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OPEC

Chair: Phoebe Rogers

Director: Olivia Ott

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Contents

Letter from the Chair…….………………………...……………………...3

Committee Description………………………….…………………….…….…………….4

Topic A: Raising Prices.…..…..………………….....……………..……….6 Introduction…..………………………………….……………………….……..…………6 History of the Topic………………………..…………………………..….…….…………7 Current Status…………………………………….………………...…….……...………...10 Country Policy…...………………………………………………..…….………………....14 Keywords……………………………………....……………….........…………….…..…..16 Questions for Consideration………..…………….……………….........…….……….…....17

Topic B: Swing Production ……......…………………..…………………19 Introduction……..…………………..………...……………………………………..……19 History of the Topic.…………………….….…….…....…………..………………...……20 Current Status………………………….……….………………………………………....22 Country Policy.….…………………...….……….……...…..……………………………..26 Keywords……………………………….…………….……………………………….......27 Questions for Consideration............……….…….…….…………………..……………….28 Bibliography……………….……………………………………………………………..29

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Letter from the Chair

Dear Delegates,

My name is Phoebe Rogers, and I am part of the Princeton class of 2019. I am majoring in

Economics, and pursuing a minor in Computer Science. This will be my first year chairing PMUNC,

and I am very excited to be a part of PMUNC 2016! I began Model UN my sophomore year of high

school, and this is my second year as part of the Princeton MUN Team. On campus, besides MUN, I

am a member of Envision and work for Rocky-Mathey Dining Services.

Last summer I interned at Veritas Technologies, and I am interested in continuing to work in the

tech industry in the future. I am fascinated by the intersection of economics and technology. As for

my personal life, I am originally from Eugene, Oregon. When I’m not studying I love skiing,

backpacking, hiking, kayaking, and biking. And of course, preparing for this amazing committee.

I look forward to seeing you all at the conference in November! I hope you are all coming

excited to be working together on resolving the issues facing OPEC, and understanding more about

how these oil extracting giants form decisions.

Sincerely,

Phoebe Rogers

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Committee Description

OPEC, the Organization of the Petroleum Exporting Countries, is an international body of

some of the world’s prominent oil-exporting countries. Its official mission is to, “coordinate and

unify the petroleum policies of its member countries and ensure the stabilization of oil markets in

order to secure an efficient, economic and regular supply of petroleum to consumers, a steady

income to producers and a fair return on capital for those investing in the petroleum industry.”1 All

decisions regarding the organization are made in OPEC Conferences, where delegations from each

member country are typically headed by their respective oil minister. These conferences are held

twice a year on average at the Vienna headquarters2, but additional sessions may be called when

necessary. All members of OPEC have, for the most part, a vote of equal weight in the decision

making process for the organization, because all members pay equal membership fees into the annual

budget. The decisions made at these meetings often concern production levels and oil prices, but any

and all changes occurring in the organization are also discussed in these meetings.

OPEC was created in September of 1960 at the Baghdad Conference by five Founding

Members: Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela3. These member countries were later

joined by Qatar, Indonesia, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador, Angola, and

Gabon. Throughout the 1960’s OPEC leaders worked to set the foundation for the organization,

establishing its Secretariat in Geneva before moving it to Vienna, and in 1968 adopting a ‘Declaratory

Statement of Petroleum Policy in Member Countries’ that stressed, “The inalienable right of all

countries to exercise permanent sovereignty over their natural resources in the interest of their

national development.”4

1 "Our Mission." OPEC. Accessed June 22, 2016. http://www.opec.org/opec_web/en/about_us/23.htm. 2 “OPEC Meetings.” OPEC. Accessed August 15, 2016. http://www.opec.org/opec_web/en/311.htm 3 “Brief History.” OPEC. Accessed June 22, 2016. http://www.opec.org/opec_web/en/about_us/24.htm. 4 Ibid.

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The 1970’s brought OPEC considerable recognition as it rose to become a dominant force

in the international oil market. However, turmoil also ensued in the 70’s due to the Arab Oil

Embargo of 1973 – and the subsequent international energy crisis – and the Iranian Revolution of

1979, both drastically driving up oil prices5. In 1975 OPEC held the first Summit of Heads of State

and Government of its members, calling for increased economic development and stability through

cooperation in international relations6. This marked one of the first demonstrations of OPEC’s intent

to become a stable, lasting, and globally influential force in the oil market. The early 80’s saw record

level prosperity for oil producers until a major price crash began due to falling demand after the

1970’s energy crisis. This crash is the largest crisis that the young oil market has yet faced, and it has

primarily been caused by a reaction on the consumer side of the market to the shortage of oil in the

previous decade. It is now 1986, the peak of the price crash and the early years of the oil glut, and oil

prices have already fallen from $27 to below $10 this year7. The market is in crisis and now is the

time for all large global oil producers, and this committee, to take decisive action and enact drastic

change.

5 Ibid. 6 Ibid. 7 Hershey Jr., Robert D. "Worrying Anew Over Oil Imports". The New York Times. Published 30 Dec 1989.

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Topic A: Raising Prices

Introduction

Faced with plummeting oil prices, both OPEC and non OPEC producers in the

international oil market are in crisis. Prices have dropped to record lows, bottoming out at

below $10 per barrel. Without the profits brought in by stable high prices, the economies of

oil exporters are suffering. In 1986 daily revenue from oil in Saudi Arabia dipped below 100

million, less than a quarter of the near 400 million that they had been making in 1980-818.

