The past, the future

OPEC OUTPUT EXCESS VS. QUOTA [30,293 bytes] The 25th anniversary of the Arab oil embargo challenges the petroleum industry to appreciate how much its world has changed in the past quarter-century-and to acknowledge historic change in progress now. Nothing would help the industry more than full recognition-by itself, by its customers, and by its regulators-of the extent to which conditions of the present and future differ from those of the early 1970s.

Oct. 19, 1998

3 min read

OPEC OUTPUT EXCESS VS. QUOTA [30,293 bytes]

The 25th anniversary of the Arab oil embargo challenges the petroleum industry to appreciate how much its world has changed in the past quarter-century-and to acknowledge historic change in progress now. Nothing would help the industry more than full recognition-by itself, by its customers, and by its regulators-of the extent to which conditions of the present and future differ from those of the early 1970s.

In 1973, long-term contracts, inflexible sourcing, and official price regulation dominated petroleum trade. Now, spot and futures markets eclipse term trading. Supply, demand, and price respond immediately and visibly to one another. Crude can flow from any producer to any market-and change destination in transit. Free of price controls, the market can absorb shocks-such as Iraq's invasion of Kuwait in 1990-much better than it could in the era of heavy regulation. Only new intrusions by governments could reinstate the rigidities of the 1970s.

New motives

Motivations of the world's most important oil exporters have changed, too. The price collapse of 1986 shifted the concern of OPEC members from politics to commerce. It taught them that they can't take market share for granted and that wealth means having something to lose. In line with needs of a world oriented more than ever to economic growth, OPEC members now just want-and urgently need-to sell oil.

Something else has begun to change. OPEC members on the Persian Gulf are essentially losing their historic cost advantage. While production costs of their commercial competitors have plummeted, the gulf states' total costs have effectively increased due to growth of national infrastructure wholly dependent on oil revenues. Gulf producers no longer can ride out price slumps on the attrition of higher-cost competitors.

Among other things, this shift in relative sensitivity to market weakness yields unprecedented quota discipline in OPEC. Adherence to the group's production accord of last June reached an estimated 98% last month and might top 100% this month. Members have discussed further cuts.

In the past, OPEC's output limits have tended to unravel within 3 months. On an average annual basis, total OPEC production has exceeded quota every year since before the price collapse of 1986 (see table). Monthly averages have occasionally fallen below quota, nearly always because of physical disruption associated with war.

Changing motivations of key OPEC members show up in other ways. Saudi Arabia, apparently tired of watching international capital build production capacity with which it must compete, recently solicited ideas from U.S. companies on ways they might participate in projects in the kingdom. Such a reopening might accelerate similar but sluggish initiatives in Kuwait and Iran.

Key evolutions

These changes-unusual quota discipline by OPEC and a return of international capital to formerly resistant megaproducers-represent history in the making. Much as they depart from trends of the recent past, however, they make perfect sense in the context of evolving economic and technological conditions.

Oil and gas companies and their regulators and customers ignore those evolutions at their peril. Much can happen in 25 years. Since 1973 in the petroleum industry, much has happened to make planning for a repeat of history seem like preparation for the wrong future. The next oil embargo will be imposed by consumers, not producers.