SPE 92888

OPEC: Floating Supply for a Balanced & Stable Market, Part I

S. Talabani, Baker Atlas-BHI

Copyright 2005, Society of Petroleum Engineers Inc.

Introduction

th
This paper was prepared for presentation at the 14 SPE Middle East Oil & Gas Show and
Conference held in Bahrain International Exhibition Centre, Bahrain, 1215 March 2005.

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Abstract
OPEC was formed as a joint action between five countries in
1960 in Baghdad to set a fair price for crude oil in the world
market. Today, eleven members account for 40% of world oil
production and 65-70% of proven oil reserves.
OPEC members regularly discuss oil prices and set crude oil
production quotas. OPEC revenue has grown over the last
year, but instability in revenue has been repeatedly related to
geopolitical crises, instability in one or more OPEC member
states, or lower world demand. OPEC pricing is set based on
an arithmetic average of a basket of seven crude types; in
practice, this is unhealthy for the crude price and always fails
to follow the market. Furthermore, there is one trillion barrels
of crude worldwide awaiting cost effective technology to
make it ready for production. This would possibly results in
better price stability in the crude oil market.
OPEC price, based on basket trading, was set for 10 -20 days
as $22.0 28.0 for adjustment. This has not been forced in the
market since it was accounted.
Until the European Union created a unified currency, the US
dollar has been (and still is) the dominant currency since 1945
and handles over 70% of world official exchange reserves.
Will this state of affairs change? Will the oil (and possibly
gas) price become stable whilst subject to rules other than that
of supply and demand? Can the Euro replace the Dollar in the
trading of crude oil? Would it be better for OPEC members to
base production quotas on regulations other than those
currently used?
Most forecasts of prices and quotas face difficulties in finding
rules to follow. This paper discusses ways and means for
better crude market stability.

On 10th September 1960, the Organization of Petroleum

Exporting Countries (OPEC) was created in Baghdad, Iraq.
This organization was founded as a result of several meetings
between high-level delegates from Iraq, Iran, Kuwait, Saudi
Arabia and Venezuela. These states argued that the oil price,
at that time around $2.0 /bbl (and at times much lower due to
auctions), was unfair and should be adjusted. Further meetings
led to the creation of the OPEC Organization. Later, other
states joined the organization: Qatar (1961), Indonesia and
Libya (1962), UAE (1967), Algeria (1969), and Nigeria
(1971). Ecuador and Gabon were members before they
withdrew in 1992 and 1995 respectively.
Despite remaining an OPEC member, it was agreed in March
1998 by all other members that Iraq should be excluded from
the OPEC quota (1).
OPEC members hold 65-70% of the entire proven world oil
reserves and produce around 40% of the global oil production.
The organization members have two main issues to meet on:
pricing, as well as the production quota for each member, in
order to keep the market price stable. However, these states
have different agendas and policies due to variations in their
individual social and political structures.
The creation of OPEC was necessary in order to balance oil
marketing between the major suppliers and demanders, and set
rules for pricing. Unfortunately, some of the rules for pricing
were not implemented. In the early 1970s some of the OPEC
members (Iraq, Algeria, and Libya) introduced their own
political agenda into OPEC meetings. Was this the beginning
of the politicization of the oil market prices? It is believed that
since then the oil market has not followed the natural rules of
supply and demand.
OPEC has been dealing in the US dollar since 1960 for pricing
oil (gas is not involved). The pricing of crude oil is based on
several oil brands. For example, the OPEC basket brand
includes seven crudes from OPEC and non-OPEC fields,
including: the Algerian Sahara blend, Indonesian Minas,
Nigerian Bonny light, Saudi light, Dubai Fateh, Venezuelan
Tia Juana, and Mexican Isthmus (2). The price for OPEC
basket crude oil is an arithmetic average of the 7 crudes
mentioned above. OPEC first introduced this pricing policy in