Oil represents one of the primary exports of the individual member countries of OPEC, and

neither they nor other international oil producers can afford for prices to continue at their

current levels.

Since the beginning of the oil glut OPEC has done its best to limit its production of oil

in order to reduce global supply and thereby raise prices. Unfortunately efforts as of yet have

not been successful, and both prices and profits continue to drop. Individually, each major

oil producing state (or organization such as OPEC) has been unable to affect significant

change in the world market. International producers are desperate to raise prices, and

anxious that oil may be losing its standing as the world’s primary energy source.

Consumption continues to fall, and new worries have arisen that consumption will inevitably

keep declining into perpetuity and never again recover to previous levels. Many, who feel

attuned to the markets, believe that the situation is a temporary reaction to the record level

high prices of the early 80’s and a lingering result of the energy crisis in the 70’s. US

economists have expressed concern that the American public is beginning to believe in

lasting low prices, and that once the market levels out again, “The break in prices . . . may

8 Gately, Dermont. Lessons from the 1986 Oil Price Collapse. New York University, 1986. Brookings Papers on Economic Activity.

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jeopardize many hardwon achievements, such as conservation and sharply reduced

dependence on OPEC oil.”9

Whatever the cause of the glut, apathy is not an option. OPEC, alongside other

international producers, are compelled to lower oil supply and increase prices if they hope to

maintain the economic advantages and political influence that being at the forefront of a

major global market like oil has afforded them.

History of the Topic

Long standing tensions between the Middle East and the West flared during the Arab-

Israeli War in 1973, during which the United States supported and supplied Israel. This

resulted in the Arab members of OPEC imposing an embargo against the US and other

countries that supported Israel including the Netherlands, Portugal, and South Africa.

Included in the embargo was a ban on the exportation of petroleum to the above nations

and the introduction of general oil production cuts in order to raise prices even further10.

The embargo primarily affected oil importing countries that heavily depended on affordable

OPEC oil, highlighting the world’s increasing dependence on OPEC as an oil producer.

At the time, OPEC was the largest producer of oil on the global market.11 As they

reduced their production levels throughout the embargo, international oil prices per barrel

first doubled and then quadrupled.12 OPEC grew more and more influential as countries

with limited oil stockpiles struggled to meet domestic demand, setting the stage for a world

where strategic resources, particularly oil, determine leverage on the international playing

field. As prices continued to rise and supply dwindled, consumers across the world began to

9 Hershey, Robert D., Jr. "THE DARK SIDE OF THE OIL GLUT." The New York Times, March 21, 1982. http://www.nytimes.com/1982/03/21/business/the-dark-side-of-the-oil-glut.html?pagewanted=all. 10 "Oil Embargo, 1973–1974." Department of State. Accessed June 22, 2016. https://history.state.gov/milestones/1969-1976/oil-embargo. 11 Ibid. 12 Ibid.

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adjust their spending habits. Massive energy shortages in the West led to austerity measures,

many of which outlasted the embargo. The establishment of permanent regulations such as

speed limits and social movements such as environmentalism accompanied temporary gas

price controls and rationing.13 The ingrained consumer caution brought on by the 1973 Oil

Embargo and the consequent 1970’s Energy Crisis, combined with record high oil prices,

was a major cause of the Oil Glut of the 1980’s. Although the Arab Oil Embargo was lifted

as early as 1974, OPEC’s price increases remained and the energy crisis was sustained for

multiple years following.14

During and following the major energy crisis, governments across the world sought out

alternatives to Middle Eastern oil. Smaller non-OPEC oil producers including Brazil, Egypt,

India, Malaysia, and Oman doubled their output between 1979 and 1985.15 During the

1980’s, commercial exploration by states not aligned with OPEC increased, developing large

oilfields in Siberia, Alaska, the North Sea, and the Gulf of Mexico.16 During the early 1980’s

OPEC was hopeful to maintain the high price of oil in spite of the end of the energy crisis.

However, international supply for oil eventually caught up with demand and prices began to

fall. In an attempt to keep prices high, OPEC decreased oil production by nearly half by

imposing various production cuts between 1980 and 1986.17 Their efforts were largely

unsuccessful, as oil-importing countries simply turned to cheaper producers. By 1981 OPEC

lost its standing as the world’s largest oil producer to the Soviet Union.18 By early 1982, the

Boston Globe reported that OPEC’s production, having peaked in 1977, was at its lowest

13 "Energy Crisis (1970s)." History. 2010. Accessed June 22, 2016. http://www.history.com/topics/energy-crisis. 14 Ibid 15 "1980s Oil Glut." PediaView.com. Accessed June 22, 2016. https://pediaview.com/openpedia/1980s_oil_glut. 16 Ibid. 17 Ibid. 18 Ibid.

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level since 1969.19 In 1985, OPEC’s share of the world oil market dropped to less than a

third, from the nearly half it had sustained during the 1970’s.20

Dissent arose out of frustration within the OPEC member countries. Members were

expected to meet production quotas set by the organization, but as a reaction to the falling

profits due to low prices, many of the states, “inflated their reserves to achieve higher

quotas, cheated, or outright refused to accord with the quotas.”21 In 1985 OPEC’s daily

output was down to approximately 3.5 million barrels per day from around 10 million in

198122. The same year, Saudi Arabia abandoned its position as the organization’s swing

producer, creating a, “huge surplus that angered many of their colleagues in OPEC.”23 It is

typically the swing producer’s responsibility to adjust their output to balance changes in the

market, and the loss of the primary swing producer at such a time of crisis was a major blow

to oil producers.

