(solution) What environmental circumstances brought Mexico, Venezuela, and

(solution) What environmental circumstances brought Mexico, Venezuela, and

What environmental circumstances brought Mexico, Venezuela, and Saudi Arabia to the negotiating table?

   

  2.   Over the period of time reviewed in this case, Saudi Arabia was, then it wasn’t, then it was again willing to make the biggest reductions. Why were the Saudis willing to make the biggest reductions? Why did they stop, and then restart?

      3.   What circumstances maintained cohesion among oil-producing countries during the period 2005-2006? Are those circumstances still in place as you analyze this case?

     

4.   What will it take for the consumer to see a reduction in oil prices?

OPEC Negotiations
by Homero Gonzales, Jaime Rivera, and Jennifer Ann Rivera
(Reprinted by permission of the authors)
Between 1997 and 1999, oil prices fluctuated widely. In 1999 alone, the price per barrel (PBL) rose from
a twelve-year low of close to $10 PBL early in the year to $26 PBL by fall, the highest price in over a
decade. This case is about the negotiations in 1999 that initiated stable increases in oil prices for at least
seven years. From 1999 to 2007, members of the Organization of Petroleum Exporting Countries (OPEC)
have shown unprecedented unity. Even non-OPEC nations such as Mexico, Norway, and Russia were in
on the deal. What initiated this unity was not a powerful new organization of oil-exporting nations but
an informal pact reached in secret meetings in 1999 between Saudi Arabia, Venezuela, and Mexico.
Background
Oil is a commodity; its economics are rather simple. When demand exceeds supply, prices go up; when
supply exceeds demand, prices go down. Thus there are two ways to control the price of oil: manage
supply or manage demand.
The price of oil was in a state of disequilibrium between 1997 and 1999. Demand had weakened,
primarily as a result of the Asian financial crisis and a mild winter in North America and Europe.
However, instead of cutting back supply, oil producers (especially Brazil, Colombia, and the OPEC nations)
increased supply per an agreement made in Jakarta in November 1997. At about the same time, the oil
embargo on Iraq that had previously allowed only $2 billion in oil to be put on the market every six
months was changed to allow Iraq to market up to $5.26 billion in the same amount of time.
As price plummeted, various meetings were called by oil suppliers to discuss production cuts across
all OPEC nations (excluding Iraq) and other major oil suppliers around the world. Agreements made in
these meetings were followed by low compliance, resulting in a continued over-supply and drop in
prices. When the price of oil reached an all-time low in the early months of 1999, Saudi Arabia,
Venezuela, and Mexico saw the need to come up with an agreement that would be upheld. These three
countries met secretly to draw up an agreement that they themselves could accept. Saudi Arabia then
sold this agreement to OPEC nations in March 1999, and oil prices have increased steadily ever since.
This case examines the agreements reached in the secret meetings before the OPEC meeting and
how the economic, political, and cultural circumstances of each of the three participant countries
affected the negotiations? outcome.
History of OPEC
The Organization of the Petroleum Exporting Countries was formed in 1960 at the Baghdad Conference.
The five founding members were Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. They were later joined
by eight other members: Qatar, Indonesia, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador, and
Gabon. OPEC has three objectives: (1) to secure fair and stable prices for petroleum producers; (2) to ensure
an efficient, economic, and regular supply of petroleum to consuming nations; and (3) to guarantee a fair
return on capital to those investing in the industry.
Since the formation of OPEC, several political events involving the United States and Middle Eastern
countries have interrupted oil supply in a significant manner and affected prices. For example, in the Yom
Kippur War, started when Syria and Egypt attacked Israel on October 5, 1973, the United States and
many countries in the Western world supported Israel. To counter this, the Arab exporting nations
imposed an embargo on Israeli allies, curtailing production by five million barrels per day (MMBPD). Only
one MMBPD was made up by increased production from other countries, leaving a net loss of four
MMBPD that extended through March of 1974. As a result, prices increased 400 percent in those six
short months.
