenhouse game
At the start of 1998, with the ink scarcely dry on the Kyoto Protocol among nations to cut back emissions of so-called greenhouse gases-purportedly responsible for potentially calamitous climate change-OPEC watchers noted the group`s by-then routine condemnation of the climate change treaty as a dire threat to their members` survival.
Effective implementation of such a protocol would entail a massive switchover to renewable fuels, which would have much more far-reaching effects on OPEC`s market than any non-OPEC oil supply surge or demand slump sparked by high oil prices.
The OPEC ministers in 1998 regularly decried Kyoto`s threat to their countries` future livelihood. They even called for compensation from the oil-consuming countries that would effect the largest cuts in oil consumption as part of a climate change treaty.
This outlook was to some degree vindicated at the follow-up climate change treaty negotiations at Buenos Aires early in November 1998. At that meeting, a group of developing nations approved a resolution calling for such compensation for the oil exporters, whose main source of revenue would be crippled by the ripple effects from a climate change treaty.
More importantly, however, the climate change negotiations by the time of Buenos Aires had become so fractured that the likelihood of anything more than a toothless treaty ultimately getting enacted seemed dim. China and India rejected participation in emissions cuts. Their combined projected growth in carbon dioxide emissions likely would more than offset the effect of any emissions cuts in the developed world.
Furthermore, there was growing probability that the U.S. Senate would reject the treaty that the administration of President Bill Clinton had signed, coming amid signs of a spreading global economic recession set against the projections of Kyoto`s spiraling energy costs.
While 1998 ended with talk of OPEC`s imminent demise, a new refrain was also heard at the end of the year that gave the group cheer, in the words of a key U.S. senator, who pronounced the climate change treaty "dead as a doornail."
Hindsight someday may show that the economic crisis that started in Asia and the resulting collapse in oil demand, which undermined OPEC`s market expansion initiative in 1997-98, was the best thing that could have happened to the group. Developing economies were the backbone of OPEC`s market share resurgence in the 1990s; their steep fall and redoubled wariness over the economic threat posed by Kyoto`s costs seemed able to unravel the climate change treaty and its threat to OPEC`s future.
OPEC and the Middle East
While the greenhouse "cloud" seemed to be lifting for OPEC, another cloud remained: The presence of much of the world`s surplus productive capacity in the volatile Middle East remained a threat to OPEC`s future hold on markets.
After oil prices doubled in 1973 following a period of nationalization of oil company holdings in OPEC countries and the Arab oil embargo, a string of geopolitical events and trends linked the group-however erroneously-with the Middle East.
Consuming nations never forgot the oil price shocks emanating from the embargo, the 1979-80 Iranian revolution, the Iran-Iraq war of the 1980s, and Iraq`s 1990 invasion and later ouster from Kuwait. These stifled the booming growth in oil demand of the 1960s and, together with the lingering threat to the world`s most crucial oil supply sources, spawned the alternate and synthetic fuels and energy conservation movements.
Consequently, heavy dependence on OPEC oil was often seen as overreliance on Middle East crude supplies. While they are by no means the same thing, OPEC members on the Persian Gulf dominate the group`s-and the world`s-oil reserves and account for most spare production capacity in times of surplus. Politically, in consuming countries the rush to back out or find substitutes for oil meant a scramble away from OPEC oil.
Indeed, OPEC`s market share fell by more than two-thirds from 1973 to 1986, partly because of consumer nation efforts but also because the group itself tried throughout the period to elevate the price of crude by limiting production. In late 1985, the seldom-successful effort began to collapse. Saudi Arabia, which had borne most of the production cuts while other OPEC members produced at will, abandoned OPEC`s futile price targets and raised production. The move was partly an effort to regain market share but also an act of economic self-defense: Saudi oil production had fallen so low-less than 3 million b/d-that associated gas production couldn`t meet internal needs of the kingdom, which at the time had little nonassociated production.
After the oil price collapse in 1986, OPEC`s market share rebounded to about 43% in 1998, and the Persian Gulf share of that total stood at more than 28%. Members hold three fourths of the world`s proved oil reserves.
However, the Persian Gulf crisis and war of 1990-91 and subsequent crises with Iraq at the epicenter, along with the Arab-Israeli conflict, served as reminders of Middle East volatility. And despite occasional hints to the contrary, the governments of most countries on the Persian Gulf either resisted or severely limited foreign investment or, like Iran and Iraq, were subjects of international investment bans.
