POSTURA JURISPRUDENCIAL

The Organization of the Petroleum Exporting Countries (OPEC) came into existence following the Baghdad Conference in September 1960 by five-member-countries namely: Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.

Other countries joined the organisation in the subsequent years are as follows: Qatar (1961), Indonesia (1962), Libya (1962), United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973), and Gabon (1975).

Ecuador and Gabon later withdrew from the organization in 1992 and 1994 respectively for various reasons. The major source of revenue to sustain the organisation comes from the dues receivable from member nations. As part of their obligations to the organisation, genuine members are required to pay their regular and compulsory annual dues amounting to $1,000,000.00, which confirms additional rights to them as against the rights attributable to

“shadow members." Shadow members are allowed to participate in the discussions during debates relating to quantity controls but do not have any voting rights on any proposals (see Mason and Polaski, 2005 for details on this). The structure of OPEC was intended by the members to be similar to the Texas Railroad Commission (Colgan, 2014).

Among the members of OPEC, Venezuela first made a breakthrough in 1943 in its effort to benefit from a significant chunk of oil revenue when it signed a 50-50 profits-sharing contract, with a major IOC (Chalabi, 2010). Venezuela revised its tax system to accrue more revenue from its oil resources in the late 1940s. Subsequently, other producers took participation in a similar arrangement in the 1950s. When the IOCs staged an effort to retaliate against Venezuela’s tax decision, a significant shift was noticed in demand from Venezuelan oil to other Arab nations’ oil. Venezuela tactically responded by convincing and seeking cooperation of other producer nations to make similar tax changes.

Whilst the origin of OPEC was indeed similar to a “trade union” (Fattouh, 2010) the primary motive for coming together under a single umbrella was to harmonise production policies of the member nations with a view to

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influencing oil prices. This coalition became determined to resist the making of unilateral decisions by the “Seven Sisters” via the “posted prices’ (see Parra, 2004; and Chalabi, 2010). Chouri (1980) summarised three basic motivations for establishment of OPEC. 1 Fear of price-cuts by the IOCs which had powers over oil prices through a system of “posted prices”; 2 Perception that new entry of participants with lower production prices could threaten the existing developed markets; and 3 Possession of the technical know-how that increased the confidence of the producers to risk an attempt towards control of the market against the exploitative interests of the oil consuming nations and the IOCs. OPEC took the first step towards systematically influencing the post price when Libya first increased the tax rate to 55% from the initial 50%.

Subsequently, the implementation by Iran and Kuwait consolidated a move by OPEC in Caracas (in December, 1970) to adopt the same policy and further demanded that posted price should reflect any changes in foreign exchange rates. The non-compliance or rejection of OPEC’s proposal by some of the IOCs resulted in a total sanction/embargo from the OPEC. OPEC’s strategic approach was carrot and stick, which could be seen as a combination of negotiation and sanction. The outcome was favourable to OPEC. Chouri (1980) noted that, historically oil companies had been exerting significant political and economic influence in the pricing of oil, which led to intense pressure within the host nations. For example, an 8% price cut was followed by a further 6% unilateral cut in the posted price by the international oil companies (Chouri, 1980). The objective of OPEC to attain higher but fair oil prices initially appeared impossible given the evidence that the establishment of the organisation in September 1960 recorded little or no impact on oil prices (see Colgan, 2014).

The period between 1970 and 1973 marked a significant change in the balance of power to determine oil prices from the IOCs to the members of OPEC (Fattouh, 2010). Prior to the establishment of the Organisation of Petroleum Exporting Countries (OPEC) in 1960, oil prices were fundamentally cheap¹⁵ and hardly fluctuated beyond a range of $2.50 and $3 per barrel

15 Tsoskounoglou et al. (2008) attempted to analyse factors responsible for oil price changes with a view to answer whether the era of cheap oil has past. A good background of what

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(Williams, 2010) or less than 1% volatility (Regnier, 2007). Oil prices more than quadrupled in 1973 generally due to OPEC’s policy and actions resulting from Arab-Israel war. Opinion is divided with the majority attributing this sharp increase to the restricted oil supply by OPEC, which brought about shortage of oil (Adelman, 1992 and 2004; Pirog, 2007; Dvir and Rogoff, 2009). Another strand of opinion cast doubt on OPEC’s ability to raise oil prices four-fold (see Kepplinger and Roth, 1979). Other studies such as Kilian (2008) and Colgan (2014) supported the view of Kepplinger and Roth (1979) that the action of OPEC was deliberately exaggerated by the media. As mentioned earlier, it is important to note that the beginning of the 1973 oil price shock coincided with the period when the U.S. oil had already reached its own peak.