19 Warsh, David. “The Economy: The Oil Glut deepens; OPEC’s grip loosens; but a boom or a bomb could spur prices back up.” Boston Globe. 28 Feb 1982. 20 "1980s Oil Glut." PediaView.com. 21 Ibid. 22 Ibid. 23 Koepp, Stephen (1986-04-14). “Cheap Oil!”. Time. Retrieved 19 January, 2008.

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In the above graph, Brent refers to Brent Crude, which is, “a major trading classification

of sweet light crude oil that serves as a major benchmark price for purchases of oil

worldwide.”24 This graph demonstrates the precipitous drop in oil production following

1981 as producers continuously lowered output in the hopes of raising prices.

It is now 1986, and prices are at their lowest point in the oil glut so far. Oil-exporting

countries across the world have faced major losses in revenue, and oil-importing nations

have begun adjusting their economies in preparation for a prolonged period of low prices.

OPEC and its members are not the only ones to have suffered from the oil crisis.

Current Status Before 1986 the oil market experienced a price crash due to low demand and a growing number

of suppliers. In early 1986, many OPEC members followed the rebellious attitude displayed by Saudi

Arabia in rejecting its position as swing producer and began producing above OPEC-prescribed

levels.25 In their attempt to recapture a larger share of the world market, these countries inadvertently

caused the price crash to develop into the much discussed “glut of oil” in the market.26 Their desire

to increase revenue through increasing production is responsible for the massive over-supply of oil in

the international market today. These desperate times have fractured OPEC, once a strong and

influential body, and left it rife with internal dissent. Frustration over the market situation led to the

breach of organization-denoted quotas, which in turn only caused the situation to worsen further. As

of yet, neither working together nor pursuing individual interests has resulted in an improvement in

the state of the market.

It would evidently be in the best interest of all oil producing nations, both within and outside of

OPEC, to find a way to raise prices. Whether a sufficient number of producers would be either

24 "UK Brent, Crude oil, Brent crude." One Financial Markets/CB Financial Services Ltd. 2012. 25 Danielsen, Albert L. "OPEC." Encyclopedia Britannica Online. Accessed June 25, 2016. http://www.britannica.com/topic/OPEC. 26 "Crude Oil Price Collapse of 1986." Crude Oil Price Collapse of 1986. May 2002. Accessed June 22, 2016. http://www.freerepublic.com/focus/news/2019385/posts.

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willing or able to work together to effectively raise prices is another matter. Each producer now faces

choices that may heavily impact the future oil market and their own future prosperity.

There are many points of contention and obstacles that must be overcome if a workable

solution to the current crisis is to be reached. Firstly, is the fundamental issue of OPEC's structure as

a type of formalized cartel. A cartel is defined as a group of producers that have entered into a non-

legally binding agreement to minimize competition and maintain high prices in a given market.

Though OPEC does not have a complete monopoly on the oil market, they have collectively

controlled a substantial share of the market and qualify as a cartel.27 Cartels, however, are not entirely

cohesive units. Indeed, OPEC does not act as one unified organization, but as 14 individual

countries- each acting in its own interest. Historically speaking, the interests of individual states have

mostly aligned with those of OPEC as a whole, but ever since the magnitude of the price crash has

become apparent, these interests have begun to diverge. The immediate result of this divergence in

interest has been the refusal of member countries to comply with OPEC quotas and the subsequent

‘oil glut’ and worsening of the market crisis.28 The discord between the members of OPEC and their

lack of desire to reduce personal profits for the good of the body is not without precedent however.

Cartels are unstable by nature, and it is nearly always in the interest of the individual members to

‘cheat’ on the other members and produce more than their quotas permit.29 This unfortunate

situation highlights the extreme conflicts of interest within the membership of any cartel, and

underscores the importance of complete collaboration and the imposition of legally binding cartel

rules in order to ensure that the interests of any individual nation are not put ahead of the collective

interest of the group.

It is important to remember that OPEC does not exist in a vacuum. It is not the world’s

only oil producer, and as of now, is it no longer the world’s largest oil producer. The Soviet Union

27 Danielsen, Albert L. "OPEC." Encyclopedia Britannica Online. 28 Yergin, Daniel (1991). The Prize: The Epic Quest for Oil, Money, and Power. Simon & Schuster. 29 Parkin, Michael; Melanie Powell; Kent Matthews (2007). Economics. Pearson Education. p. 134.

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and other smaller producers are still extremely influential participants in the global market.30

Furthermore, it has become clear that there are a multitude of factors that play a role in the shaping

of the market. The United States began pumping oil from Alaska in 1977, and throughout the 1970’s

and 1980’s many new oilfields have been discovered in the North Sea.31 Cars are becoming more fuel

efficient by the year, and electricity generated from coal, nuclear power, and natural gas have all

played a role in reducing demand for oil.32 The oil market has become far more competitive than in

years past, and consumer dependence on oil is also diminishing. These factors are uncontrollable, but

nevertheless relevant in the deliberation surrounding how all oil producers should proceed in the face

of this crisis.

