OPEC: The Cartel That Never Was

The Atlantic

March 1983

by Edward Jay Epstein

Aside from research and public relations, the OPEC staff takes care of the more mundane housekeeping chores of the organization, including hotel and airplane reservations;. security arrangements; payroll, bookkeeping, and the hiring and firing of local clerks and secretaries. None of these tasks involves any control of the oil market.

"OPEC is merely a service organization for thirteen sovereign oil-producing nations," explained Bahman Karbassioun, an Iranian who has been associated with OPEC for nearly ten years. "We provide background data, such as the amount of OPEC oil that can be sold at a given price, to the ministers when they meet," he added. "All decisions are up to them."

The thirteen oil ministers of the member nations meet at conferences that, according to the OPEC charter, "are the supreme authority of the Organization." These conferences are convened semi-annually, and additionally whenever a majority of members requests an extraordinary session. It has held an average of about three conferences a year. At these conferences, it is required that all decisions be made unanimously. Then decisions must be ratified by the thirteen governments before taking effect. No member, not even if it is in a minority of one, can be forced to abide by a decision to which it did not explicitly agree. There is, therefore, no need for a mechanism in OPEC for implementing,

In verifying, or even monitoring agreements. Compliance is completely voluntary Most OPEC decisions concern the base price for crude oil. Members can easily evade such price decisions through the simple expedient of altering terms-such as quality or transportation differentials thereby giving discounts or premiums.

Technically, it would be relatively easy for OPEC to enforce price decisions, by keeping track of the crude-oil sales: most oil is loaded onto tankers from only a dozen or so terminals. But members won't allow OPEC to measure the actual flow of oil from their terminals, for good reason: despite the appearance of unity, they are all competitors for shares of the world market. Current oil sales are considered by many OPEC states to be the equivalent of state secrets. Saudi Arabia declared in 1980: "We refuse on principle to even discuss the subject of production, which concerns us alone. Our decisions on production derive from market conditions and Saudi Arabia's international commitments,"

When the oil ministers meet at OPEC conferences, they therefore have no choice but to depend on their own national data. Moreover, some ministers are more equal than others. Sheikh Ahmed Zaki Yamani, the Harvard-trained oil minister of Saudi Arabia, often plays the lead role at these conferences. "Yamani's in charge of long-term strategy," one Iranian technocrat explained, and added, "It is no coincidence that the benchmark price for Saudi crude oil is the official OPEC price." From his perspective, Saudi Arabia attempts to use OPEC to force the twelve other producing countries to support its standard oil price. OPEC, with its minuscule staff and tiny budget, clearly is not the sort of cartel that has captured the public's imagination. A cartel, by definition, has one indispensable characteristic: it must be able to restrict the supply of the commodity reaching the marketplace. Yet, although individual OPEC members can cut back on the amount of oil that they supply , OPEC itself is powerless to interfere in such decisions. As Sheikh Yamani said at the last OPEC meeting in Vienna, in December, "Production decisions are made in Riyadh, not Vienna."OPEC not only lacks power to impose its will on recalcitrant members, it lacks the basic information needed to operate a cartel. At best, it is only a shadow of the former international cartel of oil companies that previously controlled almost the entire oil trade. This group, known as "the Seven Sisters," was a real cartel, with thousands of employees and unlimited funds. It is useful to compare the operations of a real cartel ,with those of OPEC.

The international oil cartel traces back to a grouse shoot at Achnacarry Castle, in Inverness, Scotland, in September of 1928, which was attended by the heads of the three most powerful oil combines in the world: Sir Henri Deterding, the chairman of Royal Dutch Shell: Walter Teagle, the head of Standard Oil of New Jersey (now Exxon); and Sir John Cadman, chairman of Anglo-Persian Oil (now BP). Under the pretext of engaging in sport, these three men conspired to eliminate competition in developing new oil resources for the world. The mechanism was the "as is" principle, under which all agreed to divide future markets among themselves according to the shares of the market they held in 1928. This meant that there would be no advantage in "destructive competition," as the companies put it, among themselves for new oil fields: whatever advantage one company received would be shared proportionally by the others. In a separate "pooling" accord, the three companies also agreed to share their oil tankers, refineries, pipelines, and marketing facilities with each other. As the membership of the cartel expanded to include the other major companies, it became known as the Seven Sisters. The cartel controlled oil production, refining, transportation, and sales in almost all areas of the world except the United States, which had strict antitrust laws.

