OPEC: The Cartel That Never Was

The Atlantic

March 1983

by Edward Jay Epstein

OPEC hd originally been established in Baghdad on September 10, 1960, as an intergovernmental group to study posted oil prices. Its five founding members were Saudi Arabia, Venezuela, Iran, Kuwait, and Iraq. During its first six years, which went virtually unnoticed in the press, OPEC housed itself in Geneva and opened an "information office," which commissioned occasional studies on prices. It also admitted three new rnembers-Qatar, Indonesia and Libya. In 1966, it moved its office to Vienna because tho organization was offered diplomatic status there for its staff. Its main activity involved issuing proclamations declaring "solidarity" with the escalating demands of' the more rebellious oil producers, notably Libya and Algeria, which joined in 1969. The proposal to serve as a negotiating umbrella for the oil-producing countries was accepted by OPEC, as Henry Kissinger notes "with a vengeance."

In OPEC, the oil companies, found not only a convenient device to bring together feuding states but also a highly visible foe they could blame for the impending rise in oil prices. To negotiate as a single force with this new monolith, the oil companies obtained ail antitrust exemption for themselves from the Justice Department. OPEC was, ironically, finally by the real cartel.

Initially, the oil companies' OPEC strategy was successful. It produced the Teheran Agreement, in which the producing states, in return for a modest rise in the posted price to $2.18 a barrel and some favorable revisions in the concession term, accepted a five-year accord that would freeze oil prices. This OPEC agreement lasted, however, only months. Each country, ignoring the agreement, insisted that it had sovereignty over its oil prices. The "five-year" Tehran pact disintegrated into a free--for-all, and, one by one, the consortiums were nationalized.

Whatever hope the old cartel had of reasserting control over the oil producing nations ended on Yom Kippur of 1973, with the Egyptian invasion of the Sinai. The renewed war in the Middle East caused an oil-buying frenzy in Europe and Japan, as nations fought to build up their reserves of crude oil. Saudi Arabia and other oil producers adopted a policy of charging whatever the freight would bear. Within weeks, the posted price for crude had more than doubled, to,$5.60 a barrel. No OPEC control was involved: it was a war that permitted individual nations to raise their prices.

Another price explosion followed the announcement by Saudi Arabia and other Arab states, in October of 1973, that they were cutting back oil their oil production and embargoing shipments of oil to the United States. This cutback did not result from any OPEC decision, either. Indeed, many OPEC states, including Iran. Indonesia, Venezuela, Ecuador, and Gabon, actually increased production (and even a few Arab states in OPEC, notably Iraq and Algeria, did not reduce their production). It was almost exclusively an initiative of Saudi Arabia. Moreover, the Saudi decision to shut down 10 percent of the country~s oil production was not based entirely,on considerations of the plight of the Arabs. The Senate Subcommittee oil Multinational Corporations ascertained from testimony of American engineers who were responsible for operating the Saudi fields in 1971) that a 40 percent cutback in the giant Ghawar field was required for the installation of water injection equipment. If it had not made these cutbacks, the entire reservoir of oil would have been jeopardized. Jerome Levinson, the general counsel of the committee, writing under the name Peter Achnacarry, stated: ". . . the embargo saved Saudi Arabia from the embarrassment of having to explain supply shortages resulting from technical problems." By cloaking the cutback in a political purpose, the Saudis were able to induce other Arab producers, both inside and outside of OPEC, to join them.

In the wild price spiral that followed the Saudi shutdown, the official OPEC price was completely disregarded by other members. Iran and Qatar held auctions to determine how high they could raise prices. At its subsequent meetings, OPEC could do no more than ratify the prices that had already been established by a panicked market.

Conversely, when oil prices began to decline in 1975, because of the world recession, OPEC found itself powerless to stop its members from undercutting each other and competing for sales. Despite OPECs price declarations, the real price of oil declined by more than 25 percent between 1975 and 1978. The decline was reversed, not by any actions of OPEC but by another series of events in the Persian Gulf: the revolt against the Shah in Iran; a brief rebellion in Saudi Arabia; Iraq's invasion of Iran. In a matter of months, some 5 or 6 million barrels a day of Persian Gulf oil vanished from the export market. In 1979, importers feverishly bid up the remaining supply for their strategic reserves until prices reached $35 a barrel.

Throughout this roller coaster of falling and soaring prices, OPEC demonstrated little ability to affect or even moderate the actions of its members. Price agreements were totally ignored, and the idea of regulating oil production was pre-emptively rejected. In a comprehensive study of OPEC prices, Walter J. Mead, an economist at the University of California, found that "price and output policies [of members] appear to be determined independently of OPEC policy" He concluded that OPEC could not be considered a cartel in the light of this data, because "the essential ingredient to an effective cartel, coordinated control over output, is totally lacking." OPEC merely took credit for the results of current events.

