Opec In The Times Of Oil: Scarcity, Economic Crisis, And Price War

Introduction

It is no secret that oil today is the most important commodity in the world, where many need it and few have it. Countries use it for heating, transportation, and electricity; and as a raw material for chemicals, fertilizers, and plastics.[1] This means that due to its number of uses, it has a relatively high demand and a pivotal role in most economies in the world. However, oil is not located everywhere in the world, in fact very few countries have oil. Therefore, oil has a global demand and a local supply. [1: Bos, Oil Prices.]

The Organization of Petroleum Exporting Countries (OPEC), is an intergovernmental institution comprising thirteen oil exporting and producing economies.[2] However, capital requires access to cheap raw materials, especially oil; resulting in oil consuming economies having the need to ensure and accessible and cheap flow of oil.[3] Therefore OPEC has traditionally had a pivotal role in regulating oil supply, consequently adjusting prices.[4] [2: Focus Economics, “OPEC History.”] [3: Bichler and Nitzan, “Still About Oil?”] [4: Focus Economics, “OPEC History.”]

Venezuela was once a prosperous country that enjoyed the perks of many developed nations. This was because it was one of the world’s leading providers of oil, and historically delivered the US constant oil flows; creating a solid relationship. However, due to a number of events, -such will be explained later in the paper- it is now in political, economic and social decay.

There are two important theories to analyze, both for the role of OPEC, and for the example of Venezuela. The first one is the Narrative of Scarcity proposed by Jevons, which explains why in fossil fuels the consumption of the commodity increases parallel to efficiency. Additionally, it also paints the picture on how perceived scarcity is a crucial element in the price of oil. The second one is the Dutch Disease, where the production of a particular commodity -in this case oil- deindustrialized the economy as a result of strengthening the currency.

The following paper will illustrate the political and economic role of oil through the lens of the rise of OPEC and the Venezuelan crisis, using the aforementioned theories to explain particular events. The case of Venezuela will serve to exemplify four elements: the oil war that we are currently experiencing, the current and historical part of OPEC in the oil industry, the perceived scarcity that causes an increase in the price of oil, and how Dutch Disease affects -and can affect- oil dependent countries. Additionally, it will briefly expose why is it that in the middle of an oil war, transition to alternative energy is highly unlikely.

Theoretical Framework

The Narrative of Scarcity and Capital

Classical supply and demand theory tells us that the if the demand is constant and the offer is reduced, the price tends to increase; the opposite occurs when the offer is increased: prices decrease.[5] Efficiency curves are also present in industries. Technological innovation plays a pivotal role, where the advancements on such -assuming it generates resource efficiency-, equals a decrease in the consumption of resources. It may seem as if the more efficiency there is in the consumption of a resource -such as oil-, the less the effective consumption.

However, Jevons argues that for the case of fossil fuels -and applicable for energy resources in general-, the greater the efficiency and advancements of technological innovations, the more consumption of resources there will be.[7] This means that a decrease in the cost of a resource, will result in an increase of the demand. This is due to the fact that when the price remains constant, efficiency doubles; making the effective price halve -let us assume- and therefore consuming twice as much of the resource for an equal or similar price.[8] [7: Jevons, The Coal Question.] [8: Chan and Gillingham, “The Microeconomic Theory of the Rebound Effect and Its Welfare Implications.”]

Scarcity of a resource depends exclusively on the demand of it; in the case of oil, the supply is in the middle east -for now- and the demand is generated globally.[9] The price of oil has more to do with perceived scarcity that with actual scarcity.[10] This is something that had happened before, in the 19th century, as the perceived scarcity -the country that brought the fossil fuel to the world also the first one of raising the possibility that it could run out- of coal was a result of Britain maintaining their hegemony.

