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OPEC and the new-old realities - Speech

OPEC and the new-old realities

by HE Dr Alí Rodríguez Araque, OPEC Secretary General

Keynote address to the Venezuelan American Association of the United States (VAAUS): The Harvard Club, New York City. February 4, 2002


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Ladies and Gentlemen,

I am pleased to be here in New York, and I hope the new year will bring with it peace and prosperity to the people of this great city. I am also honoured that my schedule allows me to present this speech to the Venezuelan American Association of the United States in the stately surrounds of the Harvard Club. It has not escaped me that the Association was one of the first to invite me to speak at such an event, both when I was first appointed as the Venezuelan Minister of Energy and Mines and as OPEC Secretary General. At the time, circumstances prevented that, but now we finally meet. This is one of the interesting parts of my job — to travel the world and be given the opportunity to engage in the exchange of ideas with an array of people.

I have chosen to take an historical perspective and briefly look at how oil markets have been managed — since the Texan oil boom and bust cycle of the 1920s, to the formation of OPEC. My speech, OPEC and the new-old realities points to the certainty that oil markets need a type of regulation, other than supply and demand. Without it, threats to the security of oil supply due to boom/bust cycles serve no one’s interest. Oil price stability, and the necessary co-operation to achieve that, is really the only way forward. As a result, many leading industrialised, consuming countries have stepped up their consultation with OPEC to achieve stable prices. They too, are convinced of the need to deliver reliable, long-term energy to consumers at a reasonable price.

Before we revert to history to help explain the present, allow me to briefly comment on the reasoning behind the OPEC/non-OPEC agreement in Cairo to cut almost two million barrels per day of oil output from the market. Since September 11, oil producers were faced with a scenario of low projected demand due to the world economic downturn and the subsequent recession in the United States and several other countries. This predicament was coupled with higher levels of non-OPEC output due to come onstream this year — particularly from Russia. These scenarios, however, are not new to oil producers.

The Asian financial crisis in late 1997 triggered a similar situation to what we are currently experiencing post September 11 — surplus oil and weak demand — which saw oil prices collapse to as low as $10 per barrel. The events of 1998 caused the entire oil industry to change due to downsizing, cutbacks in budgets, spending and production, to the unprecedented wave of mergers and acquisitions that we are still experiencing. In the United States at the time, several thousand barrels per day of oil production from stripper wells were shut-in because low prices had made them uneconomical. However, it was a series of cutbacks in OPEC and non-OPEC production that saw the oil industry recover in 1999. This is the same strategy OPEC is currently pursuing, although the Organization was much quicker to react this time. Consequently, the decision was made in Cairo in December to cut production in conjunction with its non-OPEC partners — Russia, Norway, Mexico, Oman and Angola — to avert a similar price fall to that of 1998.

Of course, one can argue whether such tactics are prudent at a time when major economies are in recession. Some argue that oil producers have looked to shore up their income in the short term, at the expense of a prolonged recession. While that argument may sound convincing, any experienced observer knows that if prices stayed depressed for some time, stocks would rise, which in turn could keep oil prices at rock bottom for a protracted period of time. If this were the case, the entire oil industry would be affected, as it was in 1998.

The ramifications low prices have on the industry are severe, so much so, that after the Asian financial crisis, consuming countries encouraged OPEC’s decision to cut production to rescue prices. The United States was particularly concerned about recovering its lost production. Britain and Norway had their output costs to consider in the North Sea, and they were concerned over how long they could sustain low prices. Oil companies suffered more permanent changes, as I have already mentioned. Another lasting ramification of 1998 is that oil companies remain hesitant to commit themselves to billions of dollars of investment, in high cost areas, that make returns more risky. In fact, it is expected that the oil majors’ fourth quarter earnings for 2001 will be dismal after low crude oil prices have taken their toll on profits. Again, it is only stable prices that will produce sufficient levels of investment in the industry, which in turn guarantees the security of supply in the long-term.

Another risk to unstable oil prices is when market share becomes an issue for oil producers. Oil producers hopefully have learnt the bitter lessons of the years 1982 to 1985, 1995 and 1998 when market share was pursued at the expense of stable prices. On each occasion, there was a disastrous effect on prices, in that they sank to unreasonably low levels. As a result, petroleum producers had to change their strategy and policies, and instead stick to the adherence of a quota system.

Prior to the introduction of OPEC quotas in the early 1980s, we must ask ourselves whether world petroleum markets managed to function adequately without them, earlier in the twentieth century? The answer is quite simply, no. Oil markets, left to supply and demand as the only regulating forces, tend to generate sudden and huge variations in prices, from boom to bust, in a way that is unacceptable to natural resource owners, investors and consumers. This has been acknowledged first and foremost by the United States — historically the most important oil producing country in the world.

Let us turn to the United States in the late 1920s and early 1930s. This was when the producing states, and above all Texas, began to regulate production, setting up a system of pro-rationing. Based on the idea of conservation of natural resources, every single well was assigned — as you probably all know — a Maximum Efficient Rate (MER). Nobody was allowed to produce at higher rates, which would damage the wells. It still operates in this way today. A consequence of overproduction is a low recovery rate of crude oil when the total accumulated output is measured.

