How Does OPEC Control the Price of Oil | CFI LB

How do OPEC decisions affect Oil prices

What is OPEC?

OPEC stands for Organization of the Petroleum Exporting Countries and represents a group of the largest oil-producing countries in the world. While OPEC has been around for a while, it unofficially expanded in 2016 to include other non-OPEC member nations that are also major oil producers. The new alliance was called OPEC Plus or OPEC+.

The goal of OPEC is to create continuous control over the price of Crude Oil and for the most part, it does so very well given that OPEC members control more than 50% of global Oil supplies and over 90% of known and proven Oil reserves.

 

While control of prices over the short term is possible, the long term is affected by other factors including individual economies, global demand, unexpected events, and many other reasons. In other words, OPEC can affect prices in the near term but can only work to address long-term supply and demand shifts to the best of its efforts.

 

OPEC members include the following countries:

  • Algeria
  • Angola
  • Congo
  • Equatorial Guinea
  • Gabon
  • Iran
  • Iraq
  • Kuwait
  • Libya
  • Nigeria
  • Saudi Arabia
  • United Arab Emirates
  • Venezuela
Facts
  • OPEC includes 13 members. OPEC+ adds a further 10 and was formed in 2016.
  • OPEC+ has a bigger influence than the original OPEC.
  • The organization exports around 60% of the global petroleum trade.
  • 80% of the world’s proven reserves are within the boundaries of OPEC countries.
  • Saudi Arabia is the biggest OPEC member and was once the biggest producer in the world.
  • 100 million barrels a day were consumed on average during 2019.
  • Currently, the US is the biggest producer of Oil, boosted by the discovery of shale oil.
OPEC’s effect on oil prices

 

OPEC exerts a very strong influence on the price of oil and this is usually done by large-scale changes in production from OPEC members. If the organization sees that prices are too high, they may look to increase production, a move that could lead to lower prices in the short term but not necessarily in the long run given the potential demand at the time.

 

On the other hand, lower prices may mean demand is low or a combination of low demand and extra supply which could lead to OPEC members reducing supply and barely covering the demand available, possibly leading to higher prices.

 

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Nonetheless, OPEC can only do so much for oil prices and other factors come into place aside from supply and demand such as the pandemic that started in 2020 which led to a sharp decline in demand but was less prominent on the production side, leading to oil prices approaching zero (Figure 1) at one point.

Figure 1 – Daily Crude Oil chart during 2020 and the pandemic

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OPEC versus the United States

The United States was once the biggest producer of oil in the world and controlled pricing to a large extent. This lasted into the mid-20th century before OPEC took over. Eventually, and with the discovery of shale oil, the US became the largest producer with around 19.5 million barrels daily.

 

Such large daily production meant OPEC no longer had the same influence as before with the US also exerting enough force to affect prices when major shifts in supply or demand occurred.

 

Aside from the US’s influence on global oil prices, the weekly crude oil inventories release creates short-term price volatility and could shift trends at times given its importance. Drops in inventories mean there is less oil present and usually leads to higher prices while an increase in available supplies could lead to lower prices. Aside from the straightforward supply and demand, other factors can lead to different price conclusions including expected forecasts and previous figures.

Trading oil

Oil is one of the most traded commodities in the world and is usually bought or sold for hedging as well as speculative reasons. Companies, governments, and other large institutions may buy or sell oil for hedging reasons, especially if they are involved in oil whether as suppliers, producers, or large consumers.

 

On the other hand, investment banks, private investors, and hedge funds may speculate on oil given its high volatility and large daily ranges. This means a higher than average number of daily trading opportunities. While no financial product is easy to trade, information on oil is readily available and can help traders make more informed decisions given its connection to global economies and geopolitics.

 

Oil can be traded as futures or options contracts through a variety of global exchanges including the Chicago Mercantile Exchange, the biggest in the world. Such contracts can be used for speculative reasons or delivered for those seeking delivery of those contracts.

 

On the other hand, oil can be traded through ETFs (Figure 2) where traders can invest in funds that track the performance of oil-producing companies or funds that track energy derivatives. This is available as direct ETFs or options on ETFs.

Figure 2 – Daily USO ETF chart

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Also, traders can get oil-related exposure by directly buying stocks or options of companies that produce oil.

 

Another, less direct way of trading oil is through commodity currencies such as the Canadian Dollar and the Australian Dollar. Those currencies tend to move in correlation with Oil and can present opportunities in a similar way.

The future of oil

It’s a known fact that oil will eventually run out and estimates put this around the middle of the 21st century. Aside from the fact that oil may run out sooner or later, dependence on it has greatly decreased over the past 10 years where cleaner and alternative sources of energy came into play.

 

Some countries now produce most of their electricity needs from renewable energies such as solar and hydro while others have delved into electric cars production which can lower carbon footprint and help maintain a cleaner and less polluted earth.

 

Such changes to oil needs around the world have put long-term pressure on pricing as more and more people are earth-conscious and prefer to contribute towards a pollution-negative environment. Nonetheless, the fact that oil will eventually run out will counter the effects of an increase in renewable energy and should keep prices relatively stable for years to come.

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