From the classical perspective, the excess of supply of oil until 1980 and the scarcity of it from there on should explain the price fluctuations of the commodity. However, as seen on graph 1, the behavior of price of oil is completely inaccurate when it comes to relating it to the traditional notion of scarcity. The answer to this paradox relies on capital. Capital is needed in order to sustain growth in a region.[12] According to Bichler and Nitzan, capitalists and corporations do not necessarily seek to maximize profits, but to outperform the average; meaning that capital is seen as a measure of organized power and therefore resulting in the capitalization of power.[13] In order for their relative profit to be sustained, corporations must engage in strategic sabotage, by forming state-backed corporate coalitions known as dominant capital.[14] [12: Bichler and Nitzan, “Still About Oil?”] [13: Bichler and Nitzan.] [14: Bichler and Nitzan.]

Additionally, there is a positive correlation between two groups of dominant capital: the Petro-Core -the world’s leading private integrated oil companies- and the oil producing countries.[15] Price here plays a pivotal role, for it has been the most important determinant of oil incomes since the 1970 and whatever determines the income of one group has similar impact on the earnings of the other.[16] The result of the fluctuations in prices is either differential accumulation or differential deaccumulation; resulting in an “agreement” where profits and incomes are “all in the price”.[17] This is because in the 1970s the massive nationalization of oil resources changed the role of oil companies, as they became service providers, and lost control over oil prices.[18] Therefore, the coalitions represent in the fixation prices based on the notion of perceived scarcity. Consequently, the interruptions in the flows of oil due to different geo-political situations of the oil-producing countries create this notion of uncertainty and therefore the ups and downs in the price of the commodity.[19] [15: Bichler and Nitzan.] [16: Bichler and Nitzan.] [17: Bichler and Nitzan.] [18: Bichler and Nitzan.] [19: Barsky and Kilian, “Oil and the Macroeconomy Since the 1970s.”]

Dutch Disease and Petrostates

The term petrostate has been used to describe countries whose governments deeply rely on the exports of oil and/or natural gas, economic and political power are concentrated in an elite minority, and institutions are weak with high levels of corruptions present.[20] Many of the members that constitute OPEC fit into such framework.[21] This allows for the overview of their growth models -in a general perspective- as to explain the behavior that causes the uneven oil flows. [20: Cara Labrador, “Venezuela.”] [21: Focus Economics, “OPEC History.”]

Petrostates are particularly prone tone to what economists call Dutch Disease.[22] The term refers to the increase on the export of a particular sector -mostly commodities- and the decrease of all the other sectors.[23] This is because increase of exports results in a strengthening of the currency -in terms of real exchange rate-, that consequently makes all the other exports “expensive” for the demand and therefore less competitive. This pushes capital away from sectors such as agriculture and manufacturing, which are known to be some of the main components for growth and competitiveness.[24] The revenues of this boom create a “spending effect” increasing the demand for the non-tradable sector, and ultimately de-industrializing the economy.[25] This is why petrostates, and particularly OPEC members, are prone to Dutch Disease. [22: Cara Labrador, “Venezuela.”] [23: Corden and Neary, “Booming Sector and De-Industrialisation in a Small Open Economy.”] [24: Cara Labrador, “Venezuela.”] [25: Corden and Neary, “Booming Sector and De-Industrialisation in a Small Open Economy.”]

In many cases, along with Dutch Disease, the so-called resource curse takes place. This is because petrostates are more dependent on exports than on taxes; resulting in weak ties between governments and their citizens.[26] “Most petrostates became dependent on petroleum while, or immediately after, they were establishing a democracy, state institutions, an independent civil service and private sector, and rule of law”.[27] The resource curse can therefore be linked to the internal conflicts that trigger instability in oil flows. [26: Cara Labrador, “Venezuela.”] [27: Karl, The Paradox of Plenty.]

Historical Background

The Rise of OPEC

The roots of OPEC can be traced to the discovery of oil in the middle east and therefore the extraction that occurred until the 1970s. One cannot mention OPEC without first mentioning the famous Seven Sisters. The term refers to a group of seven private companies that controlled over 85% of the global production of oil.[28] Today the Seven Sisters still exist, either by the name of BP, Chevron, Royal Dutch Shell or ExxonMobil.[29] Because they controlled the global production of oil, they also controlled oil prices; assuring for decades a constant and cheap flow of oil; particularly to the US and Europe. [28: Focus Economics, “OPEC History.”] [29: Focus Economics.]