From 1974 to 1978 crude oil prices, adjusted for inflation, were constant. From 1978 to 1980, events
in Iran and Iraq led to another round of crude oil price increases. Between November 1978 and June
1979, the Iranian revolution resulted in the loss to the market of 2 to 2.5 MMBPD. In 1980, during the
Iran-Iraq war, Iraq?s crude oil production fell by 2.7 MMBPD, and Iran?s by 600,000 BPD. The combination
of the revolution and war resulted in crude oil prices increasing from $14 PBL in 1978 to an unthinkable
$35 PBL in 1981.
The 1979?1980 period of rapidly increasing prices caused certain consumer reactions: better home
insulation, improved energy efficiency in industrial manufacturing, and redesign of automobiles for
better fuel efficiency. These factors, along with a global recession, caused a reduction in demand that led
to a decrease in crude oil prices. Much of this reaction to oil price increases was permanent and led to a
period of stable lower prices.
OPEC?s reaction between 1982 and 1985 was to set production quotas low enough to stabilize prices.
These attempts failed as various members produced beyond their quotas. By 1985, Saudi Arabia, which
acted as the swing producer by cutting its production during previous years, got tired of that role, and
increased production from two to five MMBPD. Crude oil prices dropped to below $10 PBL by mid-1985.
In December 1986, a volume accord was set to target a price of $18 PBL, but the agreement started to
break down barely a month later.
During the early 1990s oil prices jumped temporarily due to the uncertainty of the Iraqi invasion of
Kuwait and the subsequent Gulf War. However, crude oil prices fell steadily until in 1994 inflationadjusted prices stood at their lowest level since 1973.
In the mid-1990s, the cycle seemed to have picked up. With a booming Asian economy and a strong
U.S. economy, demand for crude oil increased, and prices recovered well into 1997. However, OPEC
underestimated the impact of the Asian crisis. It increased quotas 10 percent to 27.5 MMBPD even
though Asian demand was no longer increasing. The combination of flat demand and increased supply
resulted in oil price deteriorations to levels near $10 PBL.
Meetings in 1998 and 1999
In February 1998, in the wake of the fall in prices, Louis Tellez (Mexican energy minister) and Adrian
Lajous (president of the state-owned oil company, Petroleos Mexicanos [Pemex]), approached their Venezuelan counterparts, Erwin Arrieta and Luis Giusti. Notorious for exceeding their OPEC quotas, the
Venezuelans expressed a readiness to curb output. Both countries recognized the wisdom of involving
Saudi Arabia, the world?s largest producer, in any gambit to reduce output. Long at odds with Arab states
over pricing and production issues, the Venezuelans had publicly berated Riyadh for boosting output
during the Persian Gulf conflict. Thus it was up to Mexico to bring Saudi Arabia to the table.
In March 1998, after discussions between Mexico and Saudi Arabia, the Saudi oil minister, Ali Naimi,
agreed to host the talks in Riyadh. The result of the meeting in Riyadh was a joint announcement from
the three countries of an ?unprecedented level of cooperation,? and a commitment to cut their
combined production by 600,000 BPD. Support for the Riyadh agreement was reinforced during the
OPEC meeting in Vienna that same month. Every member of OPEC (except Iraq) and five non-OPEC
members (Mexico, Oman, Egypt, Norway, and Yemen) supported the goal to curb production by as much
as 2 MMBPD.1
The oil traders were skeptical. After so many lapses in the past, OPEC agreements had little credibility.
Oil traders knew that previous attempts at collaboration had failed because members cheated as soon as
prices increased. One analyst quite courageously predicted that the Riyadh group would be ?lucky if they
are able to pull out 1 million (barrels) from the market.?
The prediction proved correct. By May 1998, oil production had been curbed by only 997,000 barrels
per day. Factors affecting the inability of the group to reach its goal included rampant Iraqi production as
a result of the food-for-oil embargo and the inability or unwillingness of the countries to honor the
production agreements.
