OPEC & Capacity (Part 1)

I've been in Philly this week attending a course at Wharton. At the moment, I'm stuck in the Philadelphia airport with a long delay, so it appears I have some time to write.

I shared a cab from my hotel to the airport with a gentleman who happened to be going at the same time -- a professor emeritus in political science from the University of Arizona, who now lives in California. We got chatting about gas prices, so I told him that I had just started this blog and he said he'd check it out.

I'm going to start with a narrative, with few specifics, in order to simply set the stage. Over time (weeks, months?), I'll add more details, references, and data, but let's start with the basics. (There will certainly be oversimplifications in the following, but otherwise we'll include too much detail to make sense of it for now.)

First, let's talk about the underlying reason that OPEC came to exist. An accurate history would include a lot of politics, but fundamentally, the creation of OPEC was all about economics.

Decades ago as the international oil companies (IOCs) scoured the globe for oil, they identified a lot of potential in the countries that today make up OPEC. The most important of the IOCs were often called the "Seven Sisters." Today these companies would be known as Exxon, Mobil, Shell, BP, Gulf, Texaco, Chevron, and Total, but most went by a different name at the time. The IOCs signed agreements with foreign governments which granted them access over a certain period of time to explore for oil. The agreements also provided a rough framework for subsequent development plans for any fields discovered.

Of course, the IOCs, were in competition with one another, so they each strove to find more and more oil, secure supplies, and beat the competition. Along the way, they found some of the largest oil fields ever discovered in places like Saudi Arabia, Kuwait, Iran, Iraq, and Venezuela, which were the eventual founding members of OPEC. As the IOCs began to develop these massive discoveries, it was soon apparent that the fields could not all be produced at maximum capacity without creating a glut of supply that could not be matched by the then current world demand. At any given time, carelessly opening up a few valves would flood the market with oil for which there was no market.

Saying this another way, the addition of these highly productive fields to world supply created excess capacity. Excess capacity is at the heart of oil price history and of OPEC itself. I'll continue with this discussion in part 2 of OPEC and Capacity in my next entry.

For a more detailed history of OPEC, see http://www.opec.org/aboutus/history/history.htm Reading this may distract you from my simplified narrative, but at least you know where you can go for more info. You can also consult Wikipedia.