Oil and Development: The role of OPEC: A historical perspective and outlook to the future

A speech by Dr Adnan Shihab-Eldin, Director, Research Division, Acting for the Secretary General to the Cosmopolitan Club Vienna, 24 March 2005

It gives me great pleasure to be here with you today at your kind invitation to talk about an Organization whose name has become a household name in global energy discussions, but whose objectives and activities are often misunderstood. I am speaking about the Organization of the Petroleum Exporting Countries (OPEC). In my address, I want to give you a brief history about our Organization, look at some of the issues shaping the current and future global oil industry, and offer an insight into how OPEC is responding to the challenges of the 21st century.

But first, I would like to say a few words about our deep-rooted friendship with your beautiful city, which has been our home for 40 years now. We first set foot on Austrian soil in September 1965 at the invitation of the Federal Government and the city of Vienna, as part of their commendable plan to turn the city into a major centre for intergovernmental organizations and other international bodies. Their far-sighted internationalist policy was a major source of attraction to our Organization. We were also drawn by the congenial working environment and warm hospitality of our hosts and very quickly realized that we had taken the right decision to settle here. We celebrated our move from Geneva with the 10th Meeting of our Ministerial Conference in December 1965. Since that time, and including our last Conference held earlier this month, we have convened 125 Ministerial Meetings, with a large proportion being held in the Austrian capital. We look forward to a continuation of this excellent relationship in the years to come.

This year, Austria marks its 10th anniversary as a member of the European Union (EU), where it has matured into a well-developed market economy, with a high standard of living. It is closely tied to other economies of the EU, especially Germany, and has drawn an influx of foreign investors attracted by the country’s access to the single European market and its proximity to other aspirant economies. There is actually an interesting parallel in the development of both the EU and OPEC. Both have their roots in commodity organizations, set up in the period of reconstruction after the Second World War, when a new international economic and political order was emerging and people were coming to terms with a new set of realities that cut across national borders. The European Coal and Steel Community (ECSC) was set up with six founder members in 1951, while OPEC followed nine years later with five signatories (slide 2). The pressing, practical need for economic and political solidarity, with regard to the roles of these three industries in the rapidly expanding international arena, was common to both groups. By the time OPEC was formed, the Treaty of Rome had been signed, and subsequent developments led to the prosperous EU as we know it today. OPEC, on the other hand, has advanced in different ways. While remaining essentially a single-commodity Organization, due mainly to the geographical spread and cultural diversity among our Members, we have continued to gain countless years of expertise in oil matters. However our development path, measured by per capita GDP growth, has not been on average steady, in contrast to the impressive steady rise seen in the EU.

In the light of this history, and the fact that the EU has continued to widen its reach, we were extremely gratified in OPEC earlier this year to receive a proposal from Brussels to establish an EU-OPEC energy dialogue. This will take place at the most senior level, on the basis of biannual meetings, with the dialogue aimed at furthering constructive cooperation between oil producers and consumers.

Let me now turn to our Organization and the reasons for its formation. OPEC was founded in Baghdad, Iraq on 14 September 1960 against a background of great change. (slide 3) The post-World War Two period of reconstruction was over and the consumer society was in full swing. Cars were becoming bigger and thirstier and air travel was more affordable for the masses. At the time, a prominent Western Prime Minister declared: “We’ve never had it so good!” He was not far wrong, but, of course, he was referring to how the richer part of the world lived. In the poorer regions – and home to the vast majority – many countries were breaking free from colonialism and gaining independence. In reality, however, most of these states had little choice but to maintain their longstanding role of servicing the needs of the richer nations, supplying them with the raw materials and other basic goods that perpetuated their prosperous lifestyles. Oil is the perfect example of how such a raw material was exploited. If one commodity can claim credit for the startling advances seen in the world in the 20th century, in particular in developed industrialized countries, it was crude - soon to be dubbed “black gold”. The richer nations relied heavily on the crude oil deposits found in abundance in some developing countries, exploiting these resources at unreasonably low prices.