As prices continued to fall, more talks were called, with much the same result. OPEC and non-OPEC
members would agree to cuts, but compliance was disappointing. Then, the political landscape in
Venezuela started changing. A populist government was elected, headed by Hugo Chavez. As a result,
new players were brought to the table.
In the second half of 1998, when oil prices reached a twelve-year low of less than $8.58 PBL, and
production costs had increased (even for the most efficient producer, Saudi Arabia) from $3 PBL to $12
PBL, the three countries met again. They recognized that, because of pressing needs to generate more
revenue, it was time for commitment. With the three countries leading the pack, for the first time in
thirteen years, the oil-producing nations once again set quotas to reduce the availability of oil.
The agreement to cut production took advantage of favorable external factors. Among other things,
the Asian economic crisis, which had erased more than 1.5 million BPD of demand for oil, was stabilizing.
Iraqi oil production also was stabilizing after peaking in 1998. Above all, ?lower prices have piled
mountains of debt onto the economies of many oil-producing countries, cut their government budgets
down to a point of endangering social and political cohesion, and ravaged oil company profits worldwide
?enough to create a consensus for OPEC discipline and worldwide cooperation.? 2
After the deal was made, the price of oil climbed until it reached a high of $26 PBL in November
1999, well above the target of $21 PBL, as countries honored the production quotas. Hopes were
renewed as Saudi Arabia took the lead by promising to cut its production by as much as 585,000 BPD.
The Gulf States as a whole promised to remove one million barrels from the market. It seems remarkable that, after many efforts made by OPEC to manage the oil market, the
breakthrough was finally made by only three countries. It seems even more remarkable that one of
these countries was not even a member of OPEC, and that two of the countries traditionally had poor
relations with other OPEC countries. So how was the breakthrough achieved?
An Analysis of Motivations
Following is an analysis of the motivations of Saudi Arabia, Mexico, Venezuela, and their representatives,
and how these factors influenced the outcome of stabilized oil prices. It explores the backgrounds of
each country to find the effect of their cultural and political circumstances on this unique negotiation. It
is assumed that each country wanted a long-term stabilization of the oil price, but other factors may also
have come into play when the countries sat down to negotiate.
In the following, each country is situated in the spectrum of cultural values, with an assessment of its
degree of individualism versus collectivism and of egalitarianism versus hierarchy, as well as its manner
of communication (high versus low context). In addition, key political and social circumstances of each
country affecting oil decisions are assessed, and the main decision makers are profiled.
Saudi Arabia.
Culture, Economy, and Politics. The kingdom of Saudi Arabia was created around 1900 when the king
of Saudi Arabia ventured out and married a princess of each tribe in the kingdom. His adventures
resulted in 70 wives, about 270 siblings, and a family to rule the kingdom. This monarchy, combined with
various manifestations of these tribes? religious traditions, established a very stable hierarchical society.
Saudi Arabia has grown into a stable nation with modest advances in the state of law. Given its very
strong roots in the Arab and Muslim traditions, government and religion are considered as one. This
unity is reflected in the constitution (article 14), which describes oil as a gift of God and declares the
country?s responsibility to deserve this gift by managing it wisely.
The Saudi economy is very highly dependent on the oil industry. Oil contributes about 80 percent of
the national revenue. This dependence and the fact that OPEC is Saudi Arabia?s brainchild makes OPEC?s
success essential to the Saudis.
The main Saudi decision maker (as of 1999) with regard to oil affairs was the minister of petroleum
and minerals, Ali Ibn Ibrahin Al-Naimi. He was educated at Stanford and received an M.Sc. in geology. He
had been in charge of oil affairs in Saudi Arabia since 1995.
Impact on Negotiations. In coming to the negotiating table, Saudi Arabia was primarily concerned
with the state of its economy. Its government had been operating under a deficit for many years. When
oil prices reached a twelve-year low, with 80 percent of the country?s economy depending on oil export
for revenue, it came as no surprise that the Saudis were ready to take the negotiations seriously. A stable
oil price not only meant economic stability, but also would allow continuation of the extravagant lifestyle
that the monarchy had been used to. From a political standpoint, the monarchy may have realized that with further economic turmoil, the
Saudi working class could begin to question the motives and capabilities of the monarchy and cause
political unrest.
