The Game of Kazakhstan Oil and OPEC
Is the Game Worth the Candles?
by
Aggei Semenov
Department of Economics
Yakutsk State University
Yakutsk, Russia
and
Professor Carol Dahl, Director
CSM/IFP Joint International Degree Program in
Petroleum Economics and Management
Division of Economics and Business
Golden, CO 80401 USA
August 3, 1999
In economics a game is a set of players who employ strategies and get payoffs. In the game of Kazakhstan Oil
and OPEC the main players are Kazakhstan, OPEC, USA, Western Europe, Turkey, Russia and China. The
payoffs are both economic and political. The main strategy touched in this article is whether Kazakhstan should
join OPEC or not. To help us decide whether to play this strategy, or whether the game is worth the candles, we
begin the article with a brief history of OPEC and the criteria for joining OPEC followed by a comparison of
Kazakhstan with other OPEC countries. Advantages and disadvantages are then discussed followed by our
conclusions.
OPEC History: In 1960 multinational oil companies cut posted prices in response to weak oil markets.
Since posted prices constituted the tax base for producing countries, their reduction reduced tax payments to
producing countries and resulted in the formation of the Organization of Oil Exporting Countries (OPEC). The
five founding members were Venezuela, Iran, Kuwait and Saudi Arabia soon to be followed by Qatar (1961),
Libya, Indonesia (1962), United Arab Emirates (1967), Algeria (1969), and Nigeria (1971). Ecuador was a
member from 1973 to 1992 and Gabon from 1975 to 1994. Small production and high fixed fees (US$ 1.8
million per year) were reasons cited for Ecuador and Gabon dropping out of the organization. To be eligible for
OPEC requires that a country be committed to the OPEC goal of a stable and prosperous oil industry and that it
be a significant oil exporter.
During the 1960's OPEC did not manage to raise prices, as seen in figure 1, or to gain control over their
domestic industries, that was left for the next decade. But they did manage to hold the line on taxes. In the
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1970's the world saw two sets of price hikes, the first in 1973 after the six-day war and the second after the
Iranian revolution in late 1978. These hikes, particularly the second, had the predictable affect of decreasing oil
consumption and diversifying consumption towards politically safer non-OPEC producers. The benefit of being
in OPEC was the higher prices received, but the cost was this loss in production. OPEC’s production, in 1985
was only 2/3 of that in 1973 and with oil at over $30 per barrel, there was downward pressure on prices. OPEC
instituted its first quotes in 1983 in response to this downward pressure. The biggest OPEC producer, Saudi
Arabia, in particular had cut production from a peak of over 9 million barrels per day in 1979 closer to 3 million
barrels per day by 1985. By the end of 1985 Saudi Arabia found its production decreases intolerable and it
increased production and went to net back pricing. The price that Saudi Arabia received was the per barrel price
for products minus refining margins and transportation. Since product prices were determined in fairly
competitive markets, the price received was essentially a market price. Despite quotas since 1983, prices never
again broke US$ 30 per barrel except for very briefly prior to the Gulf War in the second half of 1990.
Figure 1. Oil prices from 1960 to 1999
50
40
30
20
10
0
1960
1970
1980
1990
2000
Source: US Department of Energy, American Petroleum Institute.
Note: Prices represent US import prices as a proxy for OPEC prices.
Although each OPEC country enjoyed the higher oil prices their quotas brought, none enjoyed the curtailment of
production required and there were continuing disagreements inside of OPEC regarding production quotas.
Figure 3 demonstrates the result with output for the total period exceeding the quota.
Figure 2. OPEC Production and Quotas
2
Mi
llio
ns pe
of r
Ba Da
rrey
ls
40
30
Production
Quota
20
10
0
1960 1970 1980 1990 2000
Years
Source: American Petroleum Institute, Oil and Gas Journal. Note: Since 1990 Iraq has not been in the quota
system, actual Iraqi production has been used instead of a quota.
Prior to March of 1999 prices were particularly low. They fell below the $10 per barrel mark as the result of a
weak Asian market, increases in allowable Iraqi sales for humanitarian purposes and with excess production.
Over half of OPEC countries, especially Venezuela, were violating their quotas. However, since a March, 1999
meeting, when OPEC pledged production cuts of 1.7 million barrels per day and Mexico, Norway, Oman and
Russia pledged additional cuts of 400,000 barrels per day, prices have firmed considerably.
