Crude Volatility

The first two decades of the OPEC Era were extraordinarily tumultuous and marked by price upheavals instead of stability. But the third decade would be different. Things were settling down into a less volatile “new normal” for OPEC and the oil market.

Oil demand was in flux during the 1990s, but on the whole rose at a more moderate rate than in the 1970s. The breakup of the Soviet Union triggered a staggering 4.7 mb/d—a 56 percent-drop in former Soviet Union countries during the decade, but China’s demand doubled, rising by 2.1 mb/d. While not growing at the torrid 5–9 percent rates of the late 1960s and early 1970s, consumption had recovered from the miserable near-flat growth in the 1980s (0.3 percent on average) to grow in the 1990s by 1.5 percent on average or 1.1 mb/d per year.¹

Like demand, the supply side of the oil market was also in flux, but net supply increases were moderate. Supply from the former Soviet Union imploded from 11.5 mb/d to 7.1 mb/d by 1996, but then began inching back up, hitting 7.5 mb/d by the end of the decade. United Kingdom production slumped from 2.7 mb/d to 1.9 mb/d in the late 1980s and early 1990s but roared back by the end of the decade to almost 3.0 mb/d. Norwegian production nearly doubled, from 1.7 mb/d in 1990 to 3.3 mb/d in 1997.

OPEC producers were able to increase production and restore market share while also restoring a comfortable spare capacity cushion, mostly held in Saudi Arabia, of between 4 and 5 percent of global demand. Kuwaiti production quickly recovered from wartime devastation, rising from zero in May 1991 to 1.6 mb/d in December, 1992.² Sanctions kept Iraqi supply largely off the market until 1996, but ramped up quickly to 2.6 mb/d by 1999, when limits on oil sales were removed under the U.N. oil-for-food program.³

For OPEC as a whole, spare capacity (excluding sanctioned Iraq) rose from below 1.3 percent of global production in December 1991, during the First Gulf War, to over 5 percent by the spring of 2003.⁴ During the ten-year period from summer 1991 to summer 2001, Saudi crude production oscillated between 8.0 mb/d and 8.9 mb/d, with only rare departures from this range (including a small dip below 8.0 mb/d in the summer of 1999 in reaction to the Asian crisis). Saudi Arabia was able and willing to cut supply by a relatively small amount for a brief time, along with other producer cuts, and the kingdom’s share of OPEC production remained above 25 percent.⁵

One of the biggest challenges OPEC faced during the 1990s was contending with Venezuela, which adopted an all-out production increase while openly flaunting both quotas and OPEC itself (ironic, given that Venezuela was one of OPEC’s leading founders and the first champions of collective quotas). In 1990, Andrés Sosa Pietri—the new president of Venezuela’s state-owned oil company, PDVSA—pushed for a looser link both between the state-owned oil company and government in Caracas and between Venezuela and OPEC, which he regarded as a “relic of the past.”⁶ Venezuela’s production rose steadily to 1 mb/d above its OPEC quota by mid-decade. This maverick approach, later dubbed “The Opening” or “La Apertura” was advanced by his successor, Luis Giusti, who in 1996 opened Venezuela to outside investment in exploration and production under a ten-year plan to double production from 3.3 to over 6 mb/d. Venezuela’s brash approach triggered protests and warnings from OPEC, to which Giusti retorted that the organization had to “change or disappear.”⁷

Immediate crisis was averted as oil prices unexpectedly increased in 1996 and briefly in the first week of 1997 to nearly $27. The cause of the oil price spike remains uncertain; some have attributed it to data published by the international oil watchdog International Energy Agency indicating a large gap between global demand and supply, others to vigorous U.S. growth and explosive trade-generated demand from developed, free market Asian “Tigers” (Hong Kong, Singapore, South Korea, and Taiwan) as well as countries like Malaysia, Indonesia, the Philippines, Thailand, and the Chinese province of Guangdong, collectively known as “the new tigers.”⁸ Another factor may have been that many U.S. refiners expected Iraqi supply to return in late 1995 and 1996. Anticipating lower prices, those refiners ran down inventories ahead of a cold winter. Other factors included simmering tensions in Iraq and a potential shortage of heating oil in the United States.