The creation of OPEC represented a new era for the oil industry. On September 1960, in Baghdad, OPEC was funded as a response to a Seven Sister’s decision to reduce the prices of the supply of crude oil; the initial members being Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela.[30] Many of OPEC’s countries are exclusively dependent on oil, allowing their classification as Dutch Disease countries. It is important to highlight that the Declaratory Statement of Petroleum Policy, emphasize the “inalienable rights” of a country to “exercise permanent sovereignty over their natural resources in the interest of national development”.[31] Therefore, since the creation of OPEC, revenues passed from the hands of the Seven Sisters to the hands of the OPEC countries. [30: Focus Economics.] [31: OPEC, “OPEC: Vision, Mission and Development.”]

In 1973, due to the US providing support to Israel during the Yom Kippur War, OPEC proved its power by creating an embargo to Israel’s allies and therefore ushering oil prices.[32] The sudden rise of 450% in the price of oil generated a global recession; therefore causing the world to assume that the role of OPEC was key in the increase of prices.[33] This was one of the first clear manifestations of perceived scarcity, and how with a constant demand, explain the rise of prices. [32: Morse, “The End of OPEC.”] [33: Martín-Moreno, “El Papel de La OPEP Ante Los Retos de La Nueva Economía Del Petróleo.”]

The decline in production in the US, the UK, and Norway has consequently led oil consumers to seek new providers, mainly in Latin America, West Africa and the Former Soviet Union.[34] In 1950 the US imported only one tenth of its oil supplies, by 1973 it imported one third and by 2004 already two thirds.[35] This increased the global dependency on middle east oil. [36] [34: Billig, “The Venezuelan Oil Crisis.”] [35: Billig.] [36: Goodman, “¿Quién Está Comprando El Petróleo Venezolano Tras Las Sanciones de EE.UU.?”]

OPEC in the last decade has done very little to influence oil prices, except for the 2008 Oil slump as a response to the financial crisis.[37] Moreover, primary impacts of oil prices have not come from OPEC, but from decisions of individual governments to reduce oil production.[38] Another element that has played an important role are the new technologies that have allowed for a cheaper extraction of US and Canada’s shale oil; ultimately reducing the demand that these countries had for OPEC oil. [37: Lynch, “The Evil That Is OPEC.”] [38: Lynch.]

On 2014, oil prices plunged; leaving great deficits in Venezuela (24%), Saudi Arabia (21%) and Iraq (23%).[39] Two years later, oil prices fell even lower, from 100 USD per barrel in 2014 to 30 USD in 2016; sucking Venezuela into an economic and political convolution.[40] This recent drop in the price of oil had its roots in short and long term factors: a surge in oil supply due to the shale revolution in the US and Canada, robust production in the middle east from Saudi Arabia ad Iraq, the slowdown in the growth of the Chinese economy and a rapid increase of the USD in comparison to other currencies.[41] [39: Martín-Moreno, “El Papel de La OPEP Ante Los Retos de La Nueva Economía Del Petróleo.”] [40: Cara Labrador, “Venezuela.”] [41: Khan et al., “2014 Oil Plunge.”]

Venezuela and the Oil Plunge

Venezuela, a petrostate that some years ago enjoyed the benefits of developed countries such as low levels of inequality, increasing purchasing power, and low unemployment levels[42] is now facing major economic, social and political challenges. If Venezuela is able to emerge from this state, experts advice that major productive investments will have to be made with the county’s oil reserves.[43] [42: Organization of the United Nations, “Reconocimiento de La FAO a Venezuela | FAO.”] [43: Cara Labrador, “Venezuela.”]

It is no secret that Venezuela holds one of the largest oil reserves in the world, and on the past few years its economic dependence on the commodity has notably increased. The share of total export values rose from 68.7% in 1998 to 96% in the next decades years.[44] As the prices of oil kept rising, the economic dependence on it kept increasing as well. On 2004, the price of oil reached 42.33 USD per barrel, the highest point the New York Mercantile Exchange had seen in 21 years.[45] [44: Banco Central de Venezuela, “Oferta y Demanda.”] [45: Billig, “The Venezuelan Oil Crisis.”]