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SPE 92888

1987. The West Texas light (US benchmark) and Brent from
the North Sea, as well as others, affect the price of the OPEC
basket.
The crude oil market price has reflected political crises in the
world since early 1970s. Fears of oil shortages based on
expectation and speculation in the market have also greatly
affected the crude oil price.

shortages from Nigeria and Venezuela and the Yukos

scandal, as well as two consecutive production cuts
by OPEC in a short period of time, increased the
price of the crude oil to $55/bbl. The non-OPEC
producers have boosted their production capacity.
However, this has not affected the market.
12. To forecast crude oil price based on the past is very
impractical. However, I predict that the oil price will
settle at around $30 32 per barrel by end of this
year.

World Crude Oil Marketing and Prices

Figure 1 shows the crude oil price from 1960 to 2004 (2,3). The
figure shows that the price of crude oil was stable from the
creation of OPEC until 1973.
Looking at the figure the following can be observed:
Oil market prices did not grow abnormally when the
ownership of the Western assets was transferred to
the state-owned companies of OPEC countries in the
early 1970s.
2. The first increase in the market price of oil started in
October 1973 when the oil embargo began. The oil
price increased by 5 6 fold.
3. The revolution in Iran in 1979, followed by the IranIraq war (two OPEC members) caused a shortage in
the oil supply. This has resulted in an abrupt increase
in the price of crude oil, which rose by 2.5 fold.
4. Non OPEC states increased oil production (1986),
along with some OPEC members who exceeded their
quota. This resulted in a sharp decrease and
fluctuation in the price.
5. There was great fluctuation in the oil market price
since pricing was switched between netback, fixed,
spot and formula policies (1986-1988). The price
was not stable at all.
6. The first Gulf War (1991) and a reduction in oil
production increased the price quite dramatically.
This was followed by the disintegration of the Soviet
Union, which eased the market slowly.
7. Another increase in the price occurred after Iraqs
invasion, in 1997, of the Kirkuk oil fields, within the
Kurdish safe haven (the state was unofficially split in
two). The price of crude oil almost doubled.
8. A combination of increased production from Iraq,
low demand from Asia, production above quota by
others, as well as market demands meant the oil price
dropped to its lowest level since 1974. This occurred
took place in 1999.
9. Oil price tripled after an OPEC cutback, higher world
demand and low stoke levels in 1999-2000.
10. A period followed of two years (2001-2002) of low
crude oil price as a result of September 11event,
decreased world demand and over production.
11. The invasion of Iraq (2003-current) and fears of oil

As shown above, most crises in the market price of oil were

related to instability in one of the OPEC states, which in turn
reflected on the crude oil price. Oil price has therefore never
been ruled by the regulations of supply and demand. OPEC,
as an organization, was not responsible for any sharp increases
in the price of oil because it has not announced to date that it
will activate the price band mechanism.

1.

OPEC Setting Quota

OPEC has set certain production quotas for each member to
produce. The combined quota of all members equals the
OPEC quota.
The OPEC quota is based on crude oil only. Condensate and
natural gas are both excluded. The production capacity of a
member is equal or higher than its quota.
The following are some rules and regulations that might result
in differences between the official OPEC quota and the real
pumping of crude oil(2):
1.

2.
3.
4.
5.

Production capacity is related to the maximum

production that could be brought online within 30
days and be sustained for 90 days.
Saudi production includes Abu Safa field on behalf of
the Kingdom of Bahrain.
The UAE quota applies only to the Emirate of Abu
Dhabi in the UAE federation.
The Venezuelan quota excludes the extra heavy crude
used to make Orimulsion.
OPEC 10 refers to the 10 member states, excluding
Iraq since 1998, for quota settings.