The unexpected price increase in 1996 and 1997 averted a full clash between Venezuela and other OPEC members.⁹ But later in 1997 the Asian financial crisis hit, abruptly hurting oil demand, and threw OPEC and other oil producers back into crisis mode. The Asian financial crisis had its origins in the aforementioned strong growth, which had attracted massive capital inflow that was channeled into a real estate bubble. In July 1997 the Thai currency (baht) collapsed, triggering other Asian currency and banking collapses that mushroomed by year-end into widespread economic downturn and bankruptcies.¹⁰ But as OPEC prepared to meet in Jakarta in November 1997, producers’ minds were less focused on the gathering Asian crisis than on the oil price spike that had preceded it. On November 27, OPEC ministers approved a 2.5 mb/d or 10 percent quota hike, confident that demand was robust enough to keep prices stable.¹¹

OPEC producers soon regretted the decision.

The mismatch between slowing demand and rising supply caused oil inventories to swell rapidly in consuming countries in early 1998. After an IEA report, in an about-face from a few years before, estimated global supply would exceed demand by an unusually large 3.5 mb/d in the second quarter of 1998, oil prices tanked. By early 1999, prices for some grades of crude oil fell as low as $8 per barrel. In a March 1999 cover, The Economist blared that the world was “drowning in oil.” OPEC producers quickly realized they had made a mistake, and thereafter would be haunted by the “Ghost of Jakarta”—the folly of loosening quotas without accurately assessing if oil demand was strong enough to keep the prices steady.

Despite the tail winds, corralling OPEC and non-OPEC producers into agreeing to share the burden of cuts was arduous and took time. While some OPEC producers acted within a few months by cutting production, it took about a year of low prices (crude oil prices fell 36 percent between the first cuts in March 1998 and the lowest level in December that year)¹⁴ to compel recalcitrant producers inside OPEC (like Venezuela and Iran) and outside (like Norway) to cut production. Russia promised cuts but did not follow through. On March 22, 1998, Saudi Arabia secretly met with Venezuela and Mexico (while not an OPEC member, Mexico’s oil supply was perking up after flatlining in the 1980s, and Saudi Arabia wanted to rein it in) to coordinate production restraint. The three countries announced a “Riyadh Pact” to restore order by calling for a round of cuts targeting 1.7 mb/d.¹⁵

Under the Riyadh Pact, Saudi Arabia agreed to match combined cuts by Venezuela and Mexico.¹⁶ Oil prices briefly rebounded at the surprising show of resolve, especially the patch-up between Venezuela and Saudi Arabia. At a meeting on March 30, 1998, OPEC reversed the Jakarta decision, announcing 1.612 mb/d in production cuts, excluding Iraq.¹⁷ Crude prices briefly rallied to over $15 but subsequently resumed falling due to trader skepticism that the producer cuts would be sufficient.¹⁸ Deeply dismayed, Saudi Arabia, Venezuela, and Mexico met again in early June, conceded past cuts were inadequate and pledged to reduce output by another 450 kb/d (225 kb/d for Saudi Arabia, 125 kb/d for Venezuela, and 100 kb/d for Mexico).¹⁹ During another meeting on June 24, 1998, OPEC implemented another round of major cuts and, notably, Iran agreed to contribute real production cuts instead of imaginary ones (Iran was infamous for offering cuts from its own inflated estimates of its production rather than lower actual production).²⁰ Nevertheless crude prices kept tumbling, shedding another third and bottoming just above $10 at the end of 1998.

It was not until 1999 that OPEC cuts started to eat into the glut. OPEC crude production fell from 29 mb/d in March 1998 to 26.4 mb/d by June 1999 and fell again to just below 26.0 mb/d in December 1999.²¹ Non-OPEC producers Norway, Oman, and Mexico also made significant cuts and prices rose smartly, more than doubling from $10 at the end of 1998 to $25 one year later.