It is important to know that for all of the first half of the 20th century, major oil companies from the industrialized world determined the quantity of crude oil produced from the poorer nations, the price at which this oil was sold, and, to cap it all, what share to give to the owner of the natural resource. This was part of the one-sided concessionary agreement made under mostly colonial rule. And with this accord binding, the impoverished producer nations were limited in what they could do. But the final straw came when the dominant multinational oil companies – the renowned “Seven Sisters” – announced yet another unilateral reduction in the posted price of their crude, following the imposition of import controls in the United States. This apparent loss of earnings did not actually give a true picture, since these very same companies – the Seven Sisters - made up any revenue shortfall on the sale of oil products, which they also controlled. However, the reduction in the crude price was, of course, to the further detriment of the producing countries. (slide 4) To defend their patrimonial interests, representatives from five oil-producing developing states – Iran, Iraq, Kuwait, Saudi Arabia and Venezuela – met in Baghdad on 10 September 1960 to find a means of asserting legitimate sovereign rights over their own natural resources. Four days later, they made the collective decision that they could no longer stand by and watch as their domestic oil resources were unfairly exploited, and OPEC was born. The five Founding Members were soon joined by other oil-producing developing nations, which were in a similar predicament and looking for the benefits such solidarity could bring.

[Today, our membership numbers 11, with the addition of Qatar in 1961, Indonesia and Libya in 1962, Algeria in 1969, Nigeria in 1971, and the United Arab Emirates in 1974, which actually took over the membership of Abu Dhabi, which joined in 1967.] (slide 5) The total population of OPEC’s Members is around half a billion and although there is a multiplicity of political, economic and social systems, as well as cultures, languages and religions, their commonality of interest is derived from their status as developing countries with abundant supplies of one resource - crude oil - the sales of which provide the bulk of their export revenues (slide 6). Two fundamental objectives have formed the cornerstone of the Organization’s existence. These comprise establishing and maintaining a stable oil market with fair and reasonable prices, both for producers and consumers; and securing a fair return for producers and investors from the sale of Member Countries’ oil.

(slide 7) Turning the clock forward to the present day, we see a very different world to the one OPEC encountered all those years ago. Advances in technology have virtually transformed everything that touches us in our day-to-day lives, bringing with it a massive rise in global energy consumption. There are many more cars, many more planes, in fact more of every type of consumer commodity and service … for those who can afford them, of course. Sadly, millions of people in the poorest countries of the world remain poor and have not benefited from this economic miracle. Admittedly, for OPEC, the resultant surge in global oil consumption has been good news for the economic welfare of its Members, but the past years could in no way be termed as being easy. OPEC has had to overcome numerous difficult challenges — from a series of price crises, to conflicts between some of its Members. In fact, during the more difficult times, its demise was predicted on more than one occasion. But, I am here today to tell you that the strength of unity among our Members has consistently prevailed.

(slide 8) So what of the modern-day oil market? Well, the industry has been at the centre of some quite unique developments over the past couple of years. We have seen successive record highs for nominal crude prices since the autumn of last year. In fact the price of our OPEC Reference Basket of seven crudes, which we use as a barometer on pricing, broke through the $50 a barrel mark earlier this month, which was both extraordinary and disconcerting. Unfortunately, the very market fundamentals that OPEC can and does have influence over – concerning levels of supply – have not been the driving force behind the unprecedented price rise. (slide 9) A combination of factors, including a sudden and unanticipated surge in demand in Asia and the United States, geopolitical tensions, refining and distribution bottlenecks, and the effects of the hurricanes seen in the Americas last year, actually pushed prices to record levels in nominal terms. But the cycle did not stop there. The oil futures markets played a major role in amplifying the price rise as evidenced by the increased activities of speculative investments by hedge and pensions funds in futures markets fuelled by the perception of continued demand strength and oil market tightness in the years ahead. This phenomenon is threatening the formation of an oil price bubble not dissimilar to that of technology stocks prices a few years ago. As a result, prices have just kept on rising, more lately influenced by strong demand brought on by a late cold snap in the Northern Hemisphere.

(slide 10) It is important to stress that, even though prices today are considered extremely high, in real terms they are still half the levels seen in the 1980s, when the price of a barrel of crude in today’s money had reached more than 80 dollars. All recent studies show that apparently the global economy has not so far suffered as a result of the higher prices. In fact, we have observed that the larger economies have managed to cope very well with the increased fuel costs, indicative perhaps of the robustness of their fiscal standing and decrease in energy intensity in the OECD countries. But despite this somewhat rosy picture, we cannot afford to be complacent, since unreasonably high oil prices over a sustained period can be detrimental to the health of the global economy, in particular in developing countries. (slide 11) As to whether we have entered a new era, characterized by higher oil prices, it is, I think, still too early to say.

