Crude Realities: The extent of OPEC’s influence on financial markets

OPEC stands for the Organization of the Petroleum Exporting Countries. Founded in 1960, OPEC’s main objective is to coordinate and unify the petroleum policies of its member countries to secure fair and stable prices for petroleum producers. 

This article briefly outlines who this organisation is and their significant influence on the pricing of oil.

Who are OPEC?

OPEC has 13 member countries, including nations like Saudi Arabia, Iraq, Iran, and Venezuela, among others.

OPEC holds 80.4% of the world’s proven oil reserves, while the set of 11 non-OPEC nations represent 9.7% of proven oil reserves. With 90% of the world’s proven crude oil reserves held by these nations, they have the capability to disrupt or enhance the supply of crude oil. The list of non-OPEC nations includes Azerbaijan, Bahrain, Brunei, Equatorial Guinea, Kazakhstan, Russia, Mexico, Malaysia, South Sudan, Sudan and Oman.

And OPEC+?

OPEC+ refers to OPEC and its alliance with other major oil-exporting countries that are not part of OPEC. OPEC+ aims to bring more coordination to global oil production levels, thereby stabilizing prices. The most notable non-OPEC country in OPEC+ is Russia, but the group also includes Azerbaijan, Bahrain, Brunei, Kazakhstan, Malaysia, Mexico, Oman, Russia, South Sudan and Sudan

And what are the “Observer states”?

Observer states do not have voting rights in OPEC decisions but may be invited to participate in discussions, share perspectives, and sometimes even coordinate policies informally with OPEC members. The status of observer can serve as a preliminary step before becoming a full member, although this is not always the case. Observer state countries include Canada, Egypt, Norway and Oman.

What Does OPEC do?

1. Production Quotas: Both OPEC and OPEC+ set production quotas for member countries to balance supply and demand in the global oil market. These quotas aim to stabilise or increase oil prices depending on prevailing market conditions and arguably to meet their needs as oil producing nations.
2. Market Monitoring: The organisations monitor global economic conditions, energy markets, and supply/demand factors to inform their decisions.
3. Policy Coordination: Through regular meetings, OPEC and OPEC+ members coordinate their national policies regarding oil production.
4. Data and Research: They gather and publish data on oil production, exporting, and pricing, providing valuable insights into the global oil market.

How Do They Do It?

1. Regular Meetings: Both OPEC and OPEC+ hold regular meetings to review current market conditions and decide on production quotas.
2. Technical Committees: These are specialized committees that analyze market conditions and recommend policies.
3. Joint Ministerial Monitoring Committee (JMMC): In the case of OPEC+, this committee reviews compliance with agreed production quotas and recommends corrective measures if needed.
4. Consensus Decision-Making: Decisions, especially in OPEC, are generally made by unanimous agreement, although OPEC+ operates more on a negotiated basis between its leading members.

Market Implications of OPEC Decision Making

A knowledge of both the direct and wider indirect influence of OPEC on financial markets is worthwhile as this goes across the majority of asset classes, and therefore can influence traders significant irrespective of their preferred trading instrument. These include:

1. Oil Prices:
   OPEC and OPEC+ decisions hold significant sway over global oil prices. These organizations, representing a substantial portion of the world’s oil production, can influence supply levels through production cuts or increases. Consequently, their actions often result in immediate and sometimes substantial effects on oil prices. Higher production quotas tend to lower prices, while production cuts can drive prices upward. These price fluctuations impact both energy companies and consumers, as they affect fuel costs and energy-related expenses.
2. Stock Markets:
   While energy stocks and indices are particularly sensitive to OPEC/OPEC+ decisions, the broader stock market is also affected. This broader impact arises from the economic implications of oil price changes. For instance, rising oil prices can lead to increased production costs for many businesses, potentially impacting corporate profits. Conversely, lower oil prices can benefit various industries but may negatively affect energy sector companies. Therefore, stock markets, as a whole, as well as individual stocks react to these shifts in energy prices, influencing investment strategies and market sentiment.
3. Currency Markets:
   Changes in oil prices can have a cascading effect on currency markets. Oil-exporting countries e.g., Canada, often rely heavily on oil revenues to support their economies. When oil prices rise, these countries tend to experience increased income, which can strengthen their currencies. Conversely, falling oil prices can weaken their currencies. This currency impact, in turn, affects Forex markets as traders adjust their positions based on shifts in exchange rates driven by oil price movements.
4. Inflation:
   Oil prices have a direct and immediate impact on inflation levels worldwide. This is because energy costs are a significant component of the Consumer Price Index (CPI) in many countries. When oil prices rise, it often leads to higher transportation and production costs, ultimately contributing to inflation. Central banks closely monitor inflation levels, and significant changes can influence their monetary policies, including decisions on interest rates. Thus, OPEC’s choices can indirectly affect central bank decisions, which, in turn, impact financial markets.
5. Geopolitical Implications:
   The decisions made by OPEC and OPEC+ are not just economic; they also have geopolitical ramifications. Oil is a strategic resource with far-reaching geopolitical significance. Countries that are major oil producers often wield considerable influence on the global stage due to their energy resources. Therefore, OPEC’s decisions can sometimes lead to geopolitical tensions or alliances, affecting international relations and potentially impacting global security.
6. Sector Impact:
   Certain industries are highly dependent on oil prices. Airlines, transportation, and the automotive sector, for instance, are profoundly affected by OPEC/OPEC+ decisions.
   Airlines may experience changes in fuel costs, which can significantly impact their operational expenses and profitability. Similarly, transportation companies and automakers rely on affordable fuel prices to maintain competitive pricing and consumer demand. Consequently, OPEC’s choices can ripple through these sectors, influencing business strategies, stock performance, and investor sentiment.

Summary

Although by no means the only influence on the price of oil and related assets, OPEC undoubtedly plays a major part. For traders, particularly those involved in commodity trading, energy sectors, or currencies of oil-dependent countries, understanding the dynamics of OPEC and OPEC+ is crucial. Their decisions can create volatility and trading opportunities, but also pose risks that need to be managed carefully. A knowledge of timing of OPEC meetings and observation of the impact of OPEC statements are a great start point in managing such risks and taking advantages of opportunities that may exist.