The 1998 price collapse prompted protests from domestic U.S. producers who pushed a bill that came to be known as the “No Oil Producing and Exporting Cartels Act” (NOPEC) that would amend the Sherman Act to make it illegal for governments to try to limit oil and gas production to control oil prices; the bill failed to pass. (The bill resurfaced in the subsequent decade in response to rising oil prices, but was opposed by President George W. Bush and never signed into law.)²²

The 1998 price drop prompted panic among producers but elicited little more than a shrug from the Clinton administration. After the tumultuous 1970s and early 1980s, during the long period of relatively stable oil prices from 1986 to early 2000s (with the exception of the 1990–1991 Gulf War), Washington reverted to aloofness and complacency with regard to the oil industry and energy security. In 1986, the Reagan administration decided to ease fuel economy standards for model years 1987 and 1988.²³ During the 1990s the Clinton administration and Congress looked the other way when the auto industry and motorists exploited a loophole in fuel economy standards for gas-guzzling sport utility vehicles. SUVs and minivans are also exempt from a federal “gas-guzzler tax” enacted in 1978.²⁴

Public and official concern about energy security abated during the 1990s. Despite a doubling in dependence on imported oil after 1985, from about 25 percent to over 50 percent, in 1996, a Republican Congress and Democratic White House agreed to sell off some of the strategic reserves in 1996 to plug holes in the federal budget. The 1996 SPR release also coincided with a rise to over $25 per barrel crude prices, a relatively high level for that period.²⁵ It would not be the first time Washington responded to rising fuel prices by releasing strategic stocks intended for use in supply emergencies.

Washington’s nonchalance likely stemmed from two factors. First and foremost, gasoline prices were stable during the 1990s. Second, while U.S. dependence on crude imports continued to increase, the share of imports from OPEC and the unstable Persian Gulf remained steady to low compared with previous decades, with a greater share coming from more stable hemispheric neighbors Canada and Mexico.²⁶ So domestic U.S. oil producers found little help from Washington in 1998. Energy Secretary Bill Richardson floated the idea of helping producers by buying oil for the Strategic Petroleum Reserve (ironically, given that Congress had sold SPR oil two years before), but the idea went nowhere. The Clinton administration did not see the 1998 price drop as a deliberate move by Saudi Arabia or OPEC, and was in general less friendly toward the oil industry than the Reagan administration. And in any event, unlike 1986 the collapse in 1998 quickly reversed.

While U.S. producers looked on helplessly, a reinvigorated OPEC tried to establish a more formal system to stabilize prices, buoyed by its success at raising oil prices, and reinvigorated by a new Saudi Oil Minister, Ali Bin Ibrahim Al-Naimi, and a more compliant Venezuela. Minister Naimi, who had begun working for Saudi Aramco as an office boy in 1947 and went on to earn degrees in geology at Lehigh and Stanford universities, rose steadily through the ranks at Aramco. He was appointed oil minister in 1995 and served until 2016, and became the most important voice on Saudi oil policy, known for leading journalists who would flock around him at OPEC meetings on morning fast-walks around Vienna.²⁷

At its March 2000 meeting OPEC announced a new price band mechanism. Under it, a target range for the OPEC basket price was set at $22 to $28, and members agreed to a quota adjustment factor whereby quotas would rise by a total of 500 kb/d if prices exceeded $28 for 20 consecutive days, and would be reduced by the same amount of if prices fell below $22 for ten consecutive days. OPEC did not intend for this adjustment factor to work wholly on an “automatic” basis, however. It was meant as a general framework for members while signaling in advance OPEC’s intention in the event prices moved outside the range.

Later in the year, prices started to move outside the band. By September 2000, crude prices rose above $30, raising alarm in Washington, which was holding a presidential election that fall. Energy Secretary Richardson intensively lobbied OPEC for higher production and lower prices. There was no supply disruption, but market forces were pushing heating oil prices up and, for many elected officials, that counts as an emergency. In September 2000 and under election pressure, presidential candidate Al Gore reversed his earlier opposition to tapping the SPR to counteract rising heating oil prices (“All [oil-producing nations] would have to do is cut back a little bit on supply and they’d wipe out any impact from releasing oil from the reserve,” Gore had said in February that year ²⁸), and called for a release. OPEC increased production in October but then cut in November and December, when supply fell below September’s level.²⁹ Prices remained stubbornly high. In November 2000 Secretary Richardson and other IEA officials flew to Riyadh and agreed they could live with oil prices in the low to mid-$20s. Prices thereafter fell back to the high $20 range until just after September 11, 2001, when they fell sharply on economic weakness following the terrorist attacks on Washington D.C. and New York.³⁰