The rise in crude prices has inevitably led to an increase in the price consumers, such as motorists, have to pay for their petrol, although the impact varies from minimal, or hardly noticeable - as in Europe – to very significant, as in the US (slide 12). Average retail prices for gasoline have hit a new all-time high in the United States, but, once again, we have to mention that when comparing prices in nominal and real terms, the two dollar a gallon gasoline seen in the US earlier this week is a fraction of the 3.5 dollars price reached in the early 1980s in terms of today’s money. (slide 13) Our calculations show that since February 2004 the price of gasoline in the US has increased by an average of around 16 per cent. (slide 14) In Europe, the increase has been considerably smaller - averaging around six per cent, and influenced by the dollar/euro exchange rate, and the fact that there are considerably higher taxes on the end product than those across the Atlantic. You may remember that the issue of high taxes was the subject of widespread fuel protests a few years ago in the United Kingdom, where 80 per cent of the final price was going into government coffers. Today, that figure is still very high at around 73 per cent. Apart from hitting the motorist, such high taxation levels reduce the earning power of the producers, a situation which is especially felt at times of low oil prices. (slide 15) It is, therefore, interesting to note that when you fill up your petrol tank in Vienna today, 61 per cent of what you pay is taken by the Austrian government in tax, while under 22 per cent goes to the producer of the crude – domestic or foreign. The remainder is the industry take - for the companies, refiners, transportation etc. When we look at Europe as a whole, an average 68 per cent of the final product price paid by motorists goes to the national treasuries, while producing countries earn around 20 per cent. Quite frankly, we in OPEC consider these levels of taxation as unreasonable. A more flexible and balanced approach to this taxation by the governments concerned would go a long way to helping both the producer, during a period of low prices, and the end-consumer, when prices soar, as they have today. On this subject of taxation, you might be interested to know that some OPEC Countries have actually proposed supplying European countries with their crude free-of-charge, on the condition they hand over just half of the revenue they earn from taxing that oil, at existing levels Such an arrangement would be good for the consumer, good for the producer … yet not so good for the treasuries of the consuming countries. Needless to say, such proposals have consistently been ignored.

It has been said in many quarters that OPEC Members are only really concerned with getting the highest price they can for the oil they sell. Well, I have to tell you that this is a misconception. Of course, our Members wish to optimize the revenues they can glean from their oil exports – this is natural. But OPEC was, and remains, very concerned when prices rise to unreasonably high levels. We fully recognize that it is not in the interest of the global economy, of which we are an integral part, or those of developing states, the emerging economies, and especially the least-developed countries, to have the price of oil at unsustainably high levels. Even from a self-seeking perspective, OPEC would not like the price of oil to be so high as to make it less competitive as an energy source and encourage the development of costly alternatives, to its own detriment, and that of the world. That would be counterproductive to our efforts of attaining optimum revenues. (slide 16) And as for OPEC being concerned, well we have met on no fewer than seven occasions since February 2004, successively raising production by some 4 million b/d in our bid to bring prices back to more reasonable levels. At our last Meeting in Isfahan earlier this month, we agreed to increase production again to try and stem the price rise. If that does not work, we are ready to consider another production increase, most probably in April or May, if necessary. It is important that we explore all avenues to restore order to the market. But with other forces at work, unfortunately there is only so much OPEC can do.