.
Kazakhstan and OPEC
Table 1 shows that OPEC contains very diverse countries. Some have high reserves, Gulf countries and
Venezuela, the rest along with Kazakhstan have low reserves. Although Kazakhstan would fit in this latter
category many believe that its reserves are as high as 80 billion barrels and that capital in the form of productive
capacity and pipelines, rather than resources are the constraint on Kazakhstani production. Some OPEC
countries have high populations - Indonesia, Nigeria, and Iran, the rest along with Kazakhstan have low
populations. Some have low costs as measured by high production per well in the table, the Gulf countries and
Libya, the rest along with Kazakhstan have higher costs. Nigeria would fall in the low cost category as well
except that much of their production is offshore raising their costs.
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Table 1: Economic, Demographic and Petroleum Information
Country
Estimated
Proved
Reserves Population
Jan. 1, 1999 @ 1997
(million
million
bbls.)
OPEC Number of
Production Quota Producing Production
Income
Avg. 1998
Set
Oil Wells
Average
per capita thousand
Mar-99
Dec 31
per well
US$
b/d
1000 b/d
1999
b/d
Algeria
9200
28.6 1467 @95
818
731
1273
Indonesia
4980
201.4 1066 @97
1289
1187
8535
Iran
89700
60.7 2175 @96
3597
3359
1090
Iraq
112500
20.6 2000 @95
2114
n/a
1685
Kuwait
94000
1.8 17705 @96
1796
1836
790
Libya
29500
5.6 6510 @97
1395
1227
1869
Nigeria
22500
115.1
383 @94
2080
1885
2035
Qatar
3700
0.6 13664 @95
664
593
286
Saudi A
259000
18.9 6864 @95
8058
7438
1400
UAE
97800
2.6 19743@96
2278
2000
1468
Venezuela
72600
23.2 3769 @97
3108
2720
14694
Kazakhstan
5417
16.6 2700 @97
512
11715
Sources: Oil and Gas Journal, World Oil, International Monetary Fund, Celta (1998)
1760
414
9041
3437
6229
2045
2800
6361
15769
4251
579
120
Although Kazakhstan has many wells and production per well is low, production from newer Tenghiz
developments is 4000 barrels per well indicating that production costs may come down with new developments.
One can speculate that were Kazakhstan to join OPEC today with its current reserves, it would probably receive
a quota under 1 million barrels per day. If reserves develop according to the optimistic reports at the 80 billion
level, a quota between 2 and 3 million barrels per day may be more realistic. All OPEC countries with high
reserves, low populations, and low costs have high per capita incomes.
The heads of countries surrounding the Caspian Sea cannot sleep quietly hoping that oil will give their countries
a super-high rent and will allow them to achieve the social-industrial level of these richer Gulf countries.
Although Kazakhstan missed the days of $30 oil, it will likely find the reserves to have oil make a potential
contribution to the well being of the country and may one day find that it is in the enviable position of being a
high reserve country with low production costs and a low population. Transportation costs, however, are likely
to remain high reducing some of the rents for this land locked state. Whether these reserves will be distributed
across the population to improve infrastructure, health, education, and industry or used to line the pockets of the
few also remains to be seen.
Although current Kazakhstani reserves are small, potential is large and OPEC is obviously interested in the
Caspian oil. At present it seems that OPEC is more interested in Kazakhstan, than Kazakhstan in OPEC. One
of the biggest OPEC members, Iran is trying to establish control for Caspian oil. Iran is the second in OPEC
after Saudi Arabia as a producer of crude oil. Iran’s share is approximately 0.5% of the world’s production with
9% of the world’s oil reserves. The idea of the direct co-operation between Kazakhstan and OPEC appeared in
1996, when Iran offered to construct an oil pipeline to transport Kazakhstan oil to western consumers via Iran.
Iran may be motivated by a desire to weaken the influence of the West and to lighten sanctions introduced by
USA, and to influence the country through the oil market. Iran may also use Kazakh oil in Iranian domestic
refineries allowing exports of Iranian crude oil and such oil swaps between Iran and Kazakhstan have already
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been undertaken. The keen interest of OPEC is also confirmed by the contract on modernisation and widening
of the existing system of the oil pipelines in Kazakhstan, which was signed by Saudi Arabian company
“Alsuwaiket Group”. It is difficult to believe that OPEC is eager to have one more producer in the Persian Gulf
but if Kazakhstani oil will flow in some direction, it is desirable to have some influence over its flow.
