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podcast transcript
In 1960, a small group of oil-producing countries made decisions that reshaped the world economy.
They formed cartels to control the world’s most important resources, challenging powerful corporations and shifting the global balance of power.
Over the decades, that organization would trigger crises, fuel economic booms, and influence energy prices around the globe.
Learn more about the birth, growth, and ultimate decline of OPEC, the Organization of the Petroleum Exporting Countries, in this episode of Everything Everywhere Daily.
OPEC’s origins date back to the end of World War II.
The world was in a situation where its most important resources were shifting from iron and coal to oil. This was not an overnight change, but by the late 1940s planes, trains, and automobiles were all becoming increasingly dependent on oil.
At the time, the oil industry was dominated by seven Western companies known as the Seven Sisters. The Seven Sisters, including Exxon, Mobil, Chevron, Gulf Oil, Texaco, Royal Dutch Shell, and British Petroleum.
They secured long-term mining concessions across the Middle East and elsewhere in the early 20th century, before many countries recognized the value of oil.
This agreement gave them the right to explore, produce, and sell oil in return for relatively modest payments to the host government. These companies effectively operated a vertically integrated global system, controlling not only production but also price, refining, and distribution. Producing countries had little transparency and even less influence over pricing decisions.
The first cracks in this system appeared after World War II. As nationalist sentiments rose at the time, newly independent countries and governments began demanding a larger share of oil revenues.
A significant turning point came in 1950 when Saudi Arabia negotiated a 50:50 profit sharing agreement with ARAMCO. This model quickly spread to other producing countries and brought about the first major shift in the balance of power. Governments were no longer passive recipients of royalties. They were now partners entitled to a set share of profits.
But even with profit sharing, the company retained control over the “quoted price” of its oil, which determined how much it would produce and how its profits would be calculated.
Throughout the 1950s, the Soviet Union significantly increased its crude oil production, which forced the Seven Sisters to lower prices to compete with Soviet oil in many markets.
After the second successive reduction in the price of oil posted by these companies in August 1960, the major producing countries were left with ample leeway.
The Organization of the Petroleum Exporting Countries (OPEC) was established in Baghdad on September 14, 1960 by its first five members: Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela.
At the end of the founding meeting, it was announced that OPEC’s purpose was to unify the oil policies of its member countries and provide a forum for determining how their interests could be protected individually and collectively.
Members agreed that they could no longer remain indifferent to the attitude of oil companies in revising prices and demanded that oil companies keep prices stable and restore prices to those prior to the August 1960 price cut.
But the organization was not immediately strong or cohesive. At the 1962 general meeting of members, a debate arose over export restrictions. Each country wanted to export as much oil as possible, but if cheap oil flooded the market, prices would fall, the very problem that OPEC was formed to prevent. The new organization was weak and suffered from the fact that it straddles the border between the economic and political spheres.
Through the 1960s, OPEC members steadily expanded their influence. One of the most important tools they used was participation agreements, which gradually transferred ownership interests in oil operations from the company to the host government.
Instead of suddenly expropriating an oil company’s assets, countries often negotiate to gradually increase their stake, moving from minority to majority control. This approach allowed us to build technical and administrative capacity while avoiding the problems that come with immediate confrontation and immediate control.
Beyond its initial founding members, OPEC experienced significant growth throughout the 1960s. Qatar became a member in 1961, followed by Libya and Indonesia in 1962. The organization continued to expand its scope a decade later, with Algeria joining in 1969 and the United Arab Emirates, which originally represented only Abu Dhabi, joining in 1967.
By the late 1960s, OPEC had transformed from a small founding group into a broader union encompassing the Middle East, North Africa, and parts of Asia.
I’d like to tell a slightly different story here to explain the economics behind the cartel and what OPEC was trying to do.
Cartels are nothing new. A cartel is an agreement among competing producers to act like a monopoly. Instead of competing on price and production, members work together to limit supply, raising prices and increasing the group’s profits.
In economic terms, they seek to move from a competitive equilibrium where prices are lowered to a monopoly-like outcome where output is limited and profits are maximized.
However, cartels are rarely effective in the long run because they rely on members sticking to their contracts. Each participant is assigned a production quota or target, and collective production limits support higher prices.
The problem is that every individual member has a strong incentive to cheat. If others suppress production to keep prices high, a single producer can quietly exceed his quota, sell more at a higher price, and make additional profits without immediately crashing the market.
This creates a classic prisoner’s dilemma. If too many members cheat, supply increases, prices fall, and the cartel’s advantage disappears.
By the early 1970s, the balance had tipped decisively in favor of OPEC members. Oil demand has grown rapidly, especially in industrialized economies, and producing countries have recognized their strengthened position.
Most OPEC members now have most control over oil production. Nigeria joined in 1971, becoming the first sub-Saharan African member of OPEC. Ecuador joined in 1973, and Gabon joined in 1975.
