A Short History of OPEC

OPEC turns 57 years old this year. I suppose I could wait three more years for a "round" number to tell you about it, but as they say, there's no time like the present. So put a candle to the oil lamp, son, sit back, and listen up as I tell you the history of OPEC -- what it is, how it came to be, and how an oil embargo made OPEC famous.

Or infamous, as the case may be.

An even shorter map of the OPEC countries. Image source: Getty Images.

Present at the foundation

The history of OPEC began in September 1960, when five founding members signed their names to a document establishing the Organization of the Petroleum Exporting Countries (OPEC), and declared the organization open to "any country with a substantial net export of crude petroleum, which has fundamentally similar interests to those of Member Countries." In short order, eight more countries took them up on that offer (then nine, then back to eight again -- see chart below). As a result, OPEC today boasts 13 active members.

Source: finviz.com.

Curiously, some of the world's biggest oil producers do not belong to OPEC, and never have. Among them: Canada, China, Mexico, Norway, Russia, and the United States itself. And although not a single European nation is an OPEC member, the organization maintains its headquarters in Vienna, Austria.

How OPEC came to be

The founding members formed OPEC in September 1960, at a time when the developing world was rapidly decolonizing post World War II. At that time, seven major oil companies (known as the "Seven Sisters"), all originating in the developed world, controlled about 85% of global oil production. These included:

• Britain's Anglo-Persian Oil Company, which later evolved into BP plc (BP -0.94%)
• Standard Oil of California -- modern-day Chevron (CVX -0.86%)
• Texaco (later absorbed into Chevron)
• America's Gulf Oil (likewise)
• Standard Oil of New Jersey -- modern day ExxonMobil (XOM -0.57%)
• Standard Oil of New York (later absorbed into Exxon)
• And Royal Dutch Shell (RDS.A) -- the only one of the seven to retain its original name today.

OPEC's defining objective was to reclaim developing nations' oil resources from their former colonizers, and from the companies that would one day become BP, Chevron, ExxonMobil, and Royal Dutch Shell -- for the benefit of their citizens and "in the interest of their national development."

To this end, OPEC started flexing its muscles in the early 1970s, demanding a greater share of the profits from oil extracted from OPEC countries by the Seven Sisters. Things came to a head in 1973, when Egypt's invasion of Israel marked the onset of the 1973 Arab-Israeli war and provided an excuse for OPEC to test its strength. The cartel elected to punish countries supplying arms to Israel, and announced an oil embargo against the U.S. (and allies Portugal, the Netherlands, and South Africa). In addition to banning the sale of oil to these countries, OPEC cut oil production generally, causing oil prices to quadruple in price in relatively short order.

The search for stability

This was good news for OPEC, but only in part. High oil prices tend to discourage oil consumption and depress oil sales -- the lifeblood of OPEC countries -- and encourage customers to invest in alternative fuel sources. What OPEC really should aim for, member countries soon concluded, was stability in oil markets that would guarantee a "regular supply of petroleum to consumers" and "a steady income to producers."

Thus, it's probably fair to judge the history of OPEC by the yardstick of how well OPEC has succeeded in maintaining stable, high prices for oil. How has that worked out? Let's take a look:

Source: tradingeconomics.com.

One year after the oil embargo ended, OPEC countries held their first Summit of Heads of State and Government in Algiers in 1975. Policies established here helped OPEC to maintain high and stable oil prices into the end of the decade, at which point the Iranian Revolution arrived to drive them sharply higher.

Post-Revolution, oil prices remained high until the middle of the next decade, though these prices eroded over time, presumably due to covert overproduction by various OPEC countries. By 1986, this had produced sufficient surplus oil that an oil glut developed, causing a price crash. OPEC responded by instituting a new system of "production ceilings," allocating to each member country a certain level of daily production that they were not to exceed.

This strategy largely succeeded, with oil prices first stabilizing in the high-teen to low-twenty-dollar range, then holding more or less constant throughout the 1990s. By the end of the 1990s, however, oil prices had sunk back to levels approximating those of the 1986 oil bust.

In 2000, OPEC instituted a "price band" mechanism that again aimed to stabilize oil prices. Supply constraints and growing demand for energy in China, however, drove prices up in the 2004 to 2008 period -- before the 2008 Financial Crisis again destroyed demand, and sent prices tumbling. Oil prices briefly stabilized again in 2011, and held at high levels through mid-2014 -- then collapsed again later that year.

On balance, therefore, it's hard to call the history of OPEC an unqualified success. Despite boasting many of the world's leading oil producers, OPEC has failed to secure a complete lock on oil prices. As a result, despite periods of stability, oil prices still fluctuate wildly to this day. OPEC countries themselves may be to blame, as even the countries that did join OPEC have failed to maintain production discipline within their ranks. As cartels go, OPEC leaves much to be desired.