As a country, Venezuela had historically proved to be a reliable oil ally to the US, for it had continued to export oil during the 1973 embargo and provided additional supply during the shortages brought by the 1991 gulf war.[46] Venezuela provided the US almost 15% of its oil and gasoline, along with Canada and Mexico.[47] Moreover, Venezuela is geographically close to the US -in comparison to Saudi Arabia or Russia-, as it only takes 6 days for Venezuelan oil to reach US shores; making it a liability and therefore catalyzing the impact of the disruption.[48] Therefore the long-term relation of trust between the US and Venezuela was based on liability and ease of access to oil. [46: Billig.] [47: Billig.] [48: Billig.]

For decades, oil has been the main contributor to the Venezuelan economy. Long before Venezuela joined OPEC, the government had already taken a certain degree control of the oil reservoirs through requiring foreign oil companies to give half of their profit from oil to the state.[49] The same year OPEC was created, Venezuela, a founding member, increased its income tax for oil to 65%.[50] Dutch disease has haunted Venezuela for decades. Apart from oil, everything became cheaper to import than to produce; undermining efforts to promote domestic production, and gargantuan expenses in subsidizing foreign currency in order to pay for the imports.[51] Even after a century of the discovery of oil, it still plays a dominant role in the Caribbean nation.[52] [49: Cara Labrador, “Venezuela.”] [50: Cara Labrador.] [51: Lander, “Venezuela: Terminal Crisis of the Rentier Petro-State Model.”] [52: Cara Labrador, “Venezuela.”]

The rise of oil prices as a consequence of the embargo made Venezuela the country with the highest GDP per-capita in Latin America.[53] Around 100 billion USD were embezzled between 1972 and 1997; however, most of it was mismanaged.[54] The election of former president Hugo Chávez left the national oil company, Petróleos de Venezuela S.A., prone to manipulation; resulting in strikes -April and December 2002- that paralyzed oil production, ultimately dispossessing the world from some 200 million oil barrels.[55] Due to the political myopia caused by the conflict with Iraq, the US and several oil companies failed to see the halt of flow of oil from Venezuela as a consequence of the Chavez administration sacrificing oil for politics; after all, they had been a reliable main provider for seven decades.[56] [53: Cara Labrador.] [54: Cara Labrador.] [55: Billig, “The Venezuelan Oil Crisis.”] [56: Billig.]

The halt of Venezuelan oil was another manifestation of perceived scarcity that put the US in a position of mutually exclusive choices. It could either ask other countries to increase their production or use up its Strategic Petroleum Reserve (SPR); ultimately voting against the latter one.[57] The unexpected 2014 tumble of the oil prices represented the beginning of the downfall for Venezuela. After the drop of oil prices, the country struggled to pay its external debt, as well as banning all protests and dissolving the national assembly in 2018; resulting in the political, economic and humanitarian crisis of the petrostate.[58] Recently, the US imposed even more oil sanctions to Venezuela in order to pressure for the resignation of the Maduro government.[59] [57: Billig.] [58: Cara Labrador, “Venezuela.”] [59: Goodman, “¿Quién Está Comprando El Petróleo Venezolano Tras Las Sanciones de EE.UU.?”]

Discussion

The case of Venezuela and the rise of OPEC have served to exemplify four elements: the oil war that we are currently experiencing, the current and past role of OPEC in the oil industry, the perceived scarcity that causes an increase in the price of oil and how Dutch Disease affects -and can affect- countries. Additionally, it can briefly expose why is it that in the middle of an oil war, transition to alternative energy is highly unlikely.