In recent years OPEC has worked to maintain the high prices it first achieved during the

energy crisis in the 70’s. It was this prioritization of price over market share that led to the loss of

their status as world’s largest producer in 1981.33 It is clear that cutting supply and raising prices has

not been effective for the organization and has resulted in significant losses and discontent among

the membership. However, once member countries began abandoning production quotas last year

the price crash was only exacerbated and turned into a veritable oil glut. Neither adhering to or

breaking from the production quotas has led to any sort of recovery from the price crash. This is

primarily because OPEC is no longer the influential power it once was in the global market. Not only

has the oil market lost some of its strength as a result of the price crash, but OPEC is no longer even

the primary power within the market. It will be difficult, though not impossible, for the organization

to change the tide of the market forces.

If OPEC were to collaborate with other large oil producers to cut global supply and prop

prices, there would likely be a larger chance that their efforts might be successful. That being said, the

30 "1980s Oil Glut." 31 Ibid. 32 Portney, Paul R.; Parry, Ian W.H.; Gruenspecht, Howard K.; Harrington, Winston (November 2003). "The Economics of Fuel Economy Standards". 33 Hershey Jr., Robert D. (1989-12-30). "Worrying Anew Over Oil Imports".

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prospect of all OPEC member nations expressing willingness to work cooperatively with other oil

producing nations would prove extraordinarily difficult.

The member countries of OPEC have historically faced immense challenges in achieving

internal peace and cooperation, as evidenced by the ongoing war between Iran and Iraq.34 On the

other hand however, many OPEC members have far worse relationships with producers that are not

a part of the organization, such as the tenuous relationship between much of the Middle East and the

West. Regardless of the temptation to stray from the cartel and find greener grass elsewhere, it is in

the best interest of all OPEC members to instead focus their energies on the task at hand, that being

doing everything in their power to recover from the current crisis by utilizing the joint resources of

the organization’s members.

As noted previously, cartels are fundamentally unstable because they are not bound by any

official legal contract (due to the fact that the formation of cartels and the practice of collusion are

illegal).35 Each member of a cartel or each participant in a business agreement to collude is not legally

bound to their arrangement. Herein lies the problem of achieving full cooperation of all OPEC

members. While it might seem logical for the involved parties to adhere to their agreement given that

it benefits them all, there is no guarantee of this. Furthermore, it is nearly always in the immediate

best interest of a member to cheat on the agreement assuming that all other members adhere to it.

The road to a full recovery from this price crash will be a long one, and it may never be reached if

OPEC members feel that it is acceptable for them to breach their agreement with the rest of the

cartel. Complete cooperation will be necessary, though this will be impossible without some form of

incentive (whether that be a positive or negative incentive) for members to adhere to organization

standards.

With many member states following the lead of Saudi Arabia and abandoning the regulated

quotas of OPEC, the organization finds itself in a difficult yet critical conflict. The essential question

of how to handle the disobedient member countries must be raised in the deliberations over how

34 Danielsen, Albert L. "OPEC." Encyclopedia Britannica Online. 35 Parkin, Michael; Melanie Powell; Kent Matthews (2007). Economics.

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OPEC can continue as a united body. The current crisis has undoubtedly been frustrating and

damaging to the members of OPEC, and after seeing that a number of these members are willing to

renege on the rules of the organization it may be difficult to repair relations. First is the issue of

whether the member countries that are currently committing infractions will be willing to revert to

the quotas set by OPEC and thereby fully rejoin the body. However even if these countries concede

to doing the above there is currently no concrete regulation stopping them from reneging on their

agreement again at a later point in time. Now that the option appears open to them, there is a far

greater danger of further infractions. Before any progress can be made within the market, OPEC

must first address this pressing internal issue.

Once OPEC is unified and in a place to affect change in the global market, then it must turn

to economic strategy. There is no simple way to fix a problem of the magnitude of the current crisis.

Nevertheless, steps toward recovery must be taken with a long-term goal in mind. It will be necessary

for OPEC members to devise a way in which to relieve the price crash and oil glut in the short term,

yet maintain its competitive status with other large producers in the long run. This will necessitate a

difficult balancing a number of priorities, such as high prices versus market share, but such a balance

must be achieved if OPEC hopes to remain a competitive and successful power in the oil market.

Country Policy

The Middle East

Though the Arab OPEC member countries might seem to be an obvious bloc within the

organization, there has been substantial internal conflict within the region. Following the recent

Arab-Israeli War in 1973, the OPEC Siege in 1975 (in which OPEC oil ministers were taken hostage

by Palestinian militants), the Iranian Revolution in 1979, and the continuing Iran-Iraq War that began

in 1980, the situation in the region is all but stable. Given the state of war existing between Iran and

Iraq in particular, relations among the Arab OPEC members are tenuous at best. That being said,

much of the Middle East is united in its mutual conflict with the west. The west, and the United

States in particular, unifies the Arab OPEC members against a common economy, as evidenced by

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their targeting of Western oil importers during the Arab Oil Embargo. The members of OPEC that

are more closely aligned with Western powers are likely to experience tension or mistrust with the

Arab members as a result of this long standing conflict.

