Coursework

An analysis of the overall strategy of the organisation for petroleum and exporting countries (opec)

The Organisation for Petroleum Exporting Countries was conceived in the 1960s in which the member countries consists of Saudi Arabia, Algeria, Libya, Nigeria, Indonesia, Venezuela, Iran, Iraq, Kuwait, and Oman. The reason for this was in response to efforts by U.S. oil refiners, led by Standard Oil of New Jersey, to reduce the price they were paying for imported oil. Until the 1972 oil boycott, OPEC explicitly attempted to raise the price of oil. To maintain higher prices, the OPEC members must restrict their output (various government oil companies within the OPEC member states), or they will produce more oil than the world will demand. Each member nation must therefore agree to an output quota. Now in order to understand the overall strategy of OPEC, one will first need to identify the meaning attached to strategy in this context.

According to Chandler (1962), strategy can be defined as the determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action and the allocation of resources necessary for carrying out these goals. In order words strategy can be said to deal with the big decisions a business organisation faces, the decisions that ultimately determine its success or failure.
With this in mind we can now talk about the strategy assertions of the Organisation for Petroleum and Exporting Countries. We will use Porter’s five forces analysis and Whittington’s four basic concepts of competitive strategy to understand the overall business strategy of OPEC.

Porter (1980) Five Forces Model consists of internal rivalry, substitutes and complements, supplier and buyer power, and barriers to entry.

Market Definition
This analysis is confined to countries that produce oil for energy consumption all over the world. According to British Petroleum figures, OPEC member countries currently produce about 40 percent of the world’s consumption of oil, and while non-OPEC members also contribute rough the same percent that figure is decreasing due to the depletion of non-OPEC member states reserve base. As a whole, one can class OPEC member states as being a monopolist organisation where they control more than 30 percent of the market of a good or product. OPEC and non-OPEC member states account for 80 percent of the world’s production of oil, hence this analysis would focus on the two.

Internal Rivalry
As stated previously OPEC was established in 1960 and has remained what is known as a cartel ever since. Its first real impact with regard to the price of oil was in 1982, OPEC set an overall output limit of 18 million barrels per day, down from 31 million barrels per day in 1979. Prices were to be maintained at $34 per barrel. Each member nation had an individual production quota, except for Saudi Arabia, the largest producer, which adjusted its output as necessary to maintain prices. Maintaining the cartel has proven difficult. Sometimes, such as during the Iran – Iraq War (1980 – 1985), member nations sought to produce more than their allocated quota. This glutted the world market with OPEC oil. Despite attempts by the ‘swing producer’ Saudi Arabia to reduce output, prices plunged. In the mid 1980s OPEC slashed the price of oil by 15 percent and reduced output by 3 percent. Throughout most of the 1980s and 1990s, oil prices hovered around $15 - $20 per barrel. Due to the global economic expansion particularly from India and China, demand for oil has surged. Saudi Arabia (swing producer) convinced other OPEC nations not to expand production to meet demand. The result was that oil prices went up to $30 a barrel for the first time in a decade. Collectively if the member countries adhere to there allocated quotas they are a formidable force to reckon with. There has also always been that tendency for certain members to cheat which leads to internal rivalry and the breakdown of the cartel. However, OPEC as a group has strived right from its inception in the 1960s and at the present moment their coordinated efforts to reduce investment and decrease the production of oil which has lead to an increase in the price of oil to $60 per barrel shows that the cartel is still alive and well.

Barriers to Entry
High development costs, investment, and the experience-skills based advantages of the incumbent oil companies such as Royal Dutch Shell, Agip, Chevron, Total, Esso, and British Petroleum in the various OPEC member countries has made entry into oil production extremely difficult. Depending on the type of oil (heavy and light) that is found in areas where it is easy to extract oil, there are high start-up costs involved (it is easier and cheaper for the oil companies to extract oil on-shore than it is to extract oil off-shore). At the present moment all the easy areas or regions where oil has been found are being explored by one of the major oil companies mentioned above. Thereby, what is left are regions where the oil found is difficult to extract and would require large sums of investment and experience to enter the market. Hence, only the existing incumbents will be positioned to extract this oil, thereby very high barriers to entry. Incumbents are also protected by the learning curve. In countries where there are different social, cultural, and political mechanisms which require experienced and knowledgeable people to be able to get the ball rolling is essential to the speedy process of producing oil in an oil producing region. This poses another barrier to entry.

