The Impact of OPEC on the Global Market

Introduction

Over the last decade, there has been an increasing transformation of the world economy, namely the determinants of development, interdependence, and appearance of new players in the global economy. The world energy market is particularly sensitive to these alterations, while it is a catalyst for change, but it is also affected by the transformations in the global environment. Oil price fluctuations have forced oil-producing governments to develop policies to regulate oil production and manipulate oil prices. OPEC is an intergovernmental organization aimed at gaining revenue and controlling oil prices through increasing or reducing petroleum production. Despite being a significant market player, OPEC does not have absolute control over prices. According to Rousan, Sbia, and Tas (2018), the influence of OPEC significantly decreased after 2012. While the level of its power on the global oil market declines, OPEC remains effective for its members which are developing countries, giving them independence and protection in the petroleum trade.

Overview of OPEC

The developing nations, despite having a significant amount of natural resources, are often dependent on more powerful economies. OPEC was created in 1960 to protect and increase the gain of these states. Based on the idea of the sovereignty of the governments over natural resources, OPEC countries reduce competition in the market, keep the prices at a higher level, and increase the profit of each member. OPEC is often considered a typical illustration of the way how international cartels undermine competition and establish control over prices. However, its share in the global market is lower than it usually is with cartels. According to Carbaugh (2019), currently, less than 40% of global supply is under the control of OPEC, which is insufficient to form a competent cartel. Still, the power of OPEC is significant, which influences the economies of both non-OPEC and OPEC countries.

OPEC does not control the majority of the oil market and often has to cooperate with other countries, as it was with Russia in 2016. Still, participation in this organization offers significant economic protection to its members. As most of them are developing countries, the economies of which are based on natural reserve and crude production, OPEC allows them to resist influential economies such as the U.S. or Russia. According to the data presented by Rousan et al. (2018), the share of OPEC in crude oil production is 43% of the world’s total amount, while the production of natural gas exceeds 20%. As OPEC members own roughly 80% of global reserves of oil and 48% of natural gas (Rousan et al., 2018), the potential of maintaining the current influence level on the market remains.

The Recent Impact of Participation in OPEC for Member Countries

OPEC includes such key petroleum market players as the United Arab Emirates and Saudi Arabia, the latter being the informal leader of the organization with the highest production proportion. The other members are mostly developing nations, including Venezuela, Gabon, Algeria, Iraq, and Angola. The economies of these countries are still developing, and they require protection from more powerful governments. The participation in OPEC helps them to join their forces and to compete in global trade more effectively. According to Escobar and Chaffotec (2015), “membership in OPEC should improve economic development by reducing transaction costs” (p. 304). The effect of this membership is especially strong in developing economies due to information asymmetries among the regulators.

Being an OPEC member allows each country to experience an advanced economic performance, but the benefits of OPEC are not equal for all members. The study demonstrates that the level of benefit from the participation is inversely proportional to the development level of the economy (Escobar & Chaffotec, 2015). In addition to this, states with larger natural oil reserves gain more from the OPEC membership. The abundance of the reserves of oil and natural gas and low economic independence may pose a threat to the economic progress of some countries. By reducing oil price volatility, OPEC membership diminishes this threat and risk of military conflicts.

The Current Role of OPEC in the Global Market

The ability to influence the global market and control prices has always been the main asset of OPEC. The power of its members in the world’s petroleum market has been significant during recent decades. As Golombek, Irarrazabal, and Ma (2018) claim, “OPEC exerted substantial market power between 1986 and 2016” (p. 110). However, the last ten years demonstrated a decrease in this influence, and the effectiveness of OPEC is often doubted. Non-OPEC countries produce the majority of petroleum in the global market, and new players appear, such as Canada or Mexico. Rousan et al. (2018) state that “the impact of changes in oil-production of all OPEC members on global oil production declines, whereas the impact of non-OPEC on global oil production increases” (p. 30). Nevertheless, OPEC still controls over 80% of crude oil reserves remaining an essential player with the potential of maintaining or even strengthening this position.

The power of individual players on the petroleum market is defined by their ability to affect prices. A high degree of oil production coordination is required for both OPEC and non-OPEC members to have a significant influence. The level of macroeconomic connectedness bears information about the respective importance of each member to influence oil production in other countries. According to Rousan et al. (2018), “the monthly average connectedness of OPEC decreased from 40,48% in 2012 to 33,14% in 2016” (p. 41), while the non-OPEC coordination level did not change relatively during this period. The level of coordination gives OPEC members the influence over the prices which non-OPEC states lack. Although the latter produce approximately two-thirds of the global oil, they cannot demonstrate significant power due to the lack of coordination.

Despite the high coordination of OPEC members, their impact on the global market can be outweighed by other players. Carbaugh (2019) offers a set of measures that can aid such countries as the USA in the competition with OPEC, including the governmental regulation of automobile manufacturing standards focusing on raising fuel economy. The US also has a way of increasing its resources by allowing oil companies to drill on the wilderness in Alaska. However, this decision would bear danger to nature, and its implementation would cause significant complications as this land is protected. The development of alternative energy sources, such as solar energy, wind power, and biofuels, is another way to compete with petroleum-rich countries. Although it requires subsidies from the government, it is considered to be effective, especially within several decades, when the natural oil reserves will be exhausted.

Conclusion

OPEC includes 14 states with developing economies that cooperate to regulate the production of oil, manage the prices, and create beneficial conditions for trade. Economists often consider this organization to be an international cartel, but its impact today is far from absolute, and it is still decreasing. Nevertheless, the OPEC members possess more than 80% of the planet’s oil reserve – the figure that demonstrates their potential to be powerful market players in the prospect. In addition to this, participation in OPEC significantly protects its members, increasing the importance of each member country on the market.

References

  1. Carbaugh, R. J. (2019). International economics (17th ed.). Boston, MA: Cengage Learning.
  2. Escobar, O. R., & Chaffotec, A. L. (2015). The influence of OPEC membership on economic development: A transaction cost comparative approach. Research in International Business and Finance, 33, 304-318. doi: 10.1016/j.ribaf.2014.04.005
  3. Golombek, R., Irarrazabal, A. A., & Ma, L. (2018). OPECs market power: An empirical dominant firm model for the oil market. Energy Economics, 70, 98-115. doi: 10.1016/j.eneco.2017.11.009
  4. Rousan, S. A., Sbia, R., & Tas, B. K. O. (2018). A dynamic network analysis of the world oil market: Analysis of OPEC and non-OPEC members. Energy Economics, 75, 28-41. doi: 10.1016/j.eneco.2018.07.032