Central/South America

Venezuela and Ecuador, being the only two Central/South American OPEC members, share a

number of unique similarities. The most significant of these is their cooperation with the United

States. Both of these countries have historically been aligned with the West, which may invite conflict

between them and the Middle Eastern members. Apart from their shared alliance with the west,

however, Venezuela and Ecuador have little in common. Venezuela was one of the Founding

Members of OPEC and has massive oil reserves, similar in volume to Saudi Arabia36. Ecuador, on

the other hand, is one of the smallest producers in the body and has far less history with the

organization.37

Africa

The four African members of OPEC are extremely diverse, and as a group they share few

characteristics . Libya and Nigeria are large oil producers that have very little trouble participating

fully as members of the organization. Algeria and Gabon, in contrast, are far smaller producers than

the majority of OPEC members. For these countries it is sometimes difficult to meet the OPEC

production quotas, and their relative lack of petroleum resources has at times translated to a lack of

influence in the organization. The membership fees and production quotas required by OPEC are

sometimes a significant issue for these producers, and the benefits of being a member do not always

outweigh the burden38. At a time when OPEC, and the entire oil market, find itself in crisis, it is

unclear whether these low producing countries will find it beneficial to remain members. However, it

is exactly this consideration that may give these countries a special type of leverage in the body.

36 "Member Countries." OPEC. Accessed June 25, 2016. http://www.opec.org/opec_web/en/about_us/25.htm. 37 “World Proven Oil Reserves by Country.” OPEC. Accessed June 25, 2016. http://www.opec.org/library/Annual%20Statistical%20Bulletin/interactive/2004/FileZ/XL/T33.HTM 38 "Opec." PediaView.com. Accessed June 25, 2016. https://pediaview.com/openpedia/Opec.

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OPEC is aware that it is now more important than ever that the organization united front and work

together to build the necessary internal confidence to effectively recover from this crisis. To that end,

ensuring that the interests of all OPEC members, big or small, are adequately met, will be a top

priority for the organization.

Indonesia

Indonesia is the only Southeast Asian member of OPEC, and as a smaller oil producer it shares

many of the concerns of Algeria, Gabon, and Ecuador. Furthermore, the geographical and regional

constraints of Indonesia might not be shared by the other OPEC members, leading to a type of

isolation from the interests of the rest of the body.

Keywords

Cartel - an association of manufacturers or suppliers with the purpose of maintaining prices at a

high level and restricting competition39

Glut – an excessively abundant supply of something e.g. in the market

Collusion – “a non-competitive agreement between rivals that attempts to disrupt the market's

equilibrium. By collaborating with each other, rival firms look to alter the price of a good to their

advantage. The parties may collectively choose to restrict the supply of a good, and/or agree to

increase its price in order to maximize profits. Groups may also collude by sharing private

information, allowing them to benefit from insider knowledge.”40

Production Quota - a goal for the production of a good. It is typically set by a government or an

organization, and can be applied to an individual worker, firm, industry or country. Quotas can be set

high to encourage production, or can be used to limit production to control the supply of goods.

Iran-Iraq War – “prolonged military conflict between Iran and Iraq during the 1980s. Open

warfare began on Sept. 22 1980, when Iraqi armed forces invaded western Iran along the countries'

joint border. The roots of the war lay in a number of territorial and political disputes between Iraq

39 Parkin, Michael; Melanie Powell; Kent Matthews (2007). Economics. 40 "Collusion Definition | Investopedia." Investopedia. 2007. Accessed June 22, 2016. http://www.investopedia.com/terms/c/collusion.asp.

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and Iran. Iran wanted to seize control of the rich oil-producing Iranian border region of Khuzestan,

a territory inhabited largely by ethnic Arabs over which Iraq sought to extend some form of

suzerainty.”41

Questions for Consideration

Where does your country rank among the top global oil producers?

Where does your country rank among the producers in OPEC?

What relationship does your country have with other producers in OPEC?

Would your country be willing to “cheat” (produce more than agreed upon) on other

members of your cartel?

Would your country be willing to revert to low OPEC quotas if they are currently

cheating on their quotas?

What measures should be taken to ensure that in the future members refrain from

cheating on their quotas?

Will OPEC be capable of continuing as a cohesive unit in spite of the disloyal

actions of multiple members?

Is it possible for countries at odds (for example Iran and Iraq) to cooperate in

matters of the market without letting their national issues get in the way?

Is the price crash merely a temporary circumstance due to natural economic cycles

that will end in a few years without the need of interference in the market?

How can OPEC stay competitive in the market in spite of growing international

production and decreasing dependence on oil?

41 "Iran-Iraq War." Encyclopedia Britannica Online. Accessed June 22, 2016. http://www.britannica.com/event/Iran-Iraq-War.

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Topic B: The Question of the Swing Producer

Introduction

The issue of the swing producer is more technical in nature, and the way in which

OPEC handles this topic may be dependent on how they address the issue of raising prices.

In order to fully understand the issues surrounding the swing producer, it is first useful to

have some basic knowledge of economics and markets. By definition:

"a swing producer is a supplier that has a large amount of spare capacity; so much so that

they can influence market prices by ratcheting their output up or down at will. Typically,

swing producers try to 'balance', or artificially regulate the market to keep prices robust and

stable."42

Swing producers can exist in somewhat competitive markets, where the market is not

fully dominated by a monopoly or oligopoly, but they are most frequently referred to in the

context of less competitive markets.43 De Beers, for example, has a near monopoly on the

diamond market and acts as the market's swing producer, adjusting its production levels as

needed to maintain high prices and large profits.44

In such a massive and lucrative market as petroleum, a swing producer will almost

inevitably emerge. In the past, when OPEC was the main power in the oil market, the swing

producer of OPEC has also fulfilled the role of swing producer for the entire market.