OPEC`s Middle East members in the 1990s thus faced potential competition from the resource-rich Caspian Sea region, which had been closed to international investment until the Soviet empire collapsed. While the initial euphoria over "another Persian Gulf" in the Caspian region was waning in 1998, and while the area had its own set of historic troubles, the Persian Gulf bogeyman continued to be resurrected in discussions over the importance of Caspian oil.
As long as most of OPEC`s reserves and spare production capacity resided in a handful of Persian Gulf nations, and as long as those nations remained resistant to capital from abroad, the continuation of conflict in that region was certain to have a great bearing on OPEC`s future market share.
That is certainly not to discount the potential for oil supply disruptions in OPEC nations outside the Persian Gulf. In late 1998 violent civil strife or the potential for it unsettled Algeria, Nigeria, and Indonesia.
And the potential for wrenching change in the political climate and hence the oil investment climate in Venezuela loomed large with a fierypopulistwhotook power. In fact, failure of the November 1998 OPEC meeting may have resided in the soured relations between Venezuela and Saudi Arabia. The Saudis were unhappy with Caracas seemingly trying to elbow them out of the U.S. market. And the Venezuelans, facing presidential elections just 2 weeks after the OPEC meeting, were unwilling to agree to any extension or deepening of production cuts with an incoming administration likely to be opposed to such cuts because of the domestic job losses they would bring.
Economic concerns
OPEC`s worries for the 21st century were also economic in origin.
The price collapse that blunted the search for alternative energy in the late 1970s and early 1980s also contributed to an environment for developing new efficiencies and applying new technologies in the petroleum industry. These changes strengthened oil companies operating throughout the world, bolstering mature non-OPEC competitors such as the North Sea and Alaska and setting the stage for the emergence of vibrant oil exporters such as Colombia, Oman, Angola, and the central Asian states of the former Soviet Union, among others.
What also fueled the growth of non-OPEC competitors was globalization of the world economy-the push toward deregulation, privatization, transparency, and market reforms and away from central planning and state control of resources.
A broader worry for OPEC was whether its market would be fundamentally smaller than its members had anticipated before the Asian economic meltdown. The outlook for OPEC-and the rest of the oil industry-throughout the 1990s had rested heavily on the expectation oil demand would keep soaring in the developing world, particularly in the "tiger" economies of Asia. A moderate price for energy, led by affordable oil, gas, and coal, helped fuel those sizzling economies.
OPEC late in 1997 saw what it considered to be the handwriting on the wall and opted to increase its production quotas for the first time in years to accommodate the ever-rising call on its oil.
But in the space of less than 2 years, some of the Asian juggernauts came to a screeching halt as the overheated economies fizzled amid currency devaluations and collapsing banking systems. The collapse in oil demand growth came just as more OPEC supplies were entering the market and as non-OPEC production continued to defy expectations of a decline. The result: an oil price slump that, at the dawn of 1999, was still being debated as either another brief cycle or as the harbinger of a fundamental shift to a new era of low oil prices.
The outcome probably hinged on whether the economic malaise creeping worldwide at the start of 1999 turned out to be a brief correction or a "new world order." Some economists were pointing to early signs of recovery in Thailand and South Korea as positive omens, while others fretted over faltering efforts at reform in Russia and economic stimulus in Japan.
OPEC`s dilemma
Irrespective of where the global economy was headed, it was clear early in 1999 that OPEC`s dilemma grew out of problems the group created for itself in the 1970s and 1980s by seeking to control oilpricesand sharply ratcheting themuptothe pointwhere demand collapsed.
Thegroup received help from anoilindustry eager to put its in faith in an ever-rising upward price spiral. Chase Bank Managing Director Len Paton, in an October 1998 talk in Houston, said, "Producers...were giddy with the reality of $70/bbl oil and the prospect of even higher prices. Lenders and capital markets joined in, and all contributed to an excessive overbuilding of oil field capacity. During those heady days, almost no one took note of the plight of the consumer and the message coming through in the declining demand curve: `At these prices, we don`t want any more. Whatever you are doing, you can stop it.`
"The industry did not heed that advice but continued to overbuild equipment and capacity even after oil consumption turned down in 1979. That mistake led to one of the greatest industrial collapses in modern memory. Why? Again, because OPEC`s ability to control oil prices removed the normal market-driven rise and fall of commodity prices from serving as a governor of industry actions."