Seeing oil demand weaken, Riyadh pressured other producers to show discipline. In January 2001 OPEC agreed to decrease overall production by 1.4 mb/d;³¹ Saudi Arabia implemented 0.5 mb/d of cuts between December 2000 and February 2001, while Iran, UAE, and Venezuela contributed about 0.1 mb/d each. The global economy continued to deteriorate throughout 2001, prompting OPEC to cut another 1 mb/d in March and again in July. OPEC’s 3.3 mb/d in quota cuts³² from September 2000 to July 2001 stabilized prices around $25, but sagging demand sent the OPEC basket price down to $17 in November 2001.

In response, OPEC effectively suspended the price band mechanism and went into emergency mode. With memories of the 1998–1999 price collapse fresh, in November 2001 OPEC cut quotas another 1.4 mb/d ³³ and enlisted non-members Angola, Mexico, Norway, Oman, and Russia to contribute a combined 462.5 kb/d in either production or export cuts.³⁴ In terms of actual production (which quota changes did not always correspond to) EIA data show that OPEC producers slashed output by 3 mb/d in production between January 2001 and January 2002, with Saudi Arabia cutting 1.4 mb/d. In February 2002 Saudi production had fallen to 7.2 mb/d, the lowest level since just prior to the First Gulf War in 1990.³⁵ By April, 2002 total OPEC production had fallen to nearly 25.2 mb/d, a six-year low.³⁶ While some non-OPEC producers like Norway cut production as promised, Russia did not. Moscow’s failure to comply earned it a widespread reputation for untrustworthiness among producers, which Riyadh has neither forgiven nor forgotten to this day.

With rising oil prices and electricity disruptions (primarily in California), the new President George W. Bush administration made energy policy a priority, tasking Vice President Cheney with overseeing a broad overhaul of domestic and international energy policies. The energy task force recommended dozens of policies aimed at increasing supply, promoting conservation and alternative fuels, such as reforming and raising fuel economy standards. Al-Qaeda’s terrorist attacks and the prospect of military conflict in Middle East dispelled the complacency about energy security that had set in during the 1990s. After the attacks the U.S. began refilling the SPR, not only by replacing barrels that had been sold seven years before but for the first time filling the stockpile to its capacity.

Then in late 2002 and early 2003, geopolitical turmoil helped OPEC put a floor under oil prices. First, a Venezuelan oil workers’ strike against Hugo Chávez in December 2002 resulted in a collapse in Venezuelan production and exports that lasted over three months. Then in March 2003, another U.S.-led coalition invaded Iraq. These two major disruptions, combined with election violence in Nigeria, suddenly removed almost 3 mb/d of supply between November 2002 and April 2003. Unlike the Gulf War in 1990, the International Energy Agency decided not to release strategic stocks immediately upon commencement of the major military offensive against Iraq. Instead, the IEA signaled willingness to release if a disruption materialized. Oil prices, which had risen from $23 to $34 (for Brent) over the four months prior to the March 2003 invasion, fell to $24 days after military operations began, likely due to Saudi Arabia’s increased production and the U.S.-led coalition’s swift success at securing oil facilities before they could be damaged.

While oil prices were steadiest in the (early) 1980s (when Saudi Arabia was still willing to play the swing producer role), OPEC market management in the 1990s and early 2000s was fairly impressive (see figure 8.1). With a few brief exceptions, crude prices oscillated in a $15–$22 range for most of the nineties, and OPEC reacted with unusual discipline to the price crash after its unfortunate decision to increase production in 1997. OPEC was able to recapture market share, which rose from 37 percent in 1990 to over 40 percent by the end of the decade (see figure 8.2).

Sources: Derrick’s, vols. I–IV; API, Petroleum Facts and Figures (1959); Dow Jones & Company, Spot Oil Price: West Texas Intermediate; and U.S. Energy Information Administration, Cushing, OK WTI Spot Price (FOB); The Rapidan Group. © The Rapidan Group.