However, given that OPEC has fallen behind other global producers, the necessity and value

of the swing producer role has been increasingly called into question. As the market for oil

42 Tertzakian, Peter. "Defining the Swing Producer - ARC ENERGY IDEAS." ARC ENERGY IDEAS. ARC Financial Corp, 2015. Web. 43 Ibid. 44 Ibid.

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continues to evolve, it is essential that OPEC quickly and expediently determines the future

of the position.

History

OPEC led oil world oil production throughout the 1970's, but began losing market

share toward the end of the decade as a result of increasing non-OPEC production.45

Moving into the 80's OPEC struggled to maintain high prices in the face of growing

worldwide production and slowly decreasing global dependence on oil. The organization

continued cutting its own production levels in order to raise prices, but this only led to

further decreases in their market share from 47% in 1979 to below 30% in the mid-eighties.46

As the OPEC market share has decreased, so has OPEC's influence in the market. The

Soviet Union is now the main power in the oil market, having surpassed OPEC production

levels in 1981. Mexico and Norway are also developing powers in the market given the

recent discovery of large oilfields within their territories.

Since OPEC’s establishment, Saudi Arabia has acted both as the unofficial leader and

the de facto swing producer of the organization. Possessing 18% of the world's proven

petroleum reserves, it is one of the most oil-rich countries in the world and was therefore the

obvious choice for both of these positions in the organization.47 Throughout OPEC’s

existence, Saudi Arabia has acted as a buffer, increasing oil production when other member

countries were unable to produce up to their quotas, and reducing production when prices

dropped in order to balance the market. They have acted as an effective swing producer in

the past, capable of adjusting their oil production by one million barrels per day within a

45 “OPEC: Crude Oil Prices Versus Market Share.” WTRG Economics OPEC: Crude Oil Prices Versus Market Share. Accessed July 09, 2016. http://www.wtrg.com/opec.html. 46 Ibid. 47 "Saudi Arabia." Organization of the Petroleum Exporting Countries. Accessed July 09, 2016. http://www.opec.org/opec_web/en/about_us/169.htm.

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month.48 These dramatic fluctuations are made possible because of the country’s large spare

capacity that they keep on hand for market management.49

The role of swing producer is both a position of power and an oppressive

responsibility. It is true that the swing producer has the power to affect change in the market

and adjust prices to some extent, but this often comes at the expense of their own profit. In

order to maintain stable high prices, it is often necessary for the swing producer to produce

below their capacity, meaning that they must sacrifice potential profit for the stability of the

market.50 Furthermore, instead of capturing their full market share based on their oil

reserves, the swing producer gives up a portion of the market that ends up being taken

advantage of by smaller producers. Smaller producers necessarily benefit from the regulatory

actions of the swing producer, and are free to produce at their full capacity due to the prices

established by the swing producer.51 The producer that fills this position plays a vital role in

the market, and the rest of the players in the market, both producers and consumers, are

deeply affected by the actions of the swing producer. This being said, the spare capacity of a

swing producer is not always a sufficient power to counteract the fluctuations in the market.

There has historically been no official regulation of the swing producer in the

petroleum market. Large international markets often regulate themselves, and a swing

producer (or multiple swing producers) tends to emerge organically as the producer with the

largest spare capacity.52 It was natural that Saudi Arabia became the swing producer in

OPEC given that it had the largest proven petroleum reserves out of the Founding Members

48 "Swing Oil Production And The Role Of Credit: A Synthesis Of Best-In-Class Research Views - ValueWalk." ValueWalk. 2016. Accessed July 09, 2016. http://www.valuewalk.com/2016/06/swing-oil-production-and-the-role-of-credit-a-synthesis-of-best-in-class-research-views/. 49 "Swing Oil Production And The Role Of Credit: A Synthesis Of Best-In-Class Research Views - ValueWalk." ValueWalk. 50 “OPEC: Crude Oil Prices Versus Market Share.” WTRG Economics OPEC. Accessed 21 Jul 2016. 51 Ibid. 52 Tertzakian, Peter. "Defining the Swing Producer." ARC ENERGY IDEAS. 2015.

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at the time of the organization’s establishment. During the 1970’s OPEC overtook the Seven

Sisters, a group of seven then-dominant oil companies that controlled close to 85% of the

world’s oil reserves.53 As OPEC surpassed the Seven Sisters, Saudi Arabia also took on the

role as the primary international swing producer due to the organization’s newfound

domination of the market. Although no official guidelines govern the position of the swing

producer, in an interdependent organization such as OPEC both the swing and the regular

producers must work collaboratively and cooperatively in order to secure the long-term

success of the body.

Up until 1985 the Saudis faithfully fulfilled their contract to OPEC, but with the

recent precipitous drop in prices, they have since abandoned the role. Neither them nor any

OPEC member is currently the largest oil producer in the world, and no one yet knows

where the burden of swing production will fall next. At the July Conference, it will be

necessary for OPEC members to select a new swing producer and instate a new strategy

with regard to swing production. The abdication of the most recent swing producer has

highlighted the need for a new system for the swing producer that effectively balances the

unpredictable nature of production and of the market.