The Un-Balanced Supply Demand Equation in the

Oil Industry
As mentioned before, the only natural resource politisized in
the world market is crude oil and its products. This is
unhealthy for the oil industry and people who work in this
industry. Any international political tension affects the crude
oil market and subsequently reflects on people by creating
unemployment.
Today, the oil market supply and demand is not balanced. The
question raised here is: should the United States and other G8

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SPE 92888

states work together to control the market? The G8 statess and

Chinas economies depend on oil market stability. Should
there be periodic G8 China OPEC meetings to set and
stabilize the crude oil price? Should crude oil enter the free
market?
The United States, like every other country in the world,
works in its own interests by keeping the crude oil market
secure and stable. In contrast, in the past, particularly in the
years between the two world wars, both England and France
directly controlled the oil industry through the countries they
occupied.
On the other hand, OPEC members are looking for the best
market price because they depend either partially or entirely
on oil revenue to develop their states.
Currently, the real oil market is responding to the day to day
political instability in some states that export oil. The
responses are usually based on speculation and fears of instant
production disruption. In this case, a 30 day price deal is
based on auction rather than on any other rules. The political
instability in some states (for example Iraq, Iran, Nigeria, and
Venezuela) causes the crude oil market to behave in this way.
In the near future Chinas growth, the US decline in
production by around 9%, and some disruption in crude oil
supply will require an extra 1.7 2.8 mbbl/day to be produced.
OPEC currently supplies the market with 27 mbbl/day, which
is close to its ultimate capacity. Mexico and Canada may be
able to recover and counter the US decline. However, this
increase is still required.
Currently, the Middle East is producing around 25% of the
entire crude oil market, whilst it possesses around 65-70% of
the worlds reserves (the worlds reserves total 1150 billion
barrels). If OPEC, and particularly the Middle Eastern states
within OPEC, invest a total of $150-$200 billions in this
industry(3,4), they can boost production by up to 49
MMbbls/day. Otherwise, OPEC will only be able to increase
production by 6 million barrels/day.
However, does the market need production to be boosted by
up to 100 MMbbl/day by 2020? Why the fear of shortages in
oil production? Why the worry about a crisis looming up
ahead in about 10-15 years time?
In fact, all these fears and daily forcasts of crude oil
production have no strong base and are mostly politisized.
Once the oil price reflects the true market, different
technologies that depend on oil will be modified rapidly in
order to reduce oil consumption.
The price of a barrel of oil in the market should be in the range
of $30-32/bbl. With this price most car manufacterers and
other oil dependent companies will invest in modifying their
products and this will result in lower levels of oil
consumption. Can the crude oil price be linked to
technological developments for better marketing?

Todays car fuel consumption efficiency does not even reach

38%. If we assume that 70% of oil products are used for
transportation, then an increase in the efficiency of fuel to
50% will keep the demand on oil constant until the year 2020.
By this time, the oil industry needs to be repaired and
maintained, rather than increasing investment for
development.
Technology in the oil industry will maximize the ultimate
recovery and will elongate the life of oil fields. This results in
better price stability. As well as this, other sources of energy
especially in countries that completely depend on importing
crude oil will reduce the burden of the oil industry.
It is also possible that the demand on oil production in the
future will be below what we are currently producing.

Will OPEC Switch from US Dollar to the EURO ?

OPEC members held their latest meeting in Vienna and
discussed whether they should switch the denomination of
their crude oil sales from the US dollar to the Euro. The
meeting ended up with the possibility of having a basket of
both currencies for OPEC to deal in. In fact, OPEC members
met some years ago and discussed the idea of having a basket
of 16 different currencies worldwide. However, the idea did
not have the support of the majority. This decision was related
directly to economics (excluding for an odd decision taken by
the Iraqi authorities in 2002 to deal only with Euro, which did
not work).
In 1979 the dollar devaluated to historically low levels and it
was not known whether it would bottom out (4). However, by
early 1980 the dollar had regained its value. OPEC members
have decided not go for the basket currency and dropped the
idea again.
The Euro, the new European currency that first entered the
market in January 1st 1999 and as paper and coin currency in
January 1st 2002, has become an important currency. This is
because it resulted from the combination of 9 strong
currencies as well as some other currencies in Europe that
were also healthy, although not as strong. The Euro began as a
currency fighting in the market to equal the value of the Dollar
and stabilize at that level. Today, Euro is stronger than the
Dollar by around 35%. This has benefitted Europe by creating
a bit more wealth and making it economically capable. Even
so, should OPEC deal in Euros and not in Dollars? The answer
to this question is not as simple as it may seem.
When the Euro rose against the Dollar, the US treasury simply
balanced the interest rate so that the dollar would flow easily
in the market. On the other hand, the high value of the Euro
against the Dollar resulted in a decrease in the Europes world
trading and an increase the US world trading. US exports
increased by 30 40% whilst Europe lost trade by the same
percentage. One can therefore conclude that the Euro has not