As mentioned in the introductory chapter of this study, a range of policy measures were introduced in response to the 1973 oil price shock which included: establishment of the U.S.-SPR in 1974 and the creation of the IEA in 1975. Furthermore, investments were seen to be growing into the high costly areas such as Alaska, Gulf of Mexico, North Sea. (Chalabi, 2010). This evidence conforms to the earlier argument that volatile oil prices have implications on OPEC’s revenue in the long run (see Byzalov, 2002; Horn, 2004). While approaching the end of the first oil price shock, when oil prices began to decline towards the pre-price shock period, the crisis in Iran in which the U.S. government was involved indirectly, led to what was considered the second global oil price shock in 1979, which lasted until 1982 (see Gately, 1986).

Furthermore, the 1979 second oil-price-shock ended in 1986 and there was a subsequent oil price fall for over a decade until the end of the 1990s. No one will dispute that Saudi Arabia is one of the America’s friends in the Middle East. Cheating by OPEC members (members ignoring the output limits set by OPEC) has been evident since the day OPEC first introduced the first quota system in the early 1980s (Chalabi, 2010). In 1986, Saudi Arabia and its allies within OPEC took a decisive action to consistently increase their oil

makes up cheap oil can be found in their paper titled:- The end of cheap oil: Current status and prospects.

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supply (Gately, 1986). Evidence of increased stockpiling can be observed from figure 2.1 below:

Figure 2.1: U.S. Monthly Oil Closing Stock in Strategic Petroleum Reserve (SPR) from October, 1977 to December, 2013

Source: U.S.-EIA, 2013

As shown in figure 2.1, the U.S. increased its stockpile of oil as the oil prices declined in the early 1980s following the second oil price shock. Demand for OPEC oil fell by more than 40% since 1982 (as prices went down) and remained low even after the price fall (Gately, 1986). In August 1985, more than half of the OPEC’s 4 million bpd increase in output came from Saudi Arabia, and this finally led to the oil price collapse of 1986 (Gately, 1986).

However, high oil prices were observed towards the end of the 20^th century and grew into the new century to what resembles the oil price surge in the 1970s. This period equally witnessed growing investment into the alternative energy sources, most particularly from the renewable sources due to the perceived effects of greenhouse carbon emissions on the environment or global climate change. Although increased oil prices during this period are allegedly attributed to the actions of OPEC in the oil market, the high costs of substitute sources of energy might not be ruled out easily; although it is often attributed to measures being taken by the IEA members for energy security. However, a more promising source of energy in terms of consistent

0 100000 200000 300000 400000 500000 600000 700000 800000

Oct-1977 Sep-1979 Aug-1981 Jul-1983 Jun-1985 May-1987 Apr-1989 Mar-1991 Feb-1993 Jan-1995 Dec-1996 Nov-1998 Oct-2000 Sep-2002 Aug-2004 Jul-2006 Jun-2008 May-2010 Apr-2012

Thousand Barrels

Stock

Stock

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supply exists but costly in the short-run (see Sioshansi, 2006). Shale energy revolution is taking place in the U.S. that might potentially restore its status as the global energy producer consistent with EIA (2014) U.S. energy projection under three cases scenarios as highlighted earlier in Chapter 1 of the thesis. For the high scenario (which implies highest energy production) to be achieved, one of the key assumptions being that understanding is achieved between the U.S. government and the public who often end up becoming the major burden bearers of high costly energy policies. It remains an important challenge to reconcile the conflicting policies; one from cleaner sources of renewables and the other from a riskier process of fracking but, which potentially guarantees energy independence from OPEC members. In almost a decade since 2004, investments in the renewables have seemed to be on the decline (see figure 2.2 below).

Figure 2.2: Trend in Renewable-Energy Investments

Source: McCrone 2014, Bloomberg New Energy Finance

Figure 2.2 presents trends in the investments in renewable which seem to be on the consistent increase since 2004, slowed by the 2008 global economic recession and reached the peak in 2011. Thereafter, it begins to decline by 10% in 2012 and 11% in 2013. The increased investments by the OECD/IEA

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members in the alternative energy have led to significant decline in consumption of OPEC oil as discussed later in the chapter. However, this important move by the OECD/IEA accords them some degree of energy independence. The questions remain: Is the decision to be less dependent on OPEC that is naturally endowed with low extraction cost resources helping the affordability objective by OECD/IEA members in the short-run? Is it plausible that the increased investment in the alternative sources of energy is the main driver for sustaining high oil prices or vice versa? Most EIA projections (e.g.

EIA, 2013) often look into the prospects of the long-run in pursuing energy security objectives. Oil as a major source of energy provides nearly two-third of energy demand and is likely to fuel the energy demand of the industrialised nations over the next decades (Alvarez-Ramirez et al., 2003;

Bernabe et al., 2004; OPEC, 2010; EIA, 2009). The real as against the nominal average crude oil price has exceeded $41 per barrel from 1986 to 2003 and has witnessed a consistent annual increase (e.g. by average of 23% annually and to more than $145 in the first half of the 2008) from 2003 to 2008 (Ji-Hyang and Lee, 2012; King et al., 2012).