Substitutes and Complements
From the perspective of the oil companies the only substitute for oil which is used as the main source for energy around the world are synthetic fuels such as bio gas, hydrogen, solar energy, and battery powered fuels. Although, majority of these alternative fuels are still being researched and developed by various independent organisations around the world, these synthetic fuels are already being tested on all sorts of forms, which rely on oil for energy. For example, bio gas which was first developed in Sweden is currently being tested on cars for efficiency and the fact that its use is less pollutant brings it to the foray as a very good alternative source of fuel to oil. In addition, most oil companies tend to discourage investment into the use of alternative fuels because it will put them out of business. However, the oil producing regions are fully aware that the price of oil is a major factor here. For example, Saudi Arabia are fully aware of the fact that if they allow the price of oil to hover at a rate that is too high, this will become too expensive for ordinary people to purchase oil for energy consumption, and the oil companies profits might reduce due to a decline in the demand of oil because its price is excessively high. This has the knock-on-effect of increasing research and use of alternative fuels in which if they allow this to happen, it would be disastrous to their economy. Saudi Arabia is wholly reliant on oil for foreign exchange earning, hence they have to make sure that there is enough oil in the world market where the price is not too low nor too high. This is one of the major reasons the Saudi’s act as the swing producer with OPEC. Not to forget, if synthetic fuels were to take off, it would mean complements such as cars, airplanes, etc. would need to be re-engineered. This would cost a fortune for manufacturing firms and a reduction in their profits in which most manufacturing firms would be reluctant to embark on this path.

Supplier Power
The key marketable inputs are labour and machinery. The suppliers of labour include, mining engineers, civil engineers, and construction engineers. The suppliers of machinery tend to be the major oil companies such as Royal Dutch Shell, BP etc., which manufacture and produce the machinery that is used for drilling rigs and building a platform (off-shore oil exploration). These suppliers all have indirect power. Supply and demand forces in the market for engineers have been especially tight in recent years, forcing up their wages. The price for machinery and other valuables such as transportation have also risen in recent years. OPEC and their suppliers (the oil companies) make large relationship specific investments. Engineers learn to work in teams, but also adjust to new settings as most oil exploration sites require highly trained and skilled individuals. Most engineers are not easy to replace when work start on an oil site, due to tacit knowledge and the tie constraint involved in getting an oil site up and running for the extraction of a particular oil region. This also creates a barrier to entry. The oil companies do not have the monopoly power to hold OPEC member’s states so as to obtain higher prices. This comes from the governments of the member states themselves, and if they require the oil companies to stop production or reduce production, the oil companies would have to adhere to this or face possibly contract termination.

Buyer Power
Buyers of the oil produced by OPEC include various governments around the world and the oil companies themselves who purchase oil for energy use and consumption. Various governments around the world and the oil companies do not wield purchasing power as this rests on the oil producing nations of both OPEC and non-OPEC countries. If OPEC for example decides to cease the production various governments and the oil companies cannot do anything about that. However, this would be catastrophic to world economic growth as most industrialized nations are highly reliant on oil for energy use and consumption. For example, in 1990 the major factors that lead America attacking Iraq, during the invasion of Iraq on Kuwait (Gulf War) was the fact that America heavily relied on Kuwait for its oil, and an invasion by Iraq on Kuwait was highly undesirable by American authorities as this would affect the economic growth and development of the country. Today, the oil companies to a certain degree wield substantial power. This has come about because of their historical presence in the oil producing regions with regard to experience, cultural awareness of the oil producing countries and familiarity with government authorities in these regions. However, the power of authority still lies with the governments of the oil producing regions. If for example, one of the oil producing member states was not pleased with the performance or contractual obligation of a particular oil company, they could terminate the contract and hand it over to another oil company. In reality although this rarely happens there have been cases where the oil companies have provided a very shoddy service, i.e. environmental pollution and destruction due to leakages on oil rigs (Shell in Nigeria and in 2003 an oil tanker leaked over the coast of Devon), which has led to large payment sums being made to tackle the damage done to the environment and families by the oil companies.

Table 1 Five forces analysis of the Oil market
ForceThreat to Profits
Internal rivalryMedium to High
EntryLow
Substitutes/complementsMedium
Supplier PowerMedium to High
Buyer powerMedium

Now, Whittington divides strategy into classical, evolutionary, processual, and systemic.

