Opec and the soaring cost of oil

Why blame things on Opec?
Because it has 'form' (see below). The Organisation of the Petroleum Exporting Countries - a 13-state body dominated by Saudi Arabia and the Middle Eastern nations - was created with the express purpose of influencing prices. And in the early Seventies it did, indeed, hold the world to ransom by restricting supply. The US and Britain maintain that the cartel is once again driving
up prices by limiting production, even though Opec now only controls 40 per cent of the world oil market, compared with 70 per cent in 1973.

What does Opec say in its defence?
Opec's members claim that most of them couldn't supply more even if they wanted to: they are already pumping at or near capacity. Only Saudi Arabia has substantial surplus capacity; yet when, at George Bush's behest, the Saudis did agree to produce 300,000 extra barrels per day (bpd), prices were barely affected. In any case, Opec insists it's not in its own interest to let the oil price rip.

Why wouldn't Opec want to push for higher prices?
Because the price rises it engineered in the Seventies led to a global recession, a slump in demand and a drive by other countries to find new sources of supply - in the North Sea, Russia, the Gulf of Mexico and elsewhere. This was disastrous for most of the cartel's oil-rich states, which are rich in very little else. So since then, Opec has aimed for long-term price stability: in 2000, it adopted a price policy of cutting production if it went below $22 and raising it if
it crested $28. However, after 9/11 and the Iraq invasion, prices skyrocketed; so Opec has now abandoned official price targets.

What, then, is behind the recent price explosion?
Opec points to the US Federal Reserve which, to prop up the domestic banking industry, has slashed interest rates and expanded the money supply, in the process severely weakening the dollar. As oil is bought in dollars, it now takes a lot more dollars to buy a barrel of oil. And this problem has been exacerbated, says Opec, by speculators. When economies slow, investors tend to move into commodities - food, gold, oil; their prices have recently reached record highs. Anticipating yet further price increases - a Goldman Sachs report speculates that oil prices could hit $200 in six months - investors are now piling into oil futures (contracts to buy oil at a date in the future). The financier George Soros, among many others, argues that the current situation is not a reflection of market realities: rather it shows all the signs of a classic speculation 'bubble', one that will eventually burst.

And the market realities?
Whatever the immediate causes of the price hike, it's clear that the longterm trend is deeply affected by the huge rise in demand for oil from India, Russia, the Middle East and, above all, China. Together they now consume 20.7 million bpd, picking up the slack from US demand, which is down to 20.3 million bpd. And global demand will prove increasingly difficult to meet. "85 million bpd is all the world can produce, and the demand is 87 million," says the delightfully named T. Boone Pickens, a US hedge fund trader specialising in oil. "It's as simple as that." His figures are contested - Opec claims daily supply is in fact 88.75 million. But even if there is enough to meet today's demand, the big concern is about the future.

So are oil reserves shrinking?
Oil production is decreasing in 54 of the world's top 60 oil-producing nations, including Britain (North Sea output, which peaked in 1999, has now plunged by more than half). The overall amount discovered has been falling for 40 years; easily reached oil fields are being depleted; untapped reserves are often small and hard to exploit. Many experts expect non-Opec production to peak around 2010; outside the cartel, the best hope is said to lie under the Arctic - but reserves are thought to be relatively limited, and conditions are horribly hostile.

But haven't Opec countries got huge reserves?
In theory. Yet there's increasing concern that Opec members have exaggerated the scale of them. Until recently, Saudi officials routinely claimed that the kingdom (producing 13 per cent of world exports) had an almost bottomless well; but some analysts fear its reserves aren't as plentiful or easily available as suggested, and last month, oil minister Ali al-Naimi shelved all plans to expand production capacity beyond 2009. Sadad al-Husseini, a former top executive at the state-owned oil company Saudi Aramco, says that Saudi production has already reached a peak and will begin dropping in 15 years or less.

So will world production soon reach a peak and decline?
Again, it's contested. The Association for the Study of Peak Oil thinks global crude supplies will top out at 87 million bpd at the end of this decade and then decline. But the more authoritative
International Energy Agency, adviser to 27 industrialised nations, believes that we won't hit a peak until around 2030, when supply will be at 100 billion bpd. The real problem right now, it argues, is posed by the 'above-ground hindrances' in the major oil-producing nations.

What are these hindrances?
The threat of violence from armed militias severely hampers production in Iraq and Nigeria. The nationalist autocrats of Russia, Venezuela and Iran are reluctant to let Western oil giants fully exploit their resources. And Saudi Arabia is suffering from 25 years of under-investment in some of its largest reserves. Like many producers, the Saudis could spend money to increase production and so bring down oil prices. But why would they want to do that?

The rise and (relative) fall of a cartel
Opec was founded in 1960 when the leaders of Venezuela, Iraq, Iran, Kuwait and Saudi Arabia met in Baghdad to try and do something about the low prices they were receiving for crude, and agreed to act in concert to protect their interests. Between 1960 and 1975, the group expanded to include Qatar, Indonesia, Libya, the UAE, Algeria, Nigeria and Ecuador (Angola joined in 2007). Its 13 members currently produce around 36 million barrels per day; non-Opec nations account for around 50 million.

The cartel's big moment came in 1973 when it decided to put the squeeze on Western governments for backing Israel in the 1973 Yom Kippur war, and for keeping it supplied with oil. The consequent quadrupling of the cost of a barrel caused global economic mayhem. But Opec then began to fragment as each member, trying to cash in on the high price created by their collective action, surreptitiously sought to exceed their agreed quotas. After 1980, reduced demand and over-production saw a drop in prices, which remained low throughout most of the Eighties and Nineties. They reached a nadir of $10 a barrel in 1998 thanks to the Asian financial crisis and the resumption of Iraqi oil output after the first Gulf war. ·