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SPE 92888

stabilized yet or reached its real value. Therefore, the Euro

will continue to fluctuate before it finally becomes stable.
The fluctuation of the Euro will hurt the European economy in
the same way as the Dollar affects the US economy. If the
Euro fluctuates highly over a short period of time and sharply
decreases, it might result in another 1929 market crash
(although the possibility of this is minimal). Therefore, tying
the oil market directly to the Euro is a serious risk at the
moment.
The US dollar is a mighty currency that handles almost 75%
of the world markets exchanges.
The US treasurys
securities, however, are owned by different countries
worldwide. For example, Japan owns around 15% of Dollars
in the market. The US dollar has gone through a few cycles of
high-low values in the past 100 years, although it has always
returned to its normal value within a short period of time (2-3
years).
Looking now at the European currency that fluctuates and the
Dollar that is devaluating makes one feel pessimistic about
which currency to use in the market. In fact, in a short period
of time there will little difference whether the oil market
should deal in the Dollar or the Euro. However, the Euro is
only five years old compared to the Dollar, which is an
international currency over 100 years old. The Dollar has
been through many crises before it finally gained its stability,
whilst the Euro may yet pass through several crises before the
market sets its real value.

Role of OPEC in Stabilizing the Crude Oil Market

Price
In the last few years, OPEC has taken steps towards stabilizing
the market price of oil. Would some additional ideas help
OPEC to set the price of crude oil? Here are few points the
crude oil price should be tied to:
1.

2.
3.

4.

The exact value of the Dollar in the market and how

much it devaluates at certain intervals and its inflation
rate.
The increase in the cost of the technology used in the
entire oil industry, from upstream to downstream.
The cost for the protection of the environment, both
locally and internationally. By doing so, OPEC should
lead the protection of the environment globaly through
the UN and other programs.
The cost of all the goods that developing countries
purchase from the industrialised countries.

By doing so, the price of the oil will not fluctuate and harm
either local or global economies and the oil price level will be
smooth and parallel with the prices of goods and technology.

Unlike many other global cartels, OPEC was partially

successful in controlling and increasing the price of crude oil
over the past four decades, except in the cases of some global
crises or when there were disagreements between members.
However, this may change in the coming years for the
following reasons:
1.

2.

3.
4.
5.

High oil price, if continues, will put many pending

reservoirs on investment and production, which are
uneconomic under the low crude oil prices.
Many new fields have recently been discovered in
different places in the world outside the OPEC
region.
Some developed states will switch from oil to Liquid
Petroleum Gas (LPG) in years to come.
The speed of technological development towards the
use of sources other than crude oil.
The current investment by different car
manufacturers to make it highly economical, may cut
demand for crude oil dramatically.