It is no secret that, over the years, many consuming countries, including some who are producers, have advocated an international oil market, free of all controls and outside influence. Well, as the experiences of the past, present and most likely the future have shown, that approach simply does not work – certainly not with something as important, diverse and complex as the global oil sector. Of all the commodities traded on world markets every day, oil is without doubt the most vital and subject to inevitable volatility, downstream bottlenecks, often erratic supply patterns, and sudden unforeseen changes, which can especially affect prices. It therefore requires some form of management or regulation, some kind of stabilizing apparatus, to prevent prices from crashing or soaring. But implementing some level of control is not a new concept. If we look back to the early years of the 20th Century, we can see that the first moves towards attempting to balance supply and demand, which ultimately affected prices, were made by the United States Texas Railroad Commission. This agency was actually established in 1891 with the initial mandate to regulate rail commerce, but in 1917 was given the power to regulate oil pipelines, which were regarded to be "common carriers", like railroads. The Commission was further empowered to take steps to prevent the “waste” of oil and gas. By 1931, the commission had so expanded its power that it introduced a monthly production allowance – similar to OPEC’s current quota system -, which dictated what per cent of maximum production wells in Texas could pump. Four years later, US Congress endorsed the establishment of the Interstate Oil and Gas Compact Commission, which comprised six states and had the mission “to promote the conservation and efficient recovery of domestic oil and natural gas resources, while protecting health, safety and the environment”. Both these entities had the prime function of controlling production, with a view to maintaining a certain level of price and stability. Later, the Seven Sisters took up the mantle and exercised an even stronger hold on output and pricing. But these were private companies with only a vested interest in making profits for their shareholders, irrespective of the interests of the public owners of this valuable resource.

Today, and especially with non-fundamental factors – such as speculation in oil futures markets - playing such a critical role in oil price determination, we feel that leaving such a sensitive trading environment as the oil market to its own devices would surely be a recipe for disaster, both for producers and consumers. Hence our continued commitment to ensuring market stability.

Ladies and gentlemen,

The global economy of the 21st century is far removed from the world economic order OPEC encountered at its outset. Today, globalization is proving to be a powerful force of transformation, opening up borders to trade, and leading to the creation of new economic blocks that are continuing to undergo rapid social, political and economic change. This has led to the liberalization of the global energy sector with oil industry players adapting their market strategies and increasingly moving towards forming partnerships to meet the new challenges. Environmental concerns have become paramount, and the dimensions and complexities of the contemporary and technological challenges facing both producers and consumers are considerable.

In this new global environment (slide 17), it is more important than ever that oil supplies remain secure and the market stable. The clear fact is that for prices to be sustainable and acceptable to both producers and consumers, they should neither be too low, nor too high. OPEC requires a level of price that guarantees fair returns to investors and the owners of the valuable natural resources, while the consumers need a price that can be comfortably accommodated to ensure continued robust economic growth. However, I must make one thing clear here. OPEC does not set the price of oil. It has not had this capability since 1980 such has been the growth of producers and production capacity outside the Organization. Today, it is the various markets, comprising spot and futures trading, and the business they generate that mostly determines the price. What OPEC attempts to do is influence prices to settle in a range that is comfortable and acceptable for all market players. This it does by either increasing or reducing production, and consequently, supply. But our Members are always seeking to attain a level of price that will guarantee acceptable revenues and an adequate return on their investment. In 2000, our Ministers identified an oil price band of between 22 dollars and 28 dollars a barrel for an OPEC Reference Basket of seven crudes, which they considered to be fair and reasonable, as well as being consistent with the market stability they were seeking (slide 18). Prior to 2004, and following the difficult years of the late 1990s, when the Asian financial crisis caused prices to drop to under 10 dollars a barrel, the price band helped maintain relative stability in the international oil market for four years up to the end of 2003. During this period, the price of the OPEC Basket stayed comfortably within the range of the band. However, earlier this year, following the sustained escalation in prices, our Ministers suspended the price band, feeling that, realistically, it needed to be reviewed. That process is currently ongoing. It was actually not the first time we had attempted to have a target price, although this was the first time we specified a range. In the 1980s, we sought a price for our Basket of 18 dollars a barrel, and in the following decade we increased this to 21 dollars. Both attempts were not greeted with that much success, such was the acute volatility seen in the oil market during that time-span.

Future outlook

(slide 19) It is already certain that, for the foreseeable future, oil will maintain its leading position in supplying the world’s growing energy needs. OPEC, in accounting for nearly 80 per cent of the world’s proven oil reserves – which currently amount to 1,137 billion barrels – will be called upon to supply the extra oil the world will need in the years ahead. And make no mistake, our Members have both the will and capability to do this. They are committed to ensuring that consumers receive regular, secure and sufficient amounts of oil to fuel their growing economies. But equally important for the producers, they require security of demand – to be firm in the knowledge that there will always be a market for their oil and that governments will not take steps aimed at reducing oil flows and hence leaving the producers with costly idle capacity.