Classical
This refers to theoreticians who regard profit maximisation as the supreme goal of business, with this to be achieved through deliberate planning. This thus, encompasses a realistic and rational approach to business strategy. Applying this to OPEC, the organisation does not regard profit maximisation as the supreme goal of the business, but rather to create stability in the world price of oil through reducing output. It is noted in academic literature that oil in the ground has more value than oil that is being produced. In other-words, OPEC members deem that they are better off just providing enough oil that meets world demand rather than flooding the market with too much oil (producing too much oil in order to make a profit). This differs from Whittington’s classical approach in the sense that although profit maximisation is seen by most theoreticians as the prime objective of any organisation, OPEC as a whole sees this as necessary but gauges what is known as a product which is being depleted at a fast rate in which when the product (oil) runs out there will be no more profits to be made. Hence, it gauges its actions against the world price of oil so as to see what is most beneficial to it as an organisation.

Evolutionary
Whittington, terms evolutionary as an aspect where a business has to constantly keep pace with the ever increasing changes in the business environment so that the firm can not only stay in business but also make a profit. Theoreticians as a whole ascertain these to changes in the tastes and fashion of society, in which business will have to adjust or evolve with in order to keep the business alive and healthy. Bring OPEC into the foray, OPEC has in the past keep pace with changes in the demand for oil. However, of recent they have cut back on investment into new oil fields, and production. Reasons being are that if they invested in new oil fields and produced enough oil to reach demand over a specific period of time, there is the possibility that the investment could go down the drain. I.e. when OPEC saw an increasing demand for oil from South East Asia during the rapid growth of the Tiger economies as they were known at the time they increased production in-order to meet demand. However, a recession kicked in and what followed was a drastic decline in oil inventories, a scenario OPEC members did not foresee. This lead to a drastic drop in the price of oil because there was too much oil in the world oil market, and OPEC members had to bear and take the brunt (losses). Hence, the evolutionary strategy is a paradox which is not rational to the business strategy of OPEC.

Processual
This represents the use of business processes, which will align the business goals of the organisation with strategy. Basically, it assumes that markets allow firms to be inefficient. Individuals within organisations have their own personal goals and must negotiate and compromise to reach shared goals. Hence strategy in this aspect is crafted and emerges to the benefit of the organisation as a whole. OPEC as a whole does have a management structure, which includes a rotational presidential platform between various members of the cartel, the secretary general who is voted on a two year basis, and various other management positions which are engaged in the smooth running of the organisation as a whole. This has the effect of having a coordinated approach to the business goals of OPEC, which is to stabilize the world price of oil in times of crisis.

Systemic
The systemic strategy views strategy as embedded within social systems. It sees norms as socially constructed and therefore strategy maybe planned and deliberate through making it appropriate for the social context. The systemic model sees the classical model as a particular strategy model that may be appropriate in specific contexts, and inappropriate in other contexts. Applying this to OPEC, the strategy it practices can be said to differ from socially constructed norms. Its main aim as noted is being able to stabilize the price of oil in the world oil market. Hence, social systems are inappropriate in measuring the strategy alignment of OPEC.

CONCLUSION
As a whole the key to profitability for OPEC member countries is to reduce output, whereby a shortage of oil means the price of oil will increase. Thereby increased profits for OPEC member nations. However, they will have to measure the market and make sure that they do not reduce output too much to a level where it would trigger an increased investment into alternative fuels, which would lead to a switch from oil to synthetic fuels. Reasons range from oil being the major foreign exchange earner for most OPEC member countries, and without it, their economies will falter. Notwithstanding, the supply of oil continues to increase, and the proven reserves of OPEC member nations seems to increase every year with new additional oil fields being found. This is not the case with non-OPEC members such as Norway, Russia, and Mexico. Their proven oil reserves seems have fallen much lower than originally estimated, hence OPEC has a much more solid base in which their strategy to reduce output so as to increase the price of oil or stabilize the price of oil, seems to be a strategy to reckon with. OPEC will thrive as long as they can successfully maintain and have oil and the oil companies will continue to produce more oil as far as there is profit to be made.

REFERENCES AND BIBLIOGRAPHY
Besanko, D., Dranove, D., Shanley, M., and Schaefer, S., (2003), Economics of Strategy, 3rd Edition, Wiley.

BP (2005) Statistical Review of World Energy, June.

Chandler, A., (1962), Strategy and Structure: Chapters in the History of the American Industrial Enterprise, Cambridge, MA, MIT Press, p.13.

OPEC statistical review, Annual Report and Accounts, 2005.

Porter, M., (1980), Competitive Strategy, New York, Free Press.

Scholes, K., (2002), Exploring Corporate Strategy, Prentice Hall.

Shell Transport and Trading Company PLC, Annual Report and Accounts, 2004.

Whittington, R., (1993), What is strategy, and does it matter? Routledge, London; New York.