However, economic gain (and indirectly, political stability) was not the Saudis? only goal. They viewed
the negotiations as an opportunity to learn more about the interests of non-OPEC nations such as
Mexico. And because they had little information on the latter?s interests, they moved with caution. Their
negotiation techniques called for allowing non-OPEC nations (in this case Mexico) to make the first
move. But because they did not want to leave OPEC out of the negotiations, they made sure that all
agreements were framed as if they were negotiating on OPEC?s behalf.
On the surface, as the world?s largest producer of oil, it may seem that Saudi Arabia had the best
BATNA. By flooding the market with its reserves, it could have driven out all the other players. However,
in an oligopolistic market such as the oil industry, engaging in a price war could mean selling below cost.
With an economy so dependent on oil revenues, Saudi Arabia could not allow this to happen. It could
have meant not only economic instability but political and social unrest as well.
Mexico.
Culture, Economy, and Politics. Oil is owned by the state in Mexico. Since 1936, constitutional power
has been granted exclusively to the state to own and operate oil-extracting and processing facilities. ?El
dia de la expropriacion petrolera? (celebrated May 18 as the day of the oil expropriation) is a national
holiday, and the expropriation itself constituted one of the best-remembered and first populist
achievements of the political party currently (in 1999) in power. The decision to grant this power reflects
Mexican society?s preference for nationalizing all industries that extract natural resources. Mexicans
value local ownership and are very nationalistic about their natural resources.
Another important cultural principle issue related to foreign policy has been that no external
constituency should influence the country against the will of its citizens. Mexico will not ally itself with
an international organization that would rule over the Mexican state. It disagrees with actions taken by
superpower countries to ?police the world.?
In addition to being concerned about oil as a natural resource not to be owned or controlled by
outside forces, Mexico relies on oil for economic stability. Oil exports contribute about 40 percent to
Mexico?s economy.
The Mexican chief oil negotiator in 1999 was the secretariat of energy, Luis Tellez. He obtained a
Ph.D. degree in economics from the Massachusetts Institute of Technology, but prior to his appointment
he had no working experience in the oil industry. Although he operated in a system known for red-tape
and bureaucracy, Tellez stood apart as one who did so with a relatively small staff of highly trained
professionals.
The political system in Mexico provided Tellez freedom to make decisions on his own. Mexican
society was not as concerned about the macro-economic strategies the government might get into
regarding supply and demand of oil as it was about maintaining ownership of the decision-making
process. Impact on Negotiations. Although a stable oil price would have benefited the Mexican government,
Mexico?s motivation to participate in the talks was more than economic. In many recent forums, Mexico
had been given credit for the unprecedented cooperation between OPEC and non-OPEC nations, possibly
because it had less to lose economically from low or unstable oil prices. Only 40 percent of the economy
depended on oil revenues (versus 80 percent for Saudi Arabia and 60 percent for Venezuela). Also,
Mexico could expect other, larger producers to manage the price even without its collaboration, whereas
Venezuela and Saudi Arabia were crucial to any deal. Yet Mexico played a vital role as the mediator in the
negotiations. Without its intervention, Venezuela and Saudi Arabia may have never been able to settle
their differences and therefore may not have even come to the negotiation table. Though Mexico had no
power over any of the nations involved, Mexico?s participation and underlying interests allowed it to
facilitate an agreement amenable to all sides.
Venezuela.
Culture, Economy, and Politics. Oil is a source of pride in Venezuela. Local newspapers carry as big a
section on oil as they do on sports. However, the interest in keeping the industry in government hands is
not as strong as it is in Mexico. Rules on foreign participation are rather flexible and modern. Regardless
of ownership, Venezuelan society is more concerned that the oil industry generate sufficient income.