Whereas OPEC may have proved to be no more than a paper cartel, one nation,Saudi Arabia, succeeded in altering the market by dramatically changing the output from its fields. After all, it was Saudi Arabia, not OPEC, that shut off oil during the Yom Kippur War. It was also Saudi Arabia that, without even consulting OPEC, arbitrarily reduced production in the midst of the Iranian revolt. And it was Saudi Arabia that later flooded the market to force other OPEC members to conform to its pricing policies. Yet, even though Saudi Arabia was the real manager of the world oil supply, statesmen preferred to blame an almost nonexistent organization-OPEC.

In July of 1979, President Jimmy Carter received a memorandum from his chief domestic adviser, Stuart Eizenstat, suggesting that public attention be focused on OPEC. Specifically, it counseled that "with strong steps we can mobilize the nation around a real crisis with a clear enemy-OPEC." Ignoring the determining role Saudi Arabia played in manipulating the supply of oil, Carter adopted the general strategy of blaming OPEC for the world's ills. Carter said, "I don't see how the rest of the world can sit back in a quiescent state and accept unrestrained and unwarranted increases in OPEC oil prices." Then, after castigating OPEC in a nationwide address, he read from his notebook a chilling assessment: "Our neck is stretched over the fence and OPEC has the knife." Carter gave this enemy a quality of omnipotence several months later, when he said that OPEC "has now become such an institutionalized structure that it would be very doubtful that anyone could break it down." OPEC was turned into an undefeatable foe.

OPEC made an especially convenient "clear enemy" precisely because it hardily existed. If a real country were chosen for this role, there would be real consequences. Consider, for example, what would have happened if Carter had substituted "Saudi Arabia" for "OPEC" in his denunciations. He would have to have depicted Saudi Arabia holding a knife to America's outstretched neck, an image inconsistent with continued military aid to that country. OPEC, on the other hand, with which the United States had neither trade nor foreign relations, provided an ideal diversion from reality. It also yielded a four-letter word for the press to use in headlines. Oil companies could put the blame for gas lines and soaring prices on OPEC, with which they had no commercial relations, without offending the countries on which they depended for supplies. OPEC served an even more important purpose for the oil-exporting nations. It gave powerless nations, which had the means neither to operate their oil fields nor to defend themselves, a dazzling mask. Specifically, for Saudi Arabia, which produces almost half of OPECs oil, it provided international camouflage for its oil policy. Just as the United States used the OAS as a mask for the embargo on goods shipped to Cuba in the 1960s, and the Soviet Union used the Warsaw Pact as a mask for intervention in Czechoslovakia in 1968, Saudi Arabia used OPEC to obscure its manipulation of the oil market. Such diversionary tactics were especially important to Saudi Arabia, since in 1973 its oil fields were almost entirely in the hands of American technicians and engineers, and its army, fewer than 3,000 men located at bases 1,000 miles away from the oil fields, was hardly in a position to defend the fields.

The competition within OPEC for shares of the oil market has been greatly exacerbated in recent years by the loss of nearly one third of the world market to interlopers such as Mexico, Great Britain, Norway, Malaysia, Russia, and Egypt. In 1973, when OPEC began its thundering rise to eminence, its members produced almost all the exportable oil in the world. In 1983, non-OPEC nations produce about 13 million barrels a Day, equivalent to nearly two thirds of OPEC's total. Mexico, which produces 2.9 million barrels a day, will export more oil than any OPEC country except Saudi Arabia; and Great Britain and Norway produce 2.7 million barrels a day from North Sea fields. As the available portion of the market shrinks, OPEC nations, many of whom are desperate for revenues, can compete only by lowering prices. As prices continued to slip day by day, it became clear to all concerned that OPEC could no longer even pretend to command prices to rise with any effect.

For nearly a decade, the OPEC mask has permitted Saudi Arabia to set prices for the world without having to take direct responsibility for its actions. As prices continue to fall, however, the facade no longer hides the bitter rivalries among members.. The paradoxical question "What are we fighting about, since we want the same thing?" applies to their dilemma. The answer is that they are fighting precisely because each wants a larger share of the world oil market. If, how ever, any one member succeeds in enlarging its share, it will be at the expense of another member. The OPEC members are, and will always be, competitors, not allies. While they may try to hide their fighting from outsiders by means of unenforceable paper agreements, it will persist until it is resolved by a price war.

Oil prices have risen twenty fold over the past decade. Part of this dramatic increase has been the result of the free market's attempt to reconcile dwindling production in America with expanding demand. Another part was. the result of the fears generated by wars in the Persian Gulf, which in turn led to frantic efforts to hoard oil in anticipation of an uncertain future. And partly the result of the manipulations of Saudi Arabia to cut back production at moments of world crisis. OPEC, though important as a mask, was no more than a convenient diversion that distracted public attention from the real causes of the oil crisis.

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