What is OPEC, and Why Should Traders Know About It?

OPEC is a powerful oil coalition influencing global prices and supply. Learn how its production decisions impact oil futures, energy stocks, commodities, and create trading opportunities.
Few institutions hold as much influence over the ever-evolving and volatile landscape of global energy as the Organisation of the Petroleum Exporting Countries, or OPEC.

Formed in 1960, OPEC has become synonymous with the oil industry, shaping production levels and influencing prices. This comprehensive explainer will help you discover its history, purpose, and powerful influence over the markets.

Table of Contents:

• What is OPEC?
• How Does OPEC Work?
• Why Was OPEC Formed?
• Why Is OPEC So Powerful?
• Why Is OPEC Considered a Cartel?
• Top 10 OPEC Countries by Oil Reserves
• OPEC Competitors: Major Non-OPEC Oil Producers
• Why OPEC Matters to Traders
• OPEC’s Role in Influencing Oil Prices

What is OPEC?

OPEC is a coalition of oil-producing nations that united to coordinate and stabilise oil prices in the global market.

•    It was founded on September 14, 1960, in Baghdad, Iraq.
•    Its founding members included Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela, but has since expanded to include a net total of 12 member countries.
•    These include Libya, the United Arab Emirates, Algeria, Nigeria, Gabon, Equatorial Guinea, and Congo.

OPEC’s primary goal is to ensure fair compensation for oil-producing nations and stabilise oil prices to support their economies.

How Does OPEC Work?

OPEC coordinates the petroleum policies of its member countries to control production and secure a steady income for member countries. Here’s how it works:

• Decision making: OPEC’s decision-making process involves regular meetings of its member countries to discuss market conditions and coordinate policies. Decisions are typically made by consensus, with each member country having a voice in the process.
• Production quotas: OPEC sets production quotas for each member country to help stabilise prices and manage supply. Quotas are based on factors such as each country’s production capacity, reserves, and economic needs.
• Market monitoring: OPEC closely monitors global oil supply and demand levels to inform its production decisions and prevent market oversupply or undersupply.
• Coordination with non-OPEC producers: OPEC works with other major oil producers, such as Russia, to coordinate production levels and maintain price stability.
• Public statements: OPEC uses public statements and announcements to signal its intentions and influence market sentiment.

Why Was OPEC Formed?

OPEC was established to coordinate and unify petroleum policies among member countries, ensuring fair and stable prices for petroleum producers. It was formed in response to the dominance of the "Seven Sisters," a group of multinational oil companies that controlled the global oil market at the time. By uniting, member nations sought to gain greater control over their oil resources and assert their sovereignty in the global energy market.

Why Is OPEC So Powerful?

OPEC's power stems from its significant share of global oil production and reserves. Collectively, OPEC members control over 40% of the world's crude oil production and about 79% of proven oil reserves. This substantial market share allows OPEC to influence oil prices by adjusting production levels, thereby impacting global supply and demand dynamics.

Why Is OPEC Considered a Cartel?

OPEC is often labelled a cartel because it coordinates production policies among member countries to influence oil prices, similar to how cartels control prices and output in other industries. By setting production quotas and collectively managing supply, OPEC aims to stabilise the oil market. However, it's worth noting that internal disagreements and instances of members exceeding quotas have sometimes challenged the Organisation's unity and effectiveness.

Top 10 OPEC Countries by Oil Reserves

As of recent estimates, the top 10 OPEC countries by proven oil reserves are: 

These reserves represent a significant portion of the world's total oil reserves, underscoring OPEC's influence in the global energy landscape.

OPEC Competitors: Major Non-OPEC Oil Producers

While OPEC plays a pivotal role in the oil market, several major oil-producing countries operate outside its framework. These non-OPEC producers significantly impact global oil supply and prices. Key non-OPEC oil-producing countries include:

• United States: The largest oil producer globally, with significant shale oil production.
• Russia: A leading oil exporter and a key player in the OPEC+ alliance.
• Canada: Home to vast oil sands reserves, making it one of the top oil reserve holders.
• China: A major consumer and producer of oil, with significant influence on global demand.
• Brazil: Notable for its offshore oil production and growing output.
• Norway: A significant producer in Europe, especially from the North Sea oil fields.
• Mexico: An important oil producer with substantial offshore reserves.
• Kazakhstan: A growing oil producer with large reserves in the Caspian region. 