In 1999, Venezuela was experiencing an economic recession. The population had been suffering
economically under the previous administration and was in need of immediate economic recovery.
Venezuelan society was placing its hopes on the new government (President Hugo Chavez had been
elected in 1998) that promised welfare for everyone. Society acknowledged Chavez?s party?s promises,
and rallied behind Chavez. Venezuelans were more united as a nation then than they ever had been
before. Chavez?s party was working hard to achieve immediate progress to benefit the suffering
population.
Culturally, Venezuela as a nation is slightly more hierarchical than Mexico. Having a positive populist
perception was crucial to maintaining political power.
The minister of energy, Ali Rodriguez, was handling oil negotiations. Rodriguez was a former
congressman who had studied law and economics in Venezuela. He was not experienced in international
negotiations; however, he was a close ally of President Chavez. Both Rodriguez and Chavez had been
trying to rebuild Venezuela?s reputation. They recognized that their country had been notorious for
reneging on OPEC supply agreements.
Impact on Negotiations. The new Venezuelan government saw the 1999 negotiations as an
opportunity to rebuild its reputation in the oil community by honoring the agreements. Also, entering
the deal was a way to gain international respect and trust for the new administration, which was
criticized by media worldwide.
Another opportunity for the government was to bring short-term wins for its economically troubled
population. Getting more revenues out of oil would truly make Chavez the hero he wanted to become.
The Chavez government would stick to the agreement as long as it was beneficial to its short-term goals.
The negotiator, Rodriguez, lacked negotiation experience and international exposure, but he tried to
compensate for this by using a large team of advisers. Venezuela probably wanted to showcase a successful negotiation as a short-term heroic action that would keep the administration in a very positive
populist light. Although long-term international trust and respect were important, should maintaining a
positive public perception demand selfish behavior, Rodriguez could not be expected to keep true to
international agreements. The Chavez administration would frame defection as a decision made for the
benefit of the population.
In lieu of an agreement, what were Venezuela?s options? Cheating, to which Venezuela historically
had resorted, was not much of an option. With oil prices at their lowest levels, there was not much
incentive to cheat. Overproduction would only push the price further down. On its own, Venezuela could
not bring the price up. As the new government was looking for short-term wins, the country had little
choice but to reach for an agreement with the other nations.
Some Further Remarks
In its March 6, 1999 issue, The Economist published a series of articles on the decline of oil prices,
blatantly predicting that the price would go as low as $5 per barrel. In the article, numerous economic
reasons were given for why the price should be so low. At that time, OPEC seemed powerless, and the oil
producers? situation seemed hopeless. A month later with the price soaring, the press found another
long list of economic reasons why the new prices could be justified. Had the world suddenly changed? It
was highly improbable. What had occurred was an unparalleled negotiation between unlikely partners.
It seemed remote in March 1999 that Venezuela and Saudi Arabia could agree to anything. This is
why the participation of a third party at the negotiation table seems to have been crucial to the deal. But
was Mexico so important? In fact, when compared to some OPEC countries, Mexico is just a mediumsize, rather inefficient oil producer. The importance of Mexico to the deal had to do not only with its oil
but also with its role as a catalyst that could build an agreement zone.
Discussion Questions
1. What environmental circumstances brought Mexico, Venezuela, and Saudi Arabia to the
negotiating table?
2. Over the period of time reviewed in this case, Saudi Arabia was, then it wasn?t, then it was again
willing to make the biggest reductions. Why were the Saudis willing to make the biggest reductions? Why
did they stop, and then restart?
3. What circumstances maintained cohesion among oil-producing countries during the period 2005?
2006? Are those circumstances still in place as you analyze this case?
4. What will it take for the consumer to see a reduction in oil prices?
Notes
1. Just to be sure, Norway reserved the right to withdraw from the agreement if OPEC failed to keep
its promises. 2. Y. Ibrahim, ?OPEC Is Prepared to Reduce Oil Production to Raise Prices,? New York Times, March
22, 1999.