Current Status

No country is currently acting as the swing producer. The price crash of the 1980’s

turned into an oil glut once the former swing producer abandoned its position and flooded

the market, with various other OPEC member countries following suit and disregarding

their quotas54. The beginning of the oil glut has reinforced the importance of the swing

producer, and also highlighted the flaws in the way the position has been regarded in the

53 Mann, Ian. "Shaky industry that runs the world". The Times (South Africa). Published 24 January 2010. Archived from the original on January 27, 2010. 54 "1980s Oil Glut." PediaView.com.

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past. Throughout the existence of the modern oil market, a swing producer has always

emerged in a rather organic and unstructured manner. There has never been any formal

legislation or regulation surrounding the position; it has always been tacitly accepted that the

swing producer in the oil market would be a single country rich in petroleum that is

determined without any official deliberation or negotiation. This was how the position was

passed to the previous swing producer. Given the crisis in which the market now finds itself,

and considering the role the previous swing producer played in worsening the situation, it

would be prudent to develop new policies among the oil production blocs that formalize the

swing producer position and bind the swing producer to clearly delineated rules and

regulations. .

The role of the swing producer is at once extremely powerful and extremely

burdensome. Whoever fills this role has the ability to influence prices and control the

market, punishing other producers by flooding the market or aiding them by maintaining

low levels of production and thereby keeping prices high.55 On the other hand, the swing

producer also has the responsibility of managing the market. They are forced to give up a

portion of their market share in order to keep prices high56. The swing producer for OPEC

functions as the authority figure of the body, taking on the responsibility of cleaning up after

the other member countries and taking it upon themselves to come to the aid of the rest of

the membership. Although the swing producer undoubtedly fills a position of power, they

are also very much constrained by the responsibility that comes with the role.

The graph below shows the drastic decrease in production that Saudi Arabia, as the

swing producer at the time, was inclined to submit to just before 1986. More-so than any

55 Morecroft, John D. W.; van der Heijden, Kees А. J. М. (1990). "MODELLING ТНЕ OIL PRODUCERS" (PDF). System Dynamics Society. 56 Tertzakian, Peter. "Defining the Swing Producer - ARC ENERGY IDEAS." ARC ENERGY IDEAS. ARC Financial Corp, 2015.

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other OPEC member, they were forced to minimize production and thereby revenue in

order to benefit the rest of the body.

Considering both the benefits and the obligations that come with assuming the role

of the swing producer, it is doubtful that a single entity will be able to faithfully fulfill the

commitments of the position without causing damage to the market or the other producers.

It would be naïve to believe that a single producer would be able to fill a position of such

power without regulation and simultaneously avoid inflicting harm on OPEC as a whole.

The abdication of Saudi Arabia during the oil glut provides a strong example of why a single

unregulated swing producer in the oil market is generally unable to act as a permanent

fixture. It might therefore be practical, looking forward, to implement some type of

legislation with regard to the position. In fact, a complete overhaul of the way the swing

producer functions may be necessary. These regulations will need to create a swing

production role that will be sustainable and outlast whatever crisis the market or the

individual producer might suffer.

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This leaves the members of OPEC with a number of options. First, they can choose

to enact no changes to the current system and allow a swing producer to emerge organically

and continue to act as it sees fit, being held accountable by no official regulations. A second

possible solution is to continue to designate a single large producer as the swing producer,

but simultaneously implement regulations surrounding the its production levels, thereby

ensuring that they are at no point able to flood the market or otherwise punish the other

producers. In order to succeed, the regulating body for this second solution would need

some sort of leverage over the swing producer. i.e. a credible threat that would incentivize

the swing producer to act in their favor. Varying degrees of regulation are possible, with

options ranging from a complete lack of regulation all the way to hand picking the swing

producer and closely monitoring their levels of production to the point where any deviation

from the standard is punished harshly. Utilizing a single swing producer is not the only

option however, and depending on the market situation exiting the price crash and oil glut,

possibly not the most prudent option.

Theoretically it is possible to have a market with no swing producer, or in other

words a market where all producers act as swing producers. However this is usually only

possible in more competitive markets than oil. The oil market does not have a massive

number of producers due to the fact that petroleum is a natural resource that takes a

significant amount of time to replenish organically. As such, the market is less competitive,

and different producers will have very different production capacities. It is unlikely that a

solution will emerge in the oil market in which all producers act collaboratively and

simultaneously as the swing producer.

In spite of the unlikelihood of an oil market in which everyone acts simultaneously as

the swing producer, it is nevertheless possible that multiple countries might fulfill the role of

OPEC PMUNC 2016

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the swing producer. These producers could each have smaller spare capacities, and share the

burden of either increasing or decreasing production between themselves so as to minimize

the negative impact on any one country. Furthermore, if one of the swing producers were to

experience a production failure, the other producers would easily be able to pick up the

slack. One of the drawbacks of this system, however, is that it would require extensive

regulation and maintenance, and might be difficult to implement among countries that have

historically experienced internal conflict or conflict amongst themselves.

In the same vein of utilizing multiple producers, in a well-organized and cooperative

bloc it might be possible to put into place a system of rotation. A number of countries

within the bloc, or even all of the countries depending on their respective spare capacity,

could take turns spending acting as the swing producer for the body for a set amount of

time. This potential solution would alleviate some of the pressure felt by a single swing

producer to continuously manage the market while still giving them the power to

temporarily do so. This system would also require significant coordination and collaboration

in order to be successful.