The early 1970s marked a decisive turning point. In 1971, the major oil companies operating in the Mediterranean region and OPEC members signed the Tripoli Agreement.
The agreement raised oil prices and increased the producer countries’ share of the profits. OPEC members were also moving aggressively toward full nationalization of the oil industry, transferring direct control of their oil reserves from Western oil companies.
The collapse of Bretton Woods added further financial complexity. Since oil was priced in dollars, oil producers’ real incomes fell as the dollar began to break away from its old link to gold.
OPEC finally showed the world the power of a fully operational Death Star in 1973.
The Yom Kippur War of October 1973 transformed OPEC from a regional trading organization into one of the most powerful forces in global geopolitics. At the OPEC summit held at the Sheraton Hotel in Kuwait on October 16, 1973, it was announced that the price of oil would increase from $3.01 per barrel to $5.12 per barrel.
This was just the beginning.
In December, two months after the end of the Yom Kippur War, prices rose another 130 percent, and the organization’s Arab members cut production and banned oil shipments to the United States and the Netherlands, Israel’s main supporters during the war.
The result was severe oil shortages and soaring inflation throughout the West. Between October 1973 and January 1974, the price of a standard barrel of “light Arabian” crude oil quadrupled from $2.32 to $9 per barrel. The embargo lasted only five months, but triggered a two-year economic crisis, and oil prices never returned to pre-crisis levels.
The late 1970s brought a second dramatic disruption. The revolution in Iran, the second largest oil exporter after Saudi Arabia, triggered the second oil shock in 1979. This caused Iran’s oil production to plummet, and panic buying followed.
The outbreak of the Iran-Iraq War in 1980 further disrupted supplies. By the end of the year, North Sea crude prices had hit a new high of $40 per barrel, a level that may not be exceeded for another decade.
The 1970s and early 1980s were OPEC’s golden age.
The problem with keeping oil prices high is that it forces oil to be explored and produced in places that would otherwise be uneconomical.
In the 1970s, high oil prices drove non-OPEC countries to invest in oil production, especially in higher-cost deposits, such as Alaska’s Prudhoe Bay, the North Sea fields of Britain and Norway, Mexico’s Cantarel field, and Canada’s oil sands. At the same time, Western economies have become much more energy efficient.
The 1980s and 1990s were the first years of membership instability. Economic pressures and internal policy disagreements led some countries to withdraw. Ecuador withdrew in 1992, citing the financial burden of membership fees and production quotas. Gabon followed suit in 1995 for similar reasons.
From 1982 to 1985, OPEC reduced oil production several times in an attempt to stabilize prices, but these attempts failed as many OPEC members increased production beyond their quotas.
Saudi Arabia was one of the few OPEC countries to actually implement production cuts, and soon non-OPEC oil production surpassed OPEC’s. In 1986, exhausted and losing market share, Saudi Arabia opened the tap, flooding the market and sending prices to historic lows.
From the 1990s to the early 2000s, OPEC continued to serve as a coordinating body, adjusting production targets to stabilize prices. Its influence fluctuated depending on market conditions.
During periods of supply shortages, such as those in the early 2000s, OPEC regained some of its influence. As economies rapidly industrialized, especially in Asia, demand for oil increased, leading to a long-term rise in oil prices, which peaked in 2008.
The most structurally significant challenge to OPEC’s dominance over the past few decades has come from an unexpected source: American technological innovation.
The U.S. shale revolution, driven by innovations in hydraulic fracturing and horizontal drilling, allowed U.S. producers to increase production, ultimately making the U.S. the world’s leading oil producer, a position it still holds today.
This led to an unprecedented declaration of cooperation in December 2016 that brought together OPEC members and 10 non-OPEC oil producers to rebalance markets, reduce inventory levels, and support oil market stability. This expanded group, called “OPEC+,” represents an informal expansion of the cartel’s membership.
OPEC currently consists of 11 member countries and accounts for approximately 38% of global oil production.
In some ways, OPEC has been a victim of its own success. Their ability to keep oil prices high during the ’70s and ’80s was the driving force behind increased oil production in countries outside of OPEC.
They were also victims of the same problems that all cartels face. Many members, especially small producers with less developed economies, had strong incentives to continue cheating. This led many countries to withdraw from OPEC over the years to avoid being subject to production restrictions.
OPEC still exists, but because it does not control most of the world’s oil supply, its ability to control oil prices has been extremely weakened. But OPEC controls about 75 to 80 percent of the world’s proven oil reserves, most of which are in Saudi Arabia, Venezuela and Iran.
In the coming years or decades, OPEC may become more relevant again as those reserves are tapped and other countries’ production declines.
But if that happens, they’ll face the same problems as before: high prices that encourage fraud and more production.
