Also, the greater the supplies of non-OPEC oil, the less OPEC oil that was on the market to meet world demand.įurthermore, the two oil price shocks triggered enormous investments in scientific research to improve the efficiency of technology in finding, developing, and producing oil and, thus, in reducing the high cost of upstream operations in these new areas, thereby adding for the oil companies an even higher margin of profit with which to reinvest in high-cost areas.īy 1985, OPEC production was indicative of the backlash suffered by OPEC at the hands of its own price policies. Because OPEC adhered to the system of fixed price and swing production, any additional oil coming from outside OPEC would first capture its share in the market before buyers resorted to OPEC oil. The reason behind this was that OPEC's high prices provided such a wide profit margin for oil investors that high-cost areas such as the North Sea became not only feasible but highly lucrative areas for continued reinvestment. For example, North Sea production (both British and Norwegian) leaped to 3.5 million barrels/day in 1985, up from 2.0 million barrels/day in 1975, and continued to rise thereafter. With this continued decline in the call on its oil, OPEC saw its own market share fall from 62% during the mid-1970s to 37% in 1985, all as a result of increasing supplies from outside OPEC coupled with the fall in demand as a result of high prices and improving energy efficiency in industrial nations. The fall in Saudi Arabia's production was so great that it caused a problem of insufficiency of associated gas for the generation of electricity for water desalination plants. This created a situation in which the 12 member countries of OPEC were producing practically the amount of oil commensurate with their allocated quotas, whereas Saudi Arabia was forced to swing downward relative to the fall in the call on total OPEC production, seeing its production in 1985 fall to approximately 2.5 million barrels/day, or roughly one-quarter of its production capacity (leaving three-quarters unproduced). In other words, OPEC now became the swing producer, bearing the burden of price defense at the expense of its world market share whereas Saudi Arabia bore the brunt by becoming the swing producer within OPEC, absorbing this fall in world demand for OPEC oil far more than did the other OPEC members. Meanwhile, the prices of other crudes were to be fixed upward or downward of that reference price, taking into account the quality of the crude and its geographical location in Saudi Arabia.

Ras Tanura, which Saudi Arabia became committed to charging the oil companies. OPEC decided to fix its price and take a reference price based on the crude of Arab Light API 34 f.o.b.

This system proved to be even more anomalous given that Saudi Arabia did not have a quota share and was left to be the “swing” producer within a range of 5 million barrels/day. Given increasing oil supplies from outside OPEC in the face of weakening world demand, the organization's market share would correspondingly fall naturally and continuously.Īlthough first discussed in 1982, the OPEC quota system was formally adopted in March 1983 at an extraordinary meeting held in London that set a production ceiling of 17.5 million barrels/day, reducing the OPEC price to a unified $28/barrel. OPEC chose the first option in resorting to the “quota” system, based on the concept of its member countries, as a whole, producing oil in volumes designated only to fill the gap between, on the one hand, total world demand and, on the other, world supplies from outside OPEC that is, OPEC chose to be the last resort producer or what was termed the “swing producer.” This meant that at a certain demand level, the higher the non-OPEC supplies, the lower the OPEC total quotas. OPEC had to either stick with its official price by reducing its output or else follow the market and reduce its price to retain its share of the world oil market. Chalabi, in Encyclopedia of Energy, 2004 5 OPEC as the Last Resort Oil Supplier: The Quota System

Opec stands for