x Abu Dhabi, UAEMonday 24 July 2017

Opec does not need members like this

When demand and prices are rising, Opec exporters enjoy the twin benefits of higher export volumes and prices

Ecuador's motives for joining Opec are cast in doubt by its wanting to opt out of the latest round of production cuts.
Ecuador's motives for joining Opec are cast in doubt by its wanting to opt out of the latest round of production cuts.

With the questionable honour as the only country to join Opec twice - it left from 1992 to 2007 - Ecuador could be expected to know the rules of the exporters' club by now. But a request by its oil minister earlier this month to be excluded from the latest round of output cuts casts doubt on the motivations of the president, Rafael Correa, for rejoining. So it is at times like this that it is worth reminding ourselves why countries join Opec at all, and what is expected of its members.

When demand and prices are rising, Opec exporters enjoy the twin benefits of higher export volumes and higher prices. There is a multiplier effect that has a very favourable outcome on revenue figures. But oil is a cyclical business, and when the world economy contracts and prices sink, Opec members are hit with a double whammy of lower prices and smaller export volumes. Of course, it is tempting to try to make up for the lower prices by producing more.

That is what led to the creation of Opec in the first place. Indeed, when the global oil market was controlled by private western companies - the so-called seven sisters - during the first half of the 20th century, they managed supply to avoid damaging gluts and price wars that caused havoc with companies in the early years of the industry. When exporting nations assumed control of their resources in the second half of the century, they quickly realised they, too, would be the main losers from disorderly price wars leading to national bankruptcy, the rapid exhaustion of the world's largest oil deposits and wasteful consumption habits in consumer countries. Indeed, consumer countries have even recognised the merits of higher energy prices by imposing enormous taxes on fuel, sometimes reaching 300 per cent.

So Opec's job is to even out the cycles to avoid collective financial suicide on the downturn, and prevent damaging price explosions during boom years. With climate change imposing new restrictions on the use of fossil fuels, expensive oil is now also seen as the ally of the green movement. Some will argue that there is no need for such market management, but the truth is that all cyclical commodity producers work in a similar way, although the main actors do not hold formal talks for fear of being charged with anti-competitive behaviour.

But since the Arab oil embargo in 1973, one thing Opec has tried to do is remove politics from the business of oil output policy. After all, the oil producers of the Gulf are hardly a united political bloc. But that hasn't stopped some members - such as Iran, Venezuela and Ecuador - using Opec as a platform from which to grandstand against globalisation, the dollar or capitalism itself. This was particularly true during the past nine months, when even the more conservative members of the organisation were cast in the rather strange role of denouncing traders for pushing prices too high.

This rhetoric united those nations with large reserves, who were genuinely concerned over the impact of high oil prices on the world economy and future oil demand, and opportunists who saw the chance to score political points by taking a swipe at global capitalism and its foot soldiers on trading floors across the globe. Now that prices have dropped by more than half in four months, Opec is back in its more traditional role of making tough decisions to forego exports to protect the value of their resources in line with weakening growth. It is about taking the long view, and shouldering the cost of spare output capacity during the lean years. This separates the true market managers and the opportunists.

Since rejoining the organisation last year, Ecuador has faced the first real test of its allegiance to Opec's principles, and it has failed. Opec is not about extorting consumers, price fixing or railing against capitalism. It is about the rational exploitation of a finite natural resource and an equitable sharing of the responsibility to manage volatile markets. Some countries just don't belong in Opec. The trouble is, you can only see who they are when times get tough.

tashby@thenational.ae