Understanding The OPEC Oil Supply Situation

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OPEC: How it all began

The Organization of the Petroleum Exporting Countries (OPEC) was created in 1960 to unify petroleum policies among its members. It aims to ensure fair and stable prices for producers, regular supply for consumers and fair returns to industry investors.

The five founding members of the permanent intergovernmental organization were Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Nine other members eventually joined: Qatar, Indonesia, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador, Angola, and Gabon. To view OPEC's milestones, click here.

In 1970, OPEC member countries gained control of their respective domestic petroleum industries. The group came to prominence and started to influence the prices of crude oil on world markets.

The global economy poses the greatest risk to the oil market. In the early 2000s, supply and demand were affected by social unrest in several countries. Prices stabilized starting 2011 but fell in 2014 due to speculation and oversupply. The group sees growing demand from Asian countries while that of the 34-member Organization for Economic Cooperation and Development continues to shrink.

OPEC's dominance

At present, OPEC holds a 40% market share in the global oil market and OPEC-exported oil makes up around 60% of the global oil trade.

Data from the International Energy Agency (IEA) showed that OPEC nations hold 81% of the world's proven crude oil reserves, with two-thirds coming from the Middle East. The bloc also develops technology and undertakes explorations to boost production capacity while cutting operational costs. See more data here.

OPEC is able to assert its dominance due to the absence of alternative sources with a similar scale, lack of economically-feasible alternatives to crude oil and its low-cost advantage.

The importance of crude oil

Oil price movements have significant impact on the world economy, with crude oil being the most prominent in the global commodities market.

Crude oil prices mainly depend on geopolitical and economic developments and events, affecting the oil supply levels and resulting in fluctuations in oil prices. These include the 1973 Arab oil embargo, the 1980 Iran-Iraq war, the 1990 gulf war, the 1997 Asian financial crisis, the 2008-2009 global financial crisis, and the current oil oversupply from OPEC.

Saudi Arabia's role

Saudi Arabia is the world's biggest crude oil producer, making it OPEC's most dominant member. (Related reading: How Saudi Domestic Policy Shapes OPEC's Production.)

EIA data showed that when the country cuts oil production, it results in a spike in oil prices and vice versa. All major oil price fluctuations can be traced to Saudi Arabia's production levels, along with other OPEC nations.

Early this year, the OPEC's recent decision to continue with the oil oversupply pushed oil prices to their lowest level in 12 years.

How about the US?

The United States began commercial exploration of petroleum way back in the 1800s. In 1814, it discovered petroleum in salt wells drilled in Ohio and Kentucky. In 1859, a well in western Pennsylvania was drilled specifically to search for oil.

Over the years, oil played a major role in the US economy along with the onset of the Industrial Revolution. Its demand, supply, and price have started to significantly impact the country's growth and inflation.

The US economy became one of the world's largest oil producer and consumer. In 1970, there were 80.5 million cars and 17.6 million trucks, while the country produced 9.6 million barrels of oil daily (equivalent to 21% of the world total) and consumed 31% of global supply.

However, the OPEC overtook the US in terms of production, accounting for more than half of the world supply.

Current oil oversupply

The U.S. shale boom forced OPEC to boost production to defend its market share, driving prices lower.

In January this year, USA and European Union sanctions on Iran were lifted, allowing it to access world markets. Tehran had been preparing for these in months and expects to return to its position as one of the world's top oil producers, causing prices to drop even lower.

In a media interview with CNN, Iran's oil minister Bijan Zanganeh said the country plans to hike output to near 1.5 million barrels by the end the year.

The oil glut dragged market prices to a 12-year low in January. OPEC acknowledged the oversupply in the global oil market and said the glut may further increase this year, with Iran taking the lead.

Saudi Arabia, the de-facto OPEC leader, insisted on a supply freeze among all members to boost oil prices, but Tehran refused to join the deal. Saudi Arabia is already struggling to retain its market share and is under more pressure after Iran refused to cooperate.

Signs of recovery

In its monthly oil market report released in June, OPEC said excess supply is expected to "ease over the coming quarters."

"Provided there is a clearer picture regarding oil supply and demand, the expected improvement in global economic conditions should result in a more balanced oil market toward the end of the year," the report read.

The group attributed the oil market rebalancing to the slowing inventory builds in US commercial crude stocks. It also cited disruptions in supply coming from Nigeria, Venezuela and Libya, which offset Iran's heightened production.

OPEC data showed that commercial crude stocks fell by eight million barrels in May. This is in contrast to the situation in previous months, with global stocks jumping by 12 million barrels in March and April, and by 19 million barrels in February.

As excess supply shrinks, prices started to recover. OPEC's reference price for May averaged $43.21 per barrel, $5.35 higher than the previous month.

The IEA also projected that the global oil market will likely be balanced in 2017.The Paris-based agency said demand continues to grow faster than production, while the surplus in the first half of this year turned out to be 40% smaller than May estimates.

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