OPEC is a word that jolted not only traders but also people who are a far cry from financial professionals in March 2020. The reason was obvious: oil prices plunged by 30% on March 9. Eventually, this forced the Russian ruble and other currencies, which rely heavily on oil, to plummet. Why does this organization impact oil prices? What are its functions? Let’s answer these questions in our overview.
OPEC is a union of oil exporters. This organization was founded by Kuwait, Saudi Arabia, Iraq, Venezuela, and Iran in 1960. Initially, the cartel was headquartered in Switzerland. Later on, it was moved to Vienna, Austria where it has been operating to this day.
OPEC is primarily aimed at controlling oil prices in the global market. Member countries must adhere to formulated policies in order to make oil prices suitable for the current economic situation. In addition, they must deliver oil to importing countries at economically justifiable prices, and investors who invest in the oil industry (thanks to OPEC policies) must get a fair return on investment.
As mentioned above, this organization was founded by five countries. In 2020, there are 13 countries in the cartel.
Today, OPEC member countries include:
Russia — one of the oil-producing and oil-exporting countries — isn’t a cartel’s member. However, it’s included in OPEC Plus.
In addition, OPEC doesn’t include China and the United States. Therefore, given that the two world’s largest economies pursue their own policies as to oil production, OPEC’s measures to control oil prices around the world aren’t exhaustive.
As noted above, OPEC is primarily aimed at controlling oil prices. To accomplish this goal, the cartel controls the volume of oil produced by member countries. By setting quotas for exporters, it adjusts supply in the market. Learn more about such measures at the OPEC website.
Let’s take a closer look at how it works. Oil prices, like any product’s price in the market, depend on the supply-demand ratio. The higher the demand, the higher the price people are willing to pay. If supply begins to prevail, the price drops.
Market demand is backed by the global economy that is kept alive and requires energy including oil. The stronger the global economy is, and the faster it develops, the more energy is required.
When the price goes up, oil rises in price.
Supply of oil is backed by oil-producing countries. Some of them are OPEC members, while other large producers, including the USA and China, aren’t included in the cartel but supply oil as well. When supply exceeds demand, OPEC decides to cut oil production. A decrease in supply helps to prop up the price.
It should be noted that OPEC’s decisions indirectly impact national currencies of resource-based economies. The Russian ruble, the Canadian dollar, and a number of other currencies being traded depend on oil prices. Accordingly, oil, FOREX, and currency values are interrelated and react to the supply-demand ratio in the market.
Let’s go back to Black Monday — March 9, 2020 — when the Brent price dropped from USD 45 to USD 31. What caused this 30% price gap (later on prices of May futures contracts even went negative at the time of expiration)?
That was a period of the coronavirus pandemic. The global economic slowdown triggered by the quarantine resulted in a drastically reduced demand. After a while, OPEC Plus decided to hold a meeting in order to extend oil production cuts. Prior to that, quotas for member countries were already low. This time, Russia and Saudi Arabia failed to reach a consensus on oil production cuts. As a result, OPEC announced that all of the member countries weren’t required to comply with their quotas instead of a much greater decrease in supply.
Against the backdrop of a globally reduced demand, supply was supposed to expand even further. Moreover, Saudi Arabia announced that it would ramp up production.
This OPEC’s decision brought down the market. Over time, member countries nevertheless managed to sit down at the negotiating table and conclude a new deal to cut production and set monthly floating quotas, which allowed oil prices to recover.
As can be seen, OPEC has a direct impact on oil prices. Any trader needs to keep track of when the cartel holds meetings and what decisions it makes at these meetings. If oil production plunges, the price will rise.
We should keep in mind that the oil and FOREX market is driven by expectations. Oil prices didn’t slump on March 9 due to the fact that the market was overfilled with oil overnight but against the backdrop of an expected increase in supply. The news reporting that OPEC will discuss a deal to cut oil production at the next meeting will likewise prop up the price thanks to expectations alone.
Forex traders also need to monitor oil prices when they trade pairs with the Canadian dollar.
You can use Metatrader4 by Gerchik & Co to monitor Brent and WTI quotations and also check how oil price changes impact the value of the Canadian dollar.
OPEC is an international organization that directly impacts oil prices. It’s important for traders who handle oil futures contracts or currencies of countries whose economies seem to be sensitive to oil prices to monitor cartel’s decisions for three reasons: