This text analyzes the importance of the Middle East and the Organization of Petroleum Exporting Countries (OPEC) in covering the world’s energy needs and relates the main geopolitical events in the region, and within OPEC itself, with fluctuations in the price of oil. After analyzing statistics on production, reserves and demand, the author concludes that the Middle East and OPEC are and will continue to be, the key to guaranteeing a sufficient supply of energy at a reasonable price. For this reason, achieving stability in the region (something that could not be achieved in the entire 20th century) is an increasingly important goal for the good health of the world economy and global security.
The best way to understand the strategic importance of the region and of OPEC is to connect statistics on oil production, reserves and demand. To begin with, we must state the obvious: oil continues to be the world’s main source of raw energy. In 2001, the oil accounted for 38.5% of the world energy basket, far ahead of coal and natural gas (24%) (Figure 1). Despite the energy diversification plans established by Western countries, the relative weight of oil today is similar to that its weight in the early 1980s. Furthermore, forecasts by organizations such as the International Energy Agency and the US Department of Energy indicate that the same percentage of world energy needs will continue to be covered by oil over the next twenty years. Figure 1. Relative weight of raw energy sources
Source: BP statistical review of world energy 2002
If oil is the dominant source of energy in the world, the Middle East and OPEC are the leading suppliers of this raw material. Production inMiddle Eastern countries reached 22.2 million barrels a day (m bbl/d) in 2001, equivalent to 30% of world production. The main producers in the region are Saudi Arabia (8.8m bbl/d), Iran (3.7m bbl/d), the United Arab Emirates (2.4m bbl/d), Iraq (2.4m bbl/d), Kuwait (2.1m bbl/d), Oman (1m bbl/d), Qatar (0.8m bbl/d), Syria (0.6m bbl/d) and Yemen (0.5 m bbl/d). If the production of three important “fraternal” North African countries (Egypt, Libya and Algeria) are added to the list, the total comes to 26m bbl/d, or 35% of world production. Of these twelve countries, only four are not OPEC members (Oman, Syria, Yemen and Egypt). The other eight, along with Venezuela, Nigeria and Indonesia, form the powerful Organization of Petroleum Exporting Countries (OPEC) are responsible for 41% of world production in 2001 (30.2m bbl/d).
The importance of the region and of OPEC are heightened by the fact that 65% of proven world reserves are located in the Middle East and that OPEC controls 78% of the total reserves. Also, a significant 36% of proven world reserves of natural gas - the energy source with the greatest growth potential - is found in the Middle East.
Considering that other producing countries have fewer reserves and older fields, it is clear that in the coming years the Middle East and OPEC will tend to increase their market share of the oil supply. In its forecast to the year 2020, the U.S. Department of Energy estimates that OPEC’s market share will increase to 45% in 2010 and to 50% in 2020.
Figure 2. Market share of the Middle East and OPEC
Source: U.S. Department of Energy
As can be seen in Figure 2, and as we will later analyze, OPEC already had a market share of 50% in the early 1970s.
Another interesting statistic is the volume of exports from the Middle East to the main points of energy demand, since the region consumes only 6% of world production. In 2001, the region exported about 19 million barrels: 4.2m to Japan, 6.4m to the rest of Asia, 3.5m to Europe, 2.8m to the U.S. and 1.0m to other destinations. The region accounts for approximately 50% of world exports, which is why instability there has caused such problems in the supply of world energy market, especially in the second half of the 20th century and now, as the 21st century begins.
Along with a secure supply, the other key factor is the price of oil. Although in recent years the growth of services in the world economy has reduced the economy’s sensitivity to price fluctuations, there continues to be a significant relationship between the price of crude and economic growth. Some studies estimate that every five-dollar change in the price of crude has an expansive or depressive effect on world growth of 0.5% of world GDP. This implies that although sensitivity has decreased, the price of crude can continue to cause or accelerate economic crises like the ones in 1973 (oil embargo), 1979 (Iranian revolution) and 1990 (Gulf War). It is clear that these three great shocks were the result of political instability in the Middle East. It is this historical relationship between Middle East politics and the crude market that we will set out to explain below.
A quick analysis of Figure 3 clearly reveals the strong correlation between crude prices and different geopolitical events in the Middle East. As we have seen earlier, covering energy demand seems to depend increasingly on this region. Clearly, it can be extrapolated that a key factor in maintaining price stability and energy supply is to be found in these countries.
Figure 3. Crude prices (US$/bbl) and geopolitical events
Source: the author
The Middle East’s historical role as the world’s main energy exporter is intimately linked to the need of consumer countries to find new sources of crude oil supply. The modern history of oil began in the U.S. at the end of the 19th century with the first oilfields and a growth in demand, led first by the kerosene lamp, and then by the internal combustion engine. In 1910, between 60% and 70% of world production was concentrated in the U.S. Pioneer projects in production and international exportation began before the First World War. The first discoveries of crude oil in the Middle East were made in 1908 in Iran, under the control of the British Empire, by the Anglo Persian company (predecessor of British Petroleum - BP). During the period between the two world wars exploration and production projects in the region lived a definitive boost by the arrival of American companies (Exxon and Mobil) in Iraq in 1928, after strong diplomatic tensions between Great Britain and the U.S. It is estimated that Great Britain, thanks to its colonial presence, controlled 50% of world reserves in the early 1920s. British hegemony began to decline as U.S. companies worked successfully in Saudi Arabia and Kuwait. In 1933, Chevron was granted a 60-year concession for producing in Saudi Arabia and a joint venture to produce in Kuwait was formed by the American company Gulf Oil (absorbed by Chevron) and British Petroleum.
After the Second World War, the Middle East became a region of great strategic importance to the U.S., faced with the need to guarantee sources of cheap supply for its oil-hungry market. In the 1950s, with only 6% of the world population, the U.S. consumed a third of all oil production. This was the age of great investments (new oilfields, oil pipeline networks, etc.) and of the “Seven Sisters”: BP, Royal Dutch/Shell and five U.S. companies: Texaco, Mobil Oil, Gulf Oil, Standard Oil of California (Socal) and Standard Oil of New Jersey (later Exxon). These companies monopolized the economic and political life of their host countries to the extent that they became a fundamental target of the nationalist movements that began developing in the region at the end of the Second World War.
The end of colonialism and the partition of Palestine, leading to the creation of the state of Israel in 1947, caused a strong nationalist feeling in the region and was accompanied by growing unity among Muslim countries. This combination of nationalism and the excesses committed by the Anglo-American oil companies led to the nationalization of the assets of foreign producers, first of all in Iran in 1951.
The nationalization of the assets of oil companies in Iran was a milestone in the history of this resource in the Middle East. Although it was not an innovative measure (Russia, after the Bolshevik revolution, and Mexico in 1938, had already nationalized their oil industries), the nationalization of BP’s assets by the Government of Mohammed Mossadegh, in Iran in 1951, had important consequences in the region in that it demonstrated the growing power regional governments to stand up to the Western oil companies. Nationalization led to a boycott of Iranian oil by the “Seven Sisters” and was probably the main reason for the coup d’etat carried out with the help of the CIA, which ousted the Mossadegh government and restored the Anglo-American companies to their former position in Iran. Although this process failed, the nationalization route was revealed to other governments in the region, which saw the position of the foreign oil companies in their countries as a new form of colonialism. Despite the boycott of Iranian production during this crisis, the market was well supplied and there were no greatly significant fluctuations in prices (which remained at all times under four dollars per barrel).
The next important landmark in Middle East politics was the Suez Canal crisis of 1956. This crisis began when the Egyptian government of Gamal Abdel Nasser nationalized all the assets of the Suez Canal. However, the roots of the crisis lay in the nationalist feelings of the Egyptian people and in the increasing tension between Israel and its Arab neighbors (the first war between troops of the new state of Israel and its Arab neighbors occurred between 1947 and 1949). Although the war caused by this crisis led only to defeats for the Egyptians, the final political result (the nationalization of the canal) was a great success for the Nasser government. Despite the problems that this crisis caused in the maritime transport of crude oil, prices once again remained stable below four dollars a barrel, due to surplus supply.
As we can see, the U.S. was achieving its goal of guaranteeing a stable supply of crude at competitive prices, despite the growing tension in the Middle East. These low prices were essentially the result of the dominant position of the “Seven Sisters”, which fixed artificially low benchmark prices for the payment of royalties and taxes to their host countries. The feeling among the main exporting countries that they were being plundered of their main source of wealth explains why the Organization of Petroleum Exporting Countries (OPEC) was formed in 1960. In Baghdad, in September of that year, Iran, Iraq, Kuwait, Saudi Arabia and Venezuela established this organization with three fundamental goals: (1) stable prices; (2) greater participation in the production-related decisions of the oil companies; and (3) transparent price-fixing criteria. The organization kept a low profile during its early years, while progressively increasing its members: Qatar (1961), Indonesia (1962), Libya (1962), the United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973-1992) and Gabon (1975-1994).
With the Libyan revolution in 1969, led by Muhammar Gadaffi, the process of nationalizations in the Middle East oil industry began once again – this time irreversibly. Libya’s nationalization of oil assets in 1970 was followed by other countries such as Iraq in 1972, Saudi Arabia in 1974 and Kuwait in 1975. During the 1960s, Western oil companies were expelled from the region, though usually receiving high compensation or signing long-term supply agreements.
A stronger OPEC, strong control of oil production by the governments of the region and a great deal of military movement related to the Israeli-Palestinian conflict, brings out to one of the most important events in East-West relations and the oil market: the 1973 Arab embargo of crude oil exports to the West (first oil price crisis). The embargo made crude prices triple to around twelve dollars a barrel, significantly raising the West’s energy bill and constituting a key factor in the economic crisis of 1974-1975. The embargo was ordered by Saudi Arabia and other countries in the region against the U.S. and Holland as a political weapon to combat the West’s support of Israel during the Yom Kippur War. This war, which lasted three weeks in October 1973, was the Arab countries’ response to the humiliation they felt after the overwhelming military success of Israel in the Seven Days’ War in 1967. The embargo lasted only a few months, until March 1974, but had a decisive impact, both on Middle Eastern countries, which discovered the political power of oil, and on the West, which suffered the negative effects of its great dependence on oil. After this price crisis, Western countries began energy diversification and savings programs. Among other defensive measures, the International Energy Agency (IEA) was created in 1974 as a counterweight to OPEC and the U.S. set up the Strategic Oil Reserve in 1975. It is worth noting that although the U.S. managed to reduce its consumption of crude by almost a million barrels/day in 1974 and 1975, it returned to pre-crisis consumption levels in 1976, with about 17.5m bbl/d —30% of world oil demand. On the production side, the rise in prices provided a strong incentive for the search for new reserves and areas of exploration by Western companies. This led to important discoveries in the North Sea, among other areas. Although the embargo lasted only a few months, prices did not return to pre-crisis levels, remaining between eleven and thirteen dollars a barrel until the second oil price crisis. This was most likely the result of OPEC’s greater control over supply and the loss of power by the “Seven Sisters” due to the ongoing processes of nationalization.
The second oil price crisis was the result of the Iranian revolution of 1979, which was followed by the Iran-Iraq War (1980-1988). The Iranian revolution had a very strong impact on the crude market due to the resulting collapse in production and the fact that Iran, a traditional U.S. ally had, during the 1970s, become one of the main exporters of crude to the West. Iranian production fell from 5.3m bbl/d in 1978 to only 1.3m bbl/d in 1981. As a result of the war with Iran, Iraqi production fell from 2.5m bbl/d in 1979 to 1.0m bbl/d in 1981. Although Western economies were more prepared this time to face the crisis and reduced their consumption of crude significantly, the drop in supply caused a long period of extraordinary high prices. Between 1979 and 1985, crude cost between 27 and 36 dollars a barrel, about ten times higher than before the first oil price crisis. This second crisis had a more negative impact on developing countries since, along with the increase in their energy bill and inflationary processes, they had to deal with a cycle of financial crises caused by their large foreign debt.
Another spectacular increase in crude prices gave a further boost to investment in new reserves, which put the supply-demand balance in jeopardy. To deal with this situation, in 1982 OPEC first applied the production quota systems which is force today. Saudi Arabia reduced its production from 10.2m bbl/d in 1981 (17% of world production) to 3.6m bbl/d in 1985 (6% of the market).
In 1986, faced with its constant loss of market share, (from 39% in 1981 to 29% in 1985), OPEC launched a strategy to recover its share that caused, as could be expected, the third oil price crisis, this time a positive one for consumer countries. Prices fell to below 10 dollars per barrel in 1986 and stayed between 13 and 15 dollars per barrel until the end of the decade. Among other effects, low crude prices affected investment in areas with high production costs (mainly the North Sea), boosted the consumption of goods and put energy diversification plans on the backburner. OPEC recovered its market share, reaching 38% in 1990.
A fourth oil price crisis was caused in 1990 by the Iraqi invasion of Kuwait (August 1990) and the Gulf War (January-March 1991). The embargo of Iraqi oil exports, ordered by the UN in response to the invasion, involved the risk of reducing world production by more than 4m bbl/d (6% of the total), which caused a sharp rise in prices from US$ 16/bbl before the crisis, to US$ 28/bbl, peaking at almost US$ 40/bbl in September. In October 1990, after the UN authorized the use of force to deal with the Iraqi invasion, and before the production increase by the main producing countries —especially OPEC countries—, crude prices dropped to pre-invasion levels. Saudi Arabia increased production considerably, from 7m bbl/d in 1990 to 9m bbl/d in 1992. Practically all oil producing countries in the Middle East condemned the invasion and supported the military action against Iraq led by the U.S.
The 1990s were a period of relatively stable prices, which oscillated between 15 and 18 dollars. One of the most significant trends during this decade was the drop in production in the former Soviet Union, due both to reduced domestic consumption and to a lack of investment. In the nineties, former Soviet countries lost almost 5m bbl/d in production. This was taken up almost exclusively by OPEC which during the decade increased its market share from 38% to 42% in 1998. Despite this drop in production, the Asian crisis of late 1997 and 1998 had a significant impact on global demand for crude, which was not properly appreciated by OPEC.
In the middle of the crisis in the Asian economies, in November 1997, the organization approved an increase in production that brought crude prices back down below 10 dollars a barrel. This crisis of low prices, despite its brief duration, had a significant impact on the oil industry. On one hand, the oil industry went through a spectacular consolidation process, which ended with the formation of three large global oil companies (Exxon/Mobil, the already existing RD/Shell and the new BP, after the purchase of AMOCO and ARCO) and several regional oil companies with greater international reach (Total/Fina/Elf, Chevron/Texaco and Conoco/Philips, among others). On other hand, the fall in prices helped OPEC countries achieve the strong consensus and cohesion needed to effectively carry out the quota reductions approved in early 1999. This led crude prices to recover quickly in 1999, breaking the 35 dollar a barrel barrier in September 2000, due principally to OPEC’s slowness in increasing its production quotas to meet growing demand. During this period, OPEC established an indicative price band for crude prices (US$ 22-28/bbl) for carrying out its market interventions, withdrawing production when prices dropped below 22 dollars a barrel and increasing production when they went above 28 dollars.
The attacks of September 11, 2001 led only to a brief rise in crude prices, since after initial speculation about the possibility that the U.S. could carry out reprisals against some of the producing countries most suspected of supporting international terrorism (Iraq, Iran, and Libya), the market focused on the OPEC’s energetic messages guaranteeing supply (the organization temporarily abandoned its price band) and on the fall in demand caused by the attacks, mainly related to their impact on air traffic.
At present, the oil market is once again going through a period of uncertainty and high prices (close to 30 dollars a barrel) due, on one hand, to the OPEC countries’ strict respect for their production quotas in the first half of this year and, on the other hand, to the fear of a unilateral intervention by the U.S. against the Iraqi regime. OPEC therefore now finds itself in one of the most complicated situations in recent years as it prepares for its meeting in Osaka (Japan) on September 18-19. Crude prices are very high in part due to a speculative factor (war premium) that the organization cannot control and which has been calculated at between three and seven dollars a barrel. Furthermore, despite recent overproduction in terms of quotas (8% in August 2002 compared to an average of less than 5% in recent years), stocks remain at reasonable levels, which implies that more crude is not needed in the market. The most likely solution is that OPEC will decide to send out the politically correct message that quotas will rise in order to guarantee supply and help world economic recovery, but will not significantly increase real production, which could lead to a price drop similar to the one in 1998. By raising production quotas between a million and a million and a half barrels a day (5%-7% above the current quota of 21.7m bbl/d), OPEC could simultaneously achieve both goals.
Figure 4. OPEC overproduction in terms of quotas
Source: IEA and the author
As we have seen, the geopolitical situation in the Middle East and OPEC are fundamental factors affecting the price and supply of the world’s main energy source —oil. The history of the Middle East is directly linked to oil and oil has a decisive impact on the world economy. Forecasts indicate that, regardless of the cycles of overproduction that will continue to occur and the rise of new producing regions (the Caspian Sea and western Africa), Middle East and OPEC production and reserves will continue to have a decisive weight in the oil market. In this context, many questions arise regarding the hostile climate developing between the Arab world and Western countries in the aftermath of the September 11th attacks. A unilateral U.S. intervention without the consent of the UN Security Council could once again lead the Arab world to use oil as a weapon against the military power of the United States. In any case, the complex relationships and balances that exist in the Middle East will continue to be a main focus of world attention in coming years.
Alejandro Vigil García
Specialist in the oil and gas sector, he has worked as a financial analyst in this sector for many years, especially in the European and Latin American sector.