Paton described OPEC`s dilemma in the context of an imbalance between the industry`s capacity to produce oil and the world`s appetite for it: "OPEC created this glut by manipulating oil prices from 1974 through 1986. Excess productive capacity peaked at 15 million b/d in 1984. The oil industry could outproduce consumption that year by an incredible 25%."
But Paton noted that, unlike the correction that began in 1983, when falling oil consumption led producer spending down, the situation at the end of 1998 had producers cutting spending in anticipation of weak demand: "The big difference is that OPEC is having great difficulty controlling prices in the current environment."
The other big difference between the 1998 environment and that in 1983, said Paton, was that the world no longer needed a large cushion of surplus oil inventories, especially given the transparency of oil markets. He noted that the International Energy Agency originally forecast global oil consumption to grow in 1998 by 3.7% over 1997. By fourth quarter 1998, that growth projection had been slashed to 1.9%, and projections for 1999 were that growth could be smaller still, or even flat.
"Any further reduction in demand growth, assuming no change in recent growth trends in productive capacity, would widen excess productive capacity to over 10% by the end of 1999. That cushion is now viewed as too much excess capacity."
Paton also cited a pessimistic view of the oil market that held the oil market slump would take several years to run its course-that oil demand was under many more negative pressures than most analysts realized. For example, he noted that the devaluation of currencies in oil consuming nations exacerbated the damage done to oil demand in those countries, pointing to some nations whose crude oil costs rose 11-60% from July 1997 to September 1998 because of declines in the value of their currencies: "If you consider that about 40% of the world`s oil (30 million b/d) is imported by nations whose currencies have devalued against the U.S. dollar, then you can sense the size of this hidden cost."
On the supply side, Paton again pointed to a pessimistic view that the growth trend in productive capacity could not be easily reined in, citing a drop in finding and development costs to $5/bbl owing to technological advances: "One reputable think tank says this healthy profit incentive pushed producer spending during the past few years to levels that guarantee net productive capacity will grow at least 3 million b/d, and possibly 5 million b/d, by the year 2000-regardless of what the price of oil does."
Paton also described a more optimistic view, which held that the market correction that began late in 1997 and deepened in 1998 was short term. Left to the discipline of normal market forces-unlike the market of 1974-86-the industry would suffer a "short, but soft landing in 1999...As soon as lower oil prices work their magic of reducing supply while increasing consumption, the industry will pop back into growth mode driven by increased demand for oil."
The optimists also believed growth in oil demand was about to accelerate rapidly, Paton said, contending that energy consumption would accelerate as higher living standards spread.
"With excess productive capacity around 8% and depletion taking some 4% out of production each year, optimists think it might not take long for this correction to be over. It may just be a 1999 event."
Budget pressures
Much of how OPEC dealt with the oil market doldrums expected to persist in 1999 was certain to be shaped by budget pressures affecting the key members, notably Saudi Arabia.
An indication of the scope of those budget pressures came in comments by Arab Monetary Fund chief Jassem al-Manai, who in November 1998 predicted that the drop in oil prices would cost members of the Gulf Cooperation Council 20-25% of their annual revenues for the year. He pegged the GCC members` individual budget deficits at 5-7% of gross domestic product. Four of the GCC members-Saudi Arabia, Kuwait, the U.A.E., and Qatar-are also members of OPEC.
As for Saudi Arabia, the oil price collapse in 1998 was certain to result in a large budget deficit, Centre for Global Energy Studies concluded in a report late in 1998.
While Saudi Arabia projected its 1998 budget deficit at $4.8 billion, roughly on par with the two preceding years, CGES reckoned that "the Saudi authorities have almost certainly overestimated fiscal revenues and are probably underestimatingstate expenditures."
CGES projected Saudi revenues in fiscal 1998 at about 153 billion Saudi riyals, compared with the kingdom`s own projection of 178 billion riyals and planned outlays of 196 billion riyals. This would leave a budget deficit of 43 billion riyals. The Saudi budget deficits in 1996 and 1997 were not so severe because revenues exceeded budgeted amounts by 34% and 24%, respectively.