The cartel's principal instrument of control was local consortiums set up to manage and develop oil fields in the Middle East, Venezuela, and wherever else oil was discovered. Each consortium was owned by members of the Seven Sisters in a ratio determined by the "as is" principle; each operated as an essentially nonprofit service entity, producing only enough oil to meet the requirements of its owners. To assure that supply never exceeded the demand for oil, the partners submitted "programs" specifying the oil they needed for five years, and the consortium set its exploration and development programs according to these requisites. If less oil was required by the oil companies, the consortiums would close down wells; or, if required by the country's law to drill for oil (as in Iraq), would drill in areas they knew would not yield any. The system proved so successful that by 1970 more than 90 percent of the world's exportable oil was being produced by consortiums in Iran, Iraq, Saudi Arabia, Kuwait, the United Arab Emirates, and almost every other oil-rich area.

From its refineries, tankers, and loading platforms, the Seven Sisters cartel had complete knowledge of all facets of the oil market. It also had the power to shut down entire nations that interfered with its concessions: when Mohammed Mossadegh, the prime minister of Iran, nationalized the country's oil industry, in 1951, the cartel denied Iran use of its refineries and tankers for two years, nearly bankrupting the country. Through its network of consortiums, the cartel had absolute control over how much oil was produced and shipped.

The strains that led to the breakup of the Seven Sisters cartel proceeded from a single issue: the division of profits between the international oil companies and the countries from whose territory the oil gushed. Until 1971, the cartel's consortiums gave the countries a set percentage~ 50 percent in most cases~ of an arbitrary price, called the "posted price," that the oil companies paid for each barrel. If an independent oil company attempted to buy oil, it would have to pay a much higher, "third-party" price. It was, of course, in the interest of the oil cartel to keep its posted price as low as possible, and make its profits selling refined oil. In 1970, for example, the posted price was $1.80, as it had been, with minor fluctuations, for twenty years; consumers in Western Europe paid the equivalent of $11 to $13 a barrel for refined oil.

The delicate balance that the cartel had maintained in the world export market for a half-century was irreversibly upset in the late 1960s by the unexpected decline in oil production in the Western Hemisphere. The United States, which had been almost self-sufficient in oil, became a significant importer of Middle Eastern oil. As the scramble for the available supply intensified, it became evident that prices would be forced inexorably upward. With prices for gasoline, heating oil, jet fuel, and other refined products rising in Europe, the countries that produced oil-notably Saudi Arabia, Iraq, Iran, and Libya-were not content with their share of the fixed posted prices; instead, they demanded at least part of the coming windfall.

The first cracks in the cartel's control came in 1970 in Libya, the one major exporter that had granted concessions to independent companies outside the purview of the consortiums. Under the revolutionary leadership of Colonel Qaddafi, Libya threatened to nationalize the independent companies unless they increased Libya's share. Eventually, the largest independent, Armand Hammer's Occidental Petroleum, acquiesced to Qaddafi's demands. Then Saudi Arabia, Iraq, Iran, and other producers in the Persian Gulf demanded that the consortium, grant them the same terns Libya had obtained. When the cartel acceded to these demands, Libya put pressure again oil the oil companies. and the cartel found itself caught in a ratchet between Libya and the Persian Gulf producers. both demanding more favorable terms. To solve this problem, the oil companies devised a strategy to force the oil-producing comities to negotiate as a single bloc. Because some of the producers were bitter rivals who refused to bargain together, the cartel sought a multinational organization under whose auspices they could negociate with the oil companies. In January of 1971. the cartel chose a small Vienna-based group, with a staff of nine, whose existence it had ignored for the past eleven years--OPEC.

A letter signed by the oil companies in the cartel began: "We wish to place before OPEC and its member countries the following proposal. . . "


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