The Venezuelan crisis is a symptom of the oil war that the world is currently experiencing. As mentioned before, the decision to extract shale oil from North American grounds has resulted not only in the reduction of oil prices[60], but on new players entering the game. These players not only include the North American economies, such as the US, Canada or even Mexico, but European countries such as China and Russia. This is because whenever OPEC reduces oil production in order to stabilize the economy, Russia increases; increasing its market share and not allowing OPEC to increase the price.[61] On the other hand, China, with a different strategy, stimulates African countries that have oil reserves, in exchange for permission to drill there and retrieve the oil directly to China, keeping it away from the rest of the world.[62] The dramatic fall in the price of oil, due to the reduction of oil imports from the US, left Venezuela with a high supply of oil and no demand; ultimately causing an economic crisis that has been exacerbated by the US’s sanctions to push out the Maduro administration from office. [60: Goodman.] [61: Bos, Oil Prices.] [62: Bos.]

This war is the result of a mix of elements, in which OPEC still holds an important role.[63] This is because it still supplies a considerable proportion of the world’s oil. However, it is important to recall that the oil war is causing OPEC to reduce its importance in the control of the prices of oil. It is known that the Middle Eastern -and hence, most of OPEC- oil does have a considerable advantage over the rest of the world: it is cheaper.[64] The recent increase of supply of OPEC oil is a response to the production of shale oil from the US and Canada.[65] However, the extremely, current, low prices of oil are not beneficial for anyone, not even for Saudi Arabia. [63: Bos.] [64: Insider, “Here Are the Most and Least Expensive Ways to Drill for Oil in the World | Financial Post.”] [65: Bos, Oil Prices.]

This allows to exemplify how the notion of scarcity is diffused and therefore how oil prices suddenly increase; once more exposing what Jevons observed centuries ago. The reason for this is because due to the authoritarian and inefficient government, oil strikes were generated; ultimately resulting in uneven oil flows and high oil prices. Therefore, even though that the price of shale oil needs to be subsidized[66], it is still better off for the US than to depend on an unreliable country. [66: Insider, “Here Are the Most and Least Expensive Ways to Drill for Oil in the World | Financial Post.”]

Moreover, it is a fit example of a country that has -for a great period of time- been unable to eradicate Dutch Disease from its economy. This is due to the fact that, as mentioned before, the Venezuelan industry loss competitiveness as a consequence of oil valuating the country’s currency. Moreover, this crisis is a warning to other oil-producing countries that have fallen into Dutch Disease. Due to the environmental effects of oil, alternative energy sources will be needed in the future. However, in order for this to happen, oil prices must be higher than those of alternative sources.[67] Therefore, right now, in the middle of an oil war with extremely low prices, using oil as a source of energy is more profitable than using alternative sources. [67: Bos, Oil Prices.]

Conclusions

As mentioned earlier, the Venezuelan situation as a consequence of oil prices, and the rise of OPEC, serve to illustrate several elements. First, the historical and actual role of OPEC, and how historically it had been a major price regulator, and how due to additional oil producers in the market is has lost influence in price fixing. Second, the oil war that we are currently living in as a consequence of the new players competing with OPEC, in order to secure stable flows of oil.

Additionally, Dutch Disease, and how it can affect economies who are solely dependent on the commodity; particularly after this oil war. Moreover, the dramatic fluctuations in oil prices as a consequence of perceived scarcity, that have been a part of the fossil fuel industry since its beginnings. Ultimately, the effects of oil in the transitions to alternative sources of energy, and how in order for the world to transit to alternative sources, the price of oil must be higher than that of the alternative sources. However, as a consequence of the oil war, oil prices are considerably lower, even to the point where it is not lucrative for many countries to produce.

Furthermore, history tells us that even though OPEC represented a new important player in the game of oil, the model was not changed and the high revenues from the elevated price margins only changed hands: from companies to governments. Therefore, from a broader perspective the power of oil, just like in the times of coal, was a form of oligopoly in the hands of few. Moreover, this all runs on the background of keeping oil an attractive source of energy, and therefore in the interests of the industry, avoiding the shift to alternative energy sources in order to secure power.

Perhaps OPEC will walk out victorious, and once again have gargantuan influence on oil prices, or maybe a new oil power will arise, reducing even more the influence of OPEC. Even possibly, alternative energy sources might find a way to become more attractive than oil and therefore transition will occur. However, these are only speculations and only time will tell.