(slide 20) Looking at the latest forecasts drawn up by our Secretariat here in Vienna, world economic growth is expected to expand by around 3.6 percent annually over the next 20 years. In keeping with this forecast, oil demand is set to rise by 28 million b/d to reach 111 million b/d by 2025, representing annual average growth of 1.5 million b/d, as against average expansion of some 2.2 million b/d in 2004 and 2005 combined. With non-OPEC oil production in the first two decades of this century forecast to reach its plateau, OPEC Member Countries will be relied upon to supply the lion’s share of the new demand, especially those in Asia. OECD countries will continue to account for the biggest proportion of world oil demand as the region’s economies register average annual economic growth of 2.5 per cent up to 2025. (slide 21) However, almost 75 per cent of the increase in global oil demand will come from the developing countries, whose consumption will almost double. Asian countries, home to half the world’s population, are forecast to experience annual economic growth of over 5 per cent up to 2020, and will remain the key source of oil demand in the developing world. Our figures show that, up to 2025, the region, which has emerged as a key player in global markets for commodities, manufacturing and services, is expected to account for a rise of 18 million b/d in oil demand, which represents 65 percent of the total in all developing states. (slide 22) China, [ with annual economic growth projected at around 6.6 per cent, and India, [with growth of about 5.5 per cent per annum,] will be central to this expansion, boosted by an expected boom in the transportation sector. The huge potential for growth in this sector is clear from the low density of vehicles in these two countries, which stands at just over 10 vehicles per 1,000 inhabitants, compared with over 500 vehicles per 1,000 inhabitants in the OECD region. In fact, transportation is forecast to account for almost 60 per cent of the rise in global oil demand over the next two decades. (slide 23) Overall, if the kind of demand scenario I am painting here comes to fruition, by 2025 OPEC could be producing around 55 million b/d of crude, almost half of all global supply.

(slide 24) OPEC will, of course, need to expand its oil production capacity to meet this extra demand in the future. I am pleased to inform you that following the events of the past two years, where questions have been asked about OPEC’s ability to continue to meet this rising demand, our Member Countries have advanced their capacity-building programmes, aimed at further enhancing their output capabilities (slide 25). Needless to say, the scale of investments our Members will need to make to meet the expected demand growth over the next few decades is enormous. But an important fact to note for the future is that crude oil in OPEC Member Countries is more accessible and cheaper to bring to market than in areas outside the Organization. It actually yields more than a 4-fold multiple in terms of new production capacity for the same investment. The exact magnitude of the required capital injection is subject to large uncertainty (slide 26). Factors such as future economic growth, the extent of the industry’s technological development, as well as polices of consuming countries will have an important bearing on this. In addition, it is important we get our sums right. (slide 27) Over-investment may result in excessive, idle capacity, while under-investment may lead to a shortage of crude. Both inevitably lead to undesirable boom-bust cycles.

The downstream sector of the oil industry will also require substantial investment as it responds to significant challenges in the years ahead. The competitive landscape is being changed by corporate mergers and the formation of both regional and global joint ventures and partnerships. Refining is now a truly global and highly competitive industry which is required to operate in an environment of highly volatile margins. Investors, who now have to meet ever tighter fuel specifications and emission limits, face the same kind of problems as upstream operators, in ensuring that refinery capacity is in tune with crude output. (slide 28) Too little capacity results in refining bottlenecks, which are apparent today, while too much can lead to costly plants being mothballed. But it is a fact that today’s oil must be cleaner, safer and more efficient than ever before – all to meet the expectations of the modern-day consumer. Already, many changes have been made to ensure that the world uses its oil in a more environmentally harmonious manner, such as more efficient vehicle engines (like diesel in Europe) and cleaner fuels, but one feels that the demands and regulations governing downstream development can only become more stringent in the future – and that will obviously come at a cost.