Future of OPEC and Role of Different Currencies in

The Crude Oil Market
OPEC has played a great role in the past during many global
crises. For example, sudden weather changes in the north of
the globe, a sudden cut in oil supply such as in Iran in 1979,
the two gulf wars, and many other situations. Only OPEC can
play this role, especially in the future. The West, realizes that
the presence of OPEC is crucial for a stable oil market. If
OPEC dissolves, then the market price of oil will immediately
hit the ceiling and it would be difficult to control the market.
This situation may put the wrold on the brink of an economic
disaster as most undeveloped countries will not be able to
afford crude oil.
The Euro has already gone through one cycle of value
fluctuation since it was established. The Euro lost its value by
30% in October 2000. After regaining its original value, it
increased in value by 30% in October 2004. The stabilization
of the Euro needs time because the countries within Eurozone
do not have the same economic strength. When the Euro first
devaluated, it was an extremely difficult problem for the
European Central Bank to deal with. Today, as the value of
Euro is going increases, all European states within the
Eurozone are facing difficulties in trading. This is because
most of countries, including some OPEC states, have shifted
their merchandise imports from Europe to the United States
and other countries.
Any economic crises in any of the Euro states will affect the
value of the Euro on a short and possibly long term basis.
Involving new states into the Eurozone has some advantages
and some disadvantages. It is very well known that most of
the states that have recently applied to enter the Eurozone do

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not have strong economies. The advantage of having these

states in the Eurozone will be the increased availability of
manpower, with low costs for high levels of production. On
the other hand, the weak economies of those states will create
a pressure on the Euro to devaluate.
If England and Norway join the Euro zone, this should boost
the Euros stability, firstly because both countries are oil
producers, and secondly because the Sterling is a powerful
currency.
As long as the United States remains the major oil importer,
the US Dollar will dominate the crude oil market as a trading
currency. Many under developed countires in the world still
prefer to trade in the Dollar and do not want to change their
systems by switching to another currency. As well as this, the
Dollar is a currency of one country, unlike the Euro.
The replacement of the Dollar for trading in the crude oil
market involves unseen risks that OPEC should evaluate
carefully. Moving from the Dollar to a basket of currencies
(Dollar and Euro) is risky, because the Euro is still evolving as
new countries enter the Eurozone. Some of these new
countries are stable neither politically or economically.

References
1.
2.
3.
4.

5.
6.

7.
8.

If some of the OPEC countries decide to receive payments in

Euros, this will not affect the market as long as the setting of
the oil price remains in Dollars. If all OPEC members decide
to receive their payments in Euros, I would rather call this
process Currency Cloning. The Currency Cloning (CC)
process may affect the global economy for a short period of
time before it becomes stable again. This is because 70% of
the Dollar flow in the world market will decrease by no more
than 5-10%. As soon as the Euro becomes a stable currency, it
will flow in the global market at its natural limit.
The real value of the Euro is not known yet. There may not be
enough Euro reserves in the European Central Bank for
trading in the crude oilmarket.

Conclusions
The crude oil market has been dealing in Dollar for a long
time. On the other hand, the Euro, as a new currency is
currently risky if introduced into the crude oil market. Once
the Euro becomes stabilized both in the Eurozone and globaly,
it can be introduced to the crude oil market.

Words of thanks
I would like to thank Sazan Meran (of King Edwards
Handsworth H.S., UK) for her review and comments.

* : Member of SPE, SPWLA, SCA, Energy Security

Council, Washington DC.

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Analysis Briefs on OPEC, the DOE US website;

eia.doe.gov.
World Oil market and Oil Price Chronologies: 1970
2003 the DOE US website.
The 11th ADIPEC Executive Panel Session, held in
Abu Dhabi, October 11th 2004.
Analysis: OPEC Will Switch From the Dollar to the
Euro, Lawrence Joyce, Web Today Editor, October
2004. The site is 888webtoday.com.
The Choice of Currency for the Denomination of
the Oil Bill, J. Yarjani, April 2002, Oviedo, Spain.
Oil Production Capacity Expansion Costs for the
Gulf Region, Energy Information Administration,
Office of Oil and Gas, US Depertmant of Energy,
Washington-DC, January 1996 (DOE/EIA-TR/0606).
Comments, John Donnelly, JPT, December 2004.
The Iraqi Imbroglio is Fueling the Rise in Prices,
Dr. N. Sarkis, Arab Oil & Gas Magazine, May 2004.

SPE 92888

Crude Oil Prices Since 1960

Crude Price, $/bbl

60
50
40
30
20
10
0
Years

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