OPEC vs. the United States: Who Controls Oil Prices?

Up until the middle of the 20th century, the United States of America (U.S.A) was the largest producer of oil and controlled oil prices. In the years to follow, OPEC controlled the oil markets and prices for most of the latter part of the 20th century. However, with the discovery of shale oil in the U.S.A and advances in drilling techniques, America has re-emerged as a top producer of oil. In this article, we explore the historical battle between OPEC and the United States of America to control oil prices and how world events have influenced that struggle.﻿﻿

Key Takeaways As of 2019, OPEC controlled roughly 75% of the world's total crude oil reserves and produced 42% of the world's total crude oil output.

However, the U.S. was the world's largest oil-producing country in 2019 with more than 12 million barrels per day.

Although OPEC still has the ability to drive prices, the U.S. has limited the cartel's pricing power by ramping up production whenever OPEC cuts its output.

United States

Oil was first commercially extracted and put to use in the United States of America. Consequently, pricing power for the fossil fuel lay with the U.S.A which was, at that time, the largest producer of oil in the world. In general, oil prices were volatile and high during the early years because economies of scale during extraction and refining (which mark the current extraction and drilling processes) were not present. ﻿﻿﻿For example, in the early 1860s, according to the Business Insider, the price per barrel of oil reached a peak of US $120 in today's terms, partly due to rising demand resulting from the U.S. civil war. The price fell by more than 60% over the next five years and rose by 50% during the next five years.﻿﻿

In 1901, the discovery of the Spindletop refinery in eastern Texas opened the floodgates of oil in the U.S. economy.﻿﻿ It's estimated that 1,500 oil companies were chartered within a year of the discovery. Increased supply and the introduction of specialized pipelines helped further reduce the price of oil. ﻿﻿﻿The supply and demand for oil rose additionally with the discovery of oil in Persia (present-day Iran) in 1908 and Saudi Arabia during the 1930s.﻿﻿﻿﻿﻿

By the mid-twentieth century, the use of oil in weaponry and the subsequent European coal shortage further ratcheted demand for oil, and prices came crashing down to $40 in today's terms.﻿﻿﻿﻿﻿ American reliance on imported oil began during the Vietnam war and the economic boom period of the 1950s and 1960s. In turn, this provided Arab countries and OPEC, which had been formed in 1960, with increased leverage to influence oil prices.﻿﻿

OPEC

OPEC, or the Organization of the Petroleum Exporting Countries, was formed to negotiate matters concerning oil prices and production. As of April 2020, OPEC countries included the following 13 nations:﻿﻿

Algeria

Angola

Congo

Equatorial Guinea

Gabon

Iran

Iraq

Kuwait

Libya

Nigeria

Saudi Arabia

United Arab Emirates

Venezuela

The 1973 oil shock swung the pendulum in OPEC's favor. That year, in response to America's support for Israel during the Yom Kippur War, OPEC and Iran stopped oil supplies to the United States. The crisis had far-reaching effects on oil prices. ﻿﻿

OPEC controls oil prices through its pricing-over-volume strategy. According to Foreign Affairs magazine, the oil embargo shifted the structure of the oil market from a buyer's to a seller's market. In the magazine's view, the oil market was earlier controlled by the Seven Sisters, or seven western oil companies, that operated a majority of the oil fields. Post-1973, however, the balance of power shifted towards the countries that comprise OPEC. According to them, “what the Americans import from the Persian Gulf is not so much the actual black liquid but its price.﻿﻿﻿”

A number of world events have helped OPEC maintain control over oil prices. The fall of the Soviet Union in 1991 and the resulting economic tumult disrupted Russia's production for several years. ﻿﻿﻿The Asian financial crisis, which had several currency devaluations, had the opposite effect in that it reduced oil demand.﻿﻿ In both instances, OPEC maintained a constant rate of oil production. As of 2019, OPEC controlled 74.9% of the world's total crude oil reserves and produced 42% of the world's total crude oil output.﻿﻿﻿﻿﻿

OPEC+ came into existence in late 2016 as a means for the top oil exporting nations to exert control over the price of the precious commodity. Essentially, OPEC+ is an amalgamation of OPEC and high oil exporting non-OPEC nations like Russia and Kazakhstan.﻿﻿ Combined, they control over 50 percent of global oil supplies and about 90 percent of proven oil reserves. OPEC+ remains influential due to three primary factors:

An absence of alternative sources equivalent to its dominant position A lack of economically feasible alternatives to crude oil in the energy sector OPEC, especially Saudi Arabia, has the world's lowest barrel production costs.

These advantages enable OPEC+ to have a wide-ranging influence over oil prices. Thus, when there is a glut of oil in the world, OPEC+ cuts back on its production quotas. When there is less oil, it increases oil prices to maintain stable levels of production. ﻿﻿

In the Spring of 2020, oil prices collapsed amid the COVID-19 pandemic and economic slowdown. OPEC and its allies agreed to historic production cuts to stabilize prices, but they dropped to 20-year lows.

﻿OPEC vs. the United States—The Future

But OPEC's monopoly over oil prices seems to be in danger of slipping. The discovery of shale oil in North America has helped the U.S.A achieve near-record volumes of oil production. According to the Energy Information Administration (EIA), America's oil production was 12 million barrels per day (bpd) in 2019, making them the world's largest oil-producing country.﻿﻿﻿﻿﻿ As of December 2019, U.S.A. was the world's top producer followed by Russia and Saudi Arabia. However, Saudi Arabia is still the global leader in exporting oil followed by Russia and Iraq. In fact, these three nations, all members of OPEC+, account for nearly 36% of the supply of oil for the rest of the world.

Shale is also gaining popularity beyond American shores. For example, China and Argentina have drilled more than 475 shale wells between them in the last few years. Other countries, such as Poland, Algeria, Australia, and Colombia, are also exploring shale formations. A viable alternative to OPEC+ could shift the power structure.

The Iran-U.S. nuclear debate could also impact oil production and supply in the future as further discord could provoke more sanctions to curtail production which would affect prices.﻿﻿ Other factors that impact the price of oil include the budgets of Arab nations, which need high oil prices to fund government spending programs.﻿﻿ Also, demand continues to increase from developing economies, such as China and India, further influencing prices in the face of constant production.﻿﻿﻿﻿﻿

The dynamics of the oil economy are complex, and the oil price determination process goes beyond the simple market rules of demand and supply, though at its most primal level the market is the final arbiter of the price of oil. Theoretically, oil prices should be a function of supply and demand. When supply and demand increase, prices should drop and vice versa. But the reality is often quite different. Oil's status as the preferred source of energy has complicated its pricing. Demand and supply are only part of the complex equation that has generous elements of geopolitics and environmental concerns.

Regions that hold pricing power over oil control vital levers of the world's economy. The United States controlled oil prices for a majority of the previous century, only to cede it to the OPEC countries in the 1970s.﻿﻿ Recent events, however, have helped to shift some of the pricing power back towards the United States and western oil companies, which led OPEC to form an alliance with Russia et al. to form OPEC+.

As oil prices rise, U.S. oil companies pump out more oil to capture higher profits which would limit OPEC's ability to influence the price of oil. Historically, OPEC's production cuts had devastating effects on global economies which has been somewhat diminished recently. Also, the U.S. is one of the world's top consumers of oil, and as production at home increases, there will be less demand for OPEC oil in the U.S.

But, it is important to note that, although the United States is the top producing nation, the top exporters are predominantly members of OPEC+, which means that they are still the key player in the oil price determination process. ﻿﻿﻿There may come a day when OPEC loses its clout but that day is not yet here.