Faced with continuing high prices, OPEC was in a weak position at its September 15 meeting. With spare capacity reduced to about one mbd in Saudi Arabia, OPEC sought to remedy high prices by announcing an increase in its production ceiling from 26 to 27 mbd effective November 1. This was more a signal than an actual change because current production from the OPEC-10 was already known to be 28 mbd.

Despite interest by several members, a decision was postponed on whether to raise the price band, which by this point had become irrelevant. Naimi clearly opposed the raise, saying it should only be raised if there was a structural change in the market. Saudi Arabia, now producing 9.5 mbd, did announce just before the meeting that it would add 800,000 barrels per day of production capacity in two new fields by the end of September. Kuwait is also planning a more modest expansion. The WTI crude price fell slightly after the meeting to US$43.58, influenced by a report of a decline in US crude oil stocks and by oil rig shutdowns in the Gulf of Mexico because of Hurricane Ivan.

OPEC Finances

OPEC has benefited greatly from increased oil export revenues in the past two years as a result of higher oil prices and expanded production. In June 2004, the Energy Information Administration projected OPEC net oil export revenues for 2004 at US$286 billion, up from US$240 billion in 2003 and US$195 billion in 2002. These revenues have helped OPEC in its recovery from the price collapse of 1998 and 1999.

However, adjusting for inflation and rapid population growth, OPEC has much lower per capita income today (US$530 projected for 2004) than in the peak days of the late 1970s and early 1980s (US$1,691 in real per capita export revenues in 1980). It should be noted that many countries are heavily indebted from the period of lower oil prices from the mid-1980s to the late 1990s. And many OPEC countries are moving slowly on necessary economic reforms.

Saudi Arabia, OPEC’s largest oil producer and a leader in OPEC production decisions, will probably earn US$100 billion from oil export revenues in 2004 based on average oil production of 8.7 mbd. Earnings for 2003 were US$86 billion. Last year, Saudi Arabia experienced healthy gross domestric product (GDP) growth and a government surplus, greatly improving the country’s economic situation. However, Saudi Arabia’s 2003 surplus was only the second surplus in the past 20 years, during which time the government ran deficits and trade imbalances. Total government debt has been nearly 100 percent of GDP. Surpluses in 2003 and 2004 are expected to be used to increase foreign assets and pay off some government debt. In Saudi Arabia, oil exports contribute over 90 percent of export earnings, 70 to 80 percent of state revenues, and about 40 percent of GDP. Oil export revenues per capita were about US$3,683 in 2003, which in real terms is much lower than the per capita figure for 1980 at the high point of oil prices (US$22).

Saudi Arabia continues to face serious economic challenges of fast population growth (about 3 percent per year) and high unemployment (15 to 20 percent.) More recently, the threat of domestic terrorism has provided a new challenge and will require more government spending on security. Oil price volatility makes Saudi state planning difficult, as the income varies yearly. The large financial needs of the state have been estimated to require a stable oil price of US$30 per barrel, which helps explain recent Saudi reluctance at OPEC meetings to press for lower oil prices. Other OPEC members face similar challenges with even larger populations and hefty financial needs. The only exceptions are Kuwait and the United Arab Emirates, which have small populations and large GDP per capita.

A Clumsy Cartel

OPEC production cuts in 2002 were reasonably effective at restoring oil prices to the price band after the shock and price collapse following the September 11 attacks. In 2003, after effectively raising production to account for the strikes in Venezuela and the loss of production in Iraq during the war, OPEC sharply cut production in June and September before Iraq’s production could fully recover.

The cartel seemed unwilling to allow sufficient stock-building to stabilize the market. This shortage helped drive the price above the price band by the end of the year. In 2004, OPEC misread the market and cut production again although demand was increasing. Deepening instability in Iraq and low spare capacity increased political risks in the minds of traders as oil prices soared above US$40 per barrel.

Stock traders in New York, London, and Singapore, guided by both economic fundamentals and geopolitical risks, ultimately set the price of oil. In recent months the risk premium on the oil price may have grown to US$10 to US$15 per barrel. OPEC actions to increase production have not been sufficient to dampen the price escalation, which if left unchecked, will slow economic growth and diminish future oil demand.

OPEC continues to be hampered by the fact that as a group of sovereign countries, it has no enforcement mechanism. Therefore, exceeding quotas is a constant problem which undermines its efforts to manage the market. The financial needs of Saudi Arabia and other OPEC countries appear to require oil prices well above the price band, as reflected in the debate about raising the band. Yet the members have postponed making a decision about whether to admit this and this delay has undermined OPEC’s market credibility. It is hard to believe continuing Saudi statements that they would be content with an oil price at US$25 per barrel for the OPEC basket when they clearly are not pressing to achieve this and their financial needs demand a higher price. OPEC cannot control sudden shifts in demand or geopolitical risks. The oil market is difficult to manage, and OPEC has limited instruments and often imperfect data. OPEC continues, as Massachusetts Institute of Technology economics professor Morris Adelman once put it, to act like a “clumsy cartel.”