But while more than double the budgeted amount, the projected deficit still held the potential to fall short of the mark, warned CGES:
"Since Saudi expenditure outturns have exceeded budgeted levels by very large margins in the previous 2 years, can the Saudi government be confident that its expenditures will stay within the 196 billion riyal total for 1998? The final Saudibudget deficit for 1998 is, therefore, likely to exceed the 43 billion riyal level by whatever expenditureoverrun actually occurs...As it is, a deficit of 43 billion riyalsrepresents around 8% of Saudi GDP, which is high byinternational standards. NowonderMoody`s (Investors Service)recentlychanged theoutlookfor Saudi Arabia from positive to merely stable."
Prudential Securities had an even bleaker outlook for the kingdom. It projected the Saudi budget deficit for 1998 at $15-20 billion, noting that a $16 billion budget deficit would equal 13% of Saudi GDP.
"While weak oil prices would likely trigger budget cuts by the Saudis, the government`s flexibility is limited by the fact that only 15% of government expenditures are for capital projects, a portion of which could be deferred," Prudential Securities said. "With 85% of expenditures allocated to salaries, subsidiaries, and other nondeferrable items, budget cuts would be felt immediately within the kingdom."
The analyst also noted that, with the Saudis unwilling to tap the international debt market, banking officials believed that the governmentwouldsharply increase borrowing from local Saudi banks to fund any deficit. But, Prudential Securitiessaid,"The bankers with whom we spoke believed that it would be difficult to provide the financing for the potential government deficit for more than 6 months."
Security of demand
One possible solution to OPEC`s dilemma was outlined late in 1998 by the organization`s secretary-general, Rilwanu Lukman.
At an international conference involving representatives of oil producing and consuming nations at Capetown in November 1998, Lukman conjectured beyond the usual discussion point of effective dialogue between producer and consumer nations to consider that price and production levels were a legitimate point of official discussion between the two sides.
Producer-consumertalksshould address pricing and output, Lukman said, rather than be considered "no-go" areas for consumer nations.
"This would increase the likelihood of consensus being reached among producers and consumers over the adoption of meaningfulmarket-stabilizingmeasures," Lukman said.
"Let me stress, however, that, while we are advocating deeper discussion of these issues, we do not intend this to mean that these conferences should be used for setting pricing and production volumes for the market."
Noting the conference agenda included examination of the issue of securing local frameworks for energy investment, Lukman asked, "Why does it not also include an item on the existence of secure markets for crude oil?
"There are two sides of the security coin. One, as we are repeatedly reminded by the international media, is security of supply. The other is a less trumpeted, but equally important notion, security of demand," he said. "What incentive is there for the producing nations to make a major commitment to the expansion of future production capacity if they cannot be guaranteed secure markets for their oil at the end of it?"
New ideas
It was the combined pressure of rising budget deficits and shrinking markets that had OPEC members looking hard at new ways to sustain the investment needed to add the productive capacity needed to meet future oil demand.
Rilwanu Lukman suggested at a September 1998 seminar in Oxford, England, that OPEC`s future role could evolve to include consultations over investment programs within the organization and non-OPEC countries.
Citing forecasts by the OPEC Secretariat that global oil production could peak within a decade, while worldwide oil demand was projected to top 100 million b/d in 2020, Lukman noted that the bulk of this incremental demand would have to be met by OPEC members in the Middle East.
"In order to meet the world`s growing thirst for oil, considerable capacity expansion will be necessary, and this will entail the investment of many hundreds of billions of dollars," Lukman said. "OPEC member countries, with over three quarters of the world`s oil reserves and some of the lowest production costs, are the logical place for this capacity expansion to take place.
"In future, OPEC can also play a role in making sure that the necessary investment is channeled into its member countries, rather than the less productive, higher-cost,non-OPECproducing regions."
Sharing the surplus burden
An even more novel concept on how best to develop the productive capacity required in the future was introduced by CGES Chairman Sheikh Ahmed Zaki Yamani at a London conference in November 1997.
Yamani`s concept centered on spreading the burden for maintaining a certain amount of spare capacity as a buffer against oil supply and price shocks-the level being ratcheted up or down to smooth out anomalies that spawn oil price volatility.
Most of the world`s surplus productive capacity had been in Saudi Arabia. Yamani estimated Saudi Arabia`s spare capacity at that time at 2 million b/d and noted that the kingdom was spending about $100 million/year just keep the idle capacity in a state of readiness. More importantly, he said, Saudi Arabia was forgoing market share by not selling this 2 million b/d of oil.