There are many possibilities when it comes to the role of the swing producer, and

each of the systems suggested above represents a single point on a broad spectrum of

opportunity. If the primary producers of the oil market hope to implement a lasting solution

to the problem of the swing producer, then they must tailor their resolution to the

circumstance in which the market finds itself. Much of this will depend on the internal

situation of OPEC following the discussion of the first topic of this committee.

The way in which the position of the swing producer is decided will largely depend

on the condition of the producers in the market. It will be necessary, when addressing this

topic as a committee, to take into account the changes that have occurred in the market

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since the beginning of the July 1986 Conference. These changes must play a role in

informing the deliberation of the many countries represented in this committee with regard

to the future of the swing producer position.

Weighing both the power and the burden carried by the swing producer, it is hopeful

that a solution might be reached in which those who contribute to playing the role of the

swing producer are neither overly controlling of the market nor needlessly resentful of the

responsibility they bear to the rest of the producers in the market.

Country Policy

Middle East

There exists ongoing and long-standing conflict among the OPEC members in the

Middle East. Aside from the current war between Iran and Iraq, the region has historically

been tumultuous and politically chaotic. There are many ideological conflicts in the area due

to its rich religious history. Furthermore, the political arena has witnessed many changes and

conflicts in the past century, and countries of the Middle East have often been used as

pawns or proxies in greater international conflicts. The Middle Eastern OPEC members

might be capable of forming an internal bloc were it not for the ongoing Iran-Iraq War that

has played a role in further dividing the region. Given the magnitude of the current crisis,

these members may still find it in their best interests to collaborate in spite of this conflict.

The Middle East holds much of the oil reserves of OPEC, and indeed the entire world, and

in this way the region is extremely powerful and must be protective of its power. If a

challenger to Middle Eastern oil were to emerge within OPEC and assume the power of the

swing producer, the regional producers might lose their reigning influence in the oil market.

Central/South America

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As a small producer, Ecuador will likely play a larger role in deliberation surrounding

swing production than in contributing to swing production itself. However, OPEC would be

wise to continue to court its smaller producers and entice them to remain members by

heavily involving them in decision making processes. Venezuela, a very large producer, will

most probably be a contender for contributing to swing production. The possibility of a

Western-aligned producer holding that much power in the market, however, might seem

extremely unfavorable to a number of the Arab OPEC members.

Africa/Indonesia

As the OPEC members with fewer East-West political rivalries, the African

members and Indonesia are likely to be more neutral on the subject of who might participate

in swing production than the above regional members. That being said, any OPEC member

would be remiss to see excess power fall into the hands of another producer. It is doubtful

that any one producer would be happy to see the full power of the swing producer go to

another member, regardless of whether their political interests align. The process of coming

to a reasonable solution to the problem of the swing producer will involve a serious political

balancing act. It will be necessary to weigh both the reluctance of OPEC members to cede

additional power to another and the ability of each member to feasibly contribute to the role

of swing producer. Regardless of the interests of regional blocs, in the end the issue will

come down to whether the organization can strike an effective balance of power.

Keywords

Competitive Market - A competitive market is one in which a large numbers of

producers compete with each other to satisfy the wants and needs of a large number of

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consumers. In a competitive market no single producer, or group of producers, and no

single consumer, or group of consumers, can dictate how the market operates.57

Market Share - the percentage of an industry or market's total sales that is earned by a

particular company over a specified time period.58

Monopoly - A situation in which a single company owns all or nearly all of the market for a

given type of product or service. This would happen in the case that there is a barrier to

entry into the industry that allows the single company to operate without competition. The

producer will often produce a volume that is less than the amount that would maximize

social welfare.59

Oligopoly - Oligopoly is a market structure in which a small number of firms have the

large majority of market share. An oligopoly is similar to a monopoly, except that rather than

one firm, two or more firms dominate the market.60

Spare Capacity - a situation in which actual production is less than what is achievable or

optimal for a firm. This often means that the demand in the market for the product is below

what the firm could potentially supply to the market.61

Swing Producer - a supplier that has a large amount of spare capacity; so much so that

they can influence market prices by ratcheting their output up or down at will.62

Questions for Consideration

How much does your country produce?

How much spare capacity does your country have?

What other countries are in your bloc?

57 "Economics Online." Competitive Markets. Accessed July 09, 2016. 58 "Market Share Definition | Investopedia." Investopedia. 2004. Accessed July 09, 2016. 59 "What Is a Monopoly? Definition and Meaning." InvestorWords.com. Accessed July 09, 2016. 60 "Oligopoly Definition | Investopedia." Investopedia. 2003. Accessed July 09, 2016. 61 "Excess Capacity Definition | Investopedia." Investopedia. 2006. Accessed July 09, 2016. 62 Tertzakian, Peter. “Defining the Swing Producer.”

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How much do the other countries in your bloc produce?

Who is the largest producer in your bloc?

What is your country's relationship like with the major producers in your bloc?

What is your country's relationship like with major producers outside of your bloc?

How many/what other blocs exist in the market?

What is your country's relationship like with members of other blocs?

What is your bloc's relationship like with other blocs?

What type of swing production structure will benefit your country the most as a

producer?

How can your country work with other countries to negotiate a situation both within

and without your bloc in which the most beneficial structure for you is implemented?

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