At the time, conservation was also related to price stability. Experience of oil gluts had advanced opinion that crude, an exhaustible natural resource, would be wasted at unreasonably low prices. Consequently, the Texas Railroad Commission — in charge of pro-rationing — forecast demand, month by month. In the 1930s, the Texas Railroad Commission, originally a railroad company, assumed the responsibility of regulating oil production by distributing those demand figures to the wells. This was done in the form of ‘allowables’ — which was a percentage of MER they were allowed to produce. Marginal wells, of course, were always allowed to produce at 100 per cent, because they would have had to be shut down and abandoned otherwise, with no possibility of later recovery, and the definitive cost of the remaining natural resource.

Of course, in years of high demand, the companies were authorised to produce at 100 per cent MER, but in years of low demand, it could be as low as 40 per cent. Although Texas was the most important oil-producing state, it could not cope with the problem alone. Consequently, in 1935, the Interstate Oil Compact Commission (today known as the Interstate Oil & Gas Compact Commission) was created to co-ordinate the quotas of the most important producing states of America.

The IOCC, I would argue, is the immediate and logical precedent for OPEC. Like OPEC at present, however, the time came when it could no longer regulate the markets alone. In the 1930s, the USA produced about two-thirds of world oil, whereas in the 1950s, that figure came down to less than half, and since 1947, the country has become a net importer. As production in the USA declined, and other oil came onstream, the most important producing and exporting countries of the Western Hemisphere were invited to join in, albeit as observers. Venezuela and Canada used to attend the IOCC meetings.

But with the growing importance of oil from the Eastern Hemisphere at the time, the efforts of the IOCC were no longer enough either. By 1959, the IOCC — informally assisted in its efforts by the big international oil companies — could no longer maintain an equilibrium, which meant one price structure in world petroleum markets. ‘Cheap’ oil from the exporting countries threatened the domestic industry in the US. Hence, the country decided to impose official import quotas on oil at the same time that OPEC was formed to restore world market prices to levels consistent with US domestic prices.

If the history of oil were to bear witness, world petroleum markets today cannot do without OPEC — this is despite the unfair accusation of OPEC being labelled a ‘cartel’. Many an academic and oilman has argued the case for OPEC over the years. The Organization, however, cannot do its regulating job properly without the co-operation of the most important non-OPEC exporting countries. Thus, we have to continue to join forces with other major oil exporting countries, as we did recently in Cairo, and in the late 1990s.

The ultimate question one must ask oneself is whether the system is working properly or, at least, reasonably well? I would argue, yes, it does. After many years of turmoil, of structural imbalance, I believe that there is a process towards a new equilibrium. That means a price level is emerging that is more or less acceptable to all the parties concerned: the natural resource owners, investors, and consumers. OPEC has pinpointed $25 per barrel as being the price of equilibrium, which takes into consideration adequate levels of investment to ensure the security of supply. Of course, in times of recession and falling oil prices, the intent is more on getting prices back within OPEC’s price band of $22 to $28 per barrel. With co-operation from non-OPEC, this should be possible.

OPEC’s price band has increasingly received more support from the world’s leading industrialised countries. The Vice President of the United States, Dick Cheney, commenting over high gasoline prices in America in May last year, said those prices had nothing to do with the price of crude oil, and that OPEC had very little to do with the situation. In fact he made it clear that OPEC should not be made to shoulder the blame for high gasoline prices, but that the problems pointed to a lack of refinery capacity in the United States. Specifically, he mentioned that OPEC crude oil output levels and prices had been stable during the time. The average price for the OPEC Basket of seven crudes in May last year was around $26 per barrel.

In addition, the European Commission Vice-President, responsible for transport and energy, Ms Loyola de Palacio, has made it very clear that the European Union does not want low oil prices, but rather is seeking stability in energy markets, which protect against erratic price trends. She has said quite implicitly that “it is no more in Europe’s interest to have prices which are too low, than prices which are too high”. This has been OPEC’s position for many years.

As you can all see, OPEC is an Organization that co-ordinates the policies of several member countries, from different regions around the globe. OPEC’s task, therefore, is to defend the legitimate rights of these sovereign countries regarding the crucial natural resource they all possess — namely oil. And at the same time, there are many countries whose main interest lies with the price of crude oil. The stability OPEC is searching for definitely depends on a fair agreement that recognises, on the one hand, the rights of owners to obtain a just price for their exhaustible and non-renewable resource. On the other hand, the right exists for consumers to be guaranteed crude oil supply at a price that does not hurt the economies of their countries.

This is the main topic for discussion at the 8th International Energy Forum, or the so-called producer/consumer dialogue, which will take place in Japan later this year.

I hope that after a long period of confrontation we will arrive at an agreement that helps contribute to stable energy markets and, hence, to world economic stability.

Thank you.

ENDS

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