Turning to supply, the world can rest assured that there is plenty of oil around for decades to come. While there is an understandable call to develop renewable energy sources, such as solar, wind power and hydrogen cells, to name a few, the fact remains that the technology for these applications is still in its infancy. In the meantime, oil has a big role to play in helping to satisfy the energy needs of mankind and to support sustainable development. (slide 29) And just as the cumulative amount of oil that has been produced rises with time, then so does the size of the world’s total resource base. Even by 2025, if the resource base remains the same as it is now, we should still have used less than half of it. But, with advancing technology, enhanced recovery from existing fields, and the development of new reservoirs, the resource base is expected to continue growing in the future. Therefore, the world’s oil resource base should not be seen as a constraint in meeting future demand. The oil industry itself is also benefiting from huge technological advances made in both upstream and downstream operations. (slide 30) Today, because of environmental awareness, we are justifiably impelled to ensure the welfare of our planet. We must ensure that we continue along this ‘green’ path, so that our operations always comply with modern-day standards.. Nobody has the right to pollute the planet, and OPEC’s view, like others, is that it must be preserved for future generations. However, what OPEC seeks is the right to advance the development of its Member Countries in a way that will allow them to prosper and make the best use of their natural resources, in a manner compatible with the preservation of environmental harmony. More constructive dialogue is clearly needed to work out methodologies for the future so that all parties are treated in a fair and equitable manner. (slide 31) Carbon sequestration is one of these methodologies, especially in conjunction with enhanced oil recovery techniques. This process allows more oil to be extracted from a given reservoir, but with the potential harmful emissions from the use of fossil fuels like coal, gas and oil, dramatically reduced. Hand in-hand with making fuel cleaner, more efforts should be made to gradually develop renewables and other alternative energy sources - and on the same sound and equitable economic footing.

Ladies and gentlemen,

In conclusion:

Today, the global economy is clearly less sensitive to oil price surges, compared with the situation seen in the 1970s and 1980s, thanks to major advances in energy efficiency and conservation. In simple words, countries are more resilient, and this is borne out by the fact that the global economy experienced strong growth last year in the face of rising oil prices. However,, we still feel that the best – and most sure-footed - way forward for attaining global economic prosperity is for us to have an oil market that is stable, with a fair and equitable price. Today’s oil industry is sprawling, its complex, and its vibrant. It is also made up of a number of key players who rely on it for their survival. These players all have a significant role to play in its welfare, effectiveness, growth, and general evolution. (slide 32) Cooperation and coordination among theses players - the producers, consumers, governments, the large oil companies, and the financial institutions - is a prerequisite for establishing lasting oil market stability and prosperity. We need to monitor its development, identify the driving forces, assess their implications for the global economy, and manage to come up with the right policy decisions – and we need to do this collectively. Over the past few years, steady progress has been made in developing ties with other producers, consumers and even leading institutions. [ … and I can assure you that in all its Meetings, OPEC is always looking to make decisions that will pursue this road of cooperation. We feel, after past experience, that it is the only strategy that can bear fruit and guarantee oil’s success in the future in this ever-demanding, ever-changing world.]

And just as oil has played a key role in fuelling the development of the industrialized countries in the 20th century, it should - and I feel will - play just as important a role in supporting the future growth of the economies of the developing world in the 21st century, where, as I have already stated, the pinnacle of future oil demand - and hence the future welfare of our industry - lies. Let us hope that the progress we have made can be maintained and furthered so that the 21st century will be characterized by an oil market where all players not only prosper, but most importantly, prosper in an environment that reflects fairness and stability.

[Much has been achieved over the years, but the learning curve never ends. OPEC has the proven ability to be innovative and constructive in the policies and decisions it takes. With demand for oil - and gas - set to increase markedly in the years ahead, there is now an ever-greater need to achieve and sustain lasting market order. OPEC stands ready to supply the oil the world requires, but new challenges are continuing to emerge that threaten to throw it off course. That is why our Organization today is meeting more in Conference than at any other time in its history. It has to be vigilant in closely scrutinizing the market’s direction, and it has to be responsive and accurate in taking the right decisions - and at the right time.]

Finally, I want to reiterate that OPEC takes its role in the oil market very seriously as it continues its longstanding efforts to achieve order and stability, with prices that are both reasonable and compatible with steady growth in the world economy, and, of course, to the benefit of producers and consumers alike. But we are convinced that the oil industry is better off if there is an underlying consensus on the means on handling the major issues of mutual concern, such as price stability, security of demand and supply, investment and environmental issues and sustainable development. And I do believe we are now better prepared than ever to meet the challenges the future will surely bring.

(slide 33) Thank you.

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