These countries, while not part of OPEC, play crucial roles in the global oil market, and their production decisions can influence oil prices and market dynamics.

Why OPEC Matters to Traders

OPEC’s decisions and actions have significant implications for global oil markets, which, in turn, can affect various financial instruments and trading strategies.

• Influence on oil prices: Any changes in OPEC’s production quotas or output can lead to significant fluctuations in oil prices, affecting trading opportunities in crude oil futures, exchange-traded funds (ETFs), and energy-related stocks.
• Market volatility: OPEC announcements and meetings often introduce volatility into oil markets. Traders who are prepared to capitalise on sudden price movements can find profitable opportunities, especially in derivatives markets where volatility can lead to increased trading volumes and potential earnings.
• Geopolitics: OPEC’s member countries are spread across various regions with diverse geopolitical interests. Any geopolitical tensions or conflicts among member nations can impact oil supply disruptions and market sentiment.
• Impact on currencies and commodities: Fluctuations in oil prices driven by OPEC’s actions can significantly influence currency pairs and commodity prices. For instance, currencies of oil-exporting nations—such as the Canadian Dollar (CAD), Russian Ruble (RUB), and Norwegian Krone (NOK)—often strengthen when oil prices rise, due to increased export revenues. Conversely, currencies of oil-importing countries—like the Japanese Yen (JPY) and Indian Rupee (INR)—may weaken as higher oil prices increase import costs, affecting trade balances. Moreover, commodities like gold and copper, sensitive to changes in inflation and economic growth, can also be influenced by oil price movements driven by OPEC decisions.
• Macro-economic implications: Changes in oil prices can impact inflation rates, central bank interest rate decisions, and overall economic growth prospects. Traders need to assess how OPEC’s actions align with broader economic trends and adjust their trading strategies accordingly.
• Interplay with other energies: OPEC’s decisions can influence the attractiveness and market competitiveness of alternative energy sources such as natural gas.

OPEC’s Role in Influencing Oil Prices

OPEC exercises considerable influence over global oil prices through a combination of production adjustments, coordination with other producers, market monitoring, and strategic communication.

By adjusting production quotas, OPEC can influence the supply of oil in the market, thereby affecting prices. For instance, reducing production can lead to higher prices if demand remains constant, while increasing production can lower prices. OPEC also collaborates with non-OPEC oil-producing countries, such as Russia, through agreements like OPEC+, to coordinate production levels and maintain price stability.

Additionally, OPEC closely monitors global oil supply and demand levels to inform its production decisions and prevent market oversupply or undersupply. Public statements and announcements from OPEC can signal its intentions and influence market sentiment, leading to price movements even before any actual changes in production occur.

Conclusion

OPEC remains a cornerstone in the global energy landscape, wielding significant influence over oil production and pricing. By coordinating production levels among member countries, OPEC aims to stabilise the oil market, ensuring fair returns for producers while maintaining supply reliability for consumers.

For traders, understanding OPEC's strategies and decisions is crucial. The organisation's actions can lead to substantial shifts in oil prices, affecting various financial instruments, including futures, ETFs, and energy stocks. Moreover, OPEC's interactions with non-member oil-producing nations, especially within the OPEC+ framework, further impact global oil dynamics.

As the world gradually transitions towards renewable energy sources, OPEC faces the challenge of adapting to changing energy demands while continuing to play a pivotal role in the oil sector. Staying informed about OPEC's policies and market responses will remain essential for traders navigating the complexities of the energy market.

To deepen your understanding of how OPEC's decisions can be leveraged in practical trading scenarios, be sure to check out our in-depth guide, "How to Trade Oil: A Beginner's Comprehensive Guide." This article breaks down actionable strategies, key market indicators, and real-world examples to help you navigate the oil markets with confidence.