A year before oil markets were staring glumly at the prospect of sub-$10/bbl oil in late 1998, Yamani offered this unwitting prophecy:
"How close is Saudi Arabia to the point at which it would not want to continue to hold so much of the world`s spare capacity? When prices are high, and the demand for oil is strong, Saudi Arabia can afford to sit on its spare capacity and enjoy higher oil-related revenues. Yet, all the while the pressure to open the taps builds up, because of a gradual loss of market share that is detrimental to the kingdom`s long-term interests...A similar build-up of pressure arises when most of the world`s excess oil production capacity is held by one country, and prices are low-as Saudi Arabia`s experience in 1985 clearly indicates. In both instances, the weight of idle capacity eventually tends to produce a change in policy, but the tension is much greater when prices are low."
Yamani contended that the oil industry should not expect just a few countries to carry the burden of maintaining spare capacity to meet unforeseen contingencies, such as the sudden loss of oil supplies, or to deal with the equally abrupt return of an embargoed oil producer.
"Ideally...all the oil-producing countries should share the burden of maintaining some spare oil output capacity. The real difficulty, of course, lies in how to achieve this objective."
He cited the International Energy Agency member countries` requirements to hold compulsory stocks of oil: "In light of this, what is wrong with obliging all oil-producing countries to hold, say, 5% of their oil productive capacity idle? If oil prices were suddenly to rise steeply, then this idle capacity could be swiftly activated to take the heat off oil prices."
Yamaniacknowledgeddifficulties inherent in such a plan: "The oil companies would never volunteer to keep some of their oil production capacity idle, since it would be suboptimal from an economic point of view. It is clear that some sort of legal compulsion is needed-as is the case at present regarding oil stocks."
The former Saudi oil minister cited another hurdle to such a plan: regular verification of the existence of this surplus capacity. He added, "What is more, provisions would have to be made regarding the appropriate conditions under which the idle capacity would be activated. Should the capacity be activated when prices rise by 10% in a month, 20%, 30%, or what? And who would supervise compliance? These hurdles may seem insurmountable, but they could be overcome if everyone with an interest in oil price stability understood the true extent of the potential benefits that sharing the burden of idle capacity would bring. Is it too much to require the operator of, say, a 100,000 b/d oil field to hold 5,000 b/d in reserve, to be produced when prices climb too high?"
For such a scheme to work would require the cooperation of many governments, most of the oil companies, and a few international organizations, Yamani noted. "And from past experience, the omens for this to happen are not propitious.
"Yet we should not be deterred trying to get such a scheme off the ground. Practical difficulties should not be allowed to obscure the scheme`s potential benefits."
OPEC opens the door
Even if OPEC nations continued to shoulder the burden of holding virtually all of the world`s surplus productive capacity, they were likely to do it more and more with the help of foreign capital.
In the latter half of the 1990s, OPEC members were opening their doors to foreign oil companies for upstream investment.
Venezuela and Qatar were the most successful in this regard, making significant progress toward expanding productive capacity compared with their OPEC brethren by opening their doors to foreign E&P investment.
A December 1997 report by CGES noted, "The decision to open up the upstream sector in all OPEC countries except Saudi Arabia and Kuwait has created a new investment channel for the international oil industry that should result in slower growth in non-OPEC production in the longer run."
Since CGES made this observation, Kuwait dangled the prospect of direct foreign investment in its upstream sector before a handful of multinationals but later retreated somewhat to its earlier offer of "technical services" contracts to British Petroleum Co. plc, Total, and Chevron Corp. to help it ramp up productive capacity.
But Saudi Arabia startled the oil world in October 1998, when key Saudi officials met with officials from a number of multinationals in meetings in Washington, D.C., and London regarding prospects for foreign investment in the Saudi petroleum industry. Saudi officials seemed later to backpedal from hints of direct equity investment in oil production capacity-emphasizing gas utilization, refining, and petrochemical projects. The overture still was something of a departure from Saudi Oil Minister Ali Naimi`s insistence late in 1997 that Saudi Arabia would remain entirely responsible for the development of its oil reserves.
CGES said, "If OPEC is serious about maintaining its market share, it will need to create more opportunities for foreign investment over the next few years."
This set the stage for OPEC in the new millennium.
Just as the oil companies of the world were consolidating and forming alliances to share costs and spread risk to better compete in a low-price climate, OPEC was likely to evolve into an organization more open and flexible than before with outside entities while at the same time hewing to its role as the world oil market`s swing supplier.
That evolution remains essential to OPEC`s survival well into the next century.
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