Advantages and Disadvantages of Kazakhstan Entering into OPEC
Advantages: If Kazakhstan joining the organization makes the organization stronger, there may be direct
economic benefits in the form of higher oil prices to both OPEC and Kazakhstan. Thus, it is not surprising that
OPEC is courting Kazakhstan. Higher prices are also extremely necessary for the Kazakhstan's oil industry. For
example, expenses of the Joint Venture (JV) “Tengizchevroil” including production, transportation and
commission fee to the partners are about US$ 11.2 per barrel. A price below this figure will put the JV in an
extremely unprofitable situation and finally will result in its collapse. Some argue that the critical price for a
barrel of oil, which is necessary to attract investments to the country and initiate the social-economic
development of Kazakhstan, is US$ 18.
The other major benefit to Kazakhstan from joining OPEC is the political support and strength to offset the
geopolitical power of the other major players - USA, W. Europe, Turkey, Russia, and China, who all have their
own economic and political agenda's for the area. Although Kazakhstan is the 9th largest country in the world
by geographic area, it has a small population and is an economically underdeveloped economy with limited
political or economic power. If Kazakhstan joins and contributes to a strong OPEC, the dominating force in the
world oil market, Kazakhstan will gain political significance.
The USA and Western Europe would like to see Kazakhstan an independent state, which develops in a
democratic way according to ‘free market’ principles. They would like that Kazakhstani government to
encourage western investments to prospect and exploit oil reserves to help American and European companies
diversify the world’s oil and gas supply and help reduce dependence on politically unstable energy markets such
as the Middle East and Russia. The USA, in particular, would like to limit the power of Iran, Russia, and China
in the area.
If Kazakhstan enters into OPEC, it would have more support to build an oil pipeline to the Persian Gulf via
Turkmenistan and Iran, which is currently strongly opposed by the USA. From the economic point of view, the
economics of this potential pipeline seem to be indisputable in comparison with other projects. The value of the
project is just US$ 700 to 800 million, the capacity of the project is supposed to be 500,000 barrels/day, while
transportation charges would be US$ 3 per barrel. In comparison the proposed project of oil transportation via
Azerbaijan and Turkey bypassing the Bosporus has an estimated tariff of US$ 5 per barrel with investments that
are several times more.
Turkey on the fringe of W. Europe has similar aspirations to other western countries. It would prefer that
Kazakhstan remain out of OPEC, would like to see oil pass through Turkey, but bypass the Bosporus for
environmental regions. In addition the common language in Central Asia has Turkey aspiring to a panTurkish
area looking to Turkey for leadership.
An Iranian or a Turkish pipeline, that bypasses Russia, would weaken the hold of Russia on Kazakhstani oil
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transportation but thwart Russia, who in its own turn, is eager to control the transportation of Kazakhstan oil to
the West. This explains the hastening construction of the Novorossisk project, which is under construction and
projected to be completed by 2001. Currently Kazakhstan is incorporated into the Russian pipeline network,
importing Siberian oil in the East and exporting oil in the West. However, this leaves them at the mercy of the
Russian oil pipeline transportation monopoly, Transneft, which restricts exports to 150,000 barrels per day.
Further investment through Russia is not attractive for former soviet republics due to unstable political situation
and often financial and economic crisis there.
Economically, Kazakhstan’s entering into OPEC is both profitable and unprofitable for Russia. Though it may
seem strange, strengthening of OPEC is profitable for countries producing oil. On the other hand, if Kazakhstan
joins OPEC, it will mean that its dependence on Russia is weakened. Despite all assurances regarding equality
of the CIS members, Russia is striving for domination, if not political then economic. However, the
interrelations between OPEC and Russia cannot be called easy. Russia acts in the world market as one of the
main competitor of OPEC.
Recently, OPEC countries have repeatedly criticized the destabilising role of Russia in the oil market. Russia
supplied through the “Druzhba” oil pipeline and Baltic terminals to the West European countries and world’s
markets, that volume of oil which it considered necessary to meet its requirements. However, the crisis in the oil
sphere, the global fall of prices of oil and oil products made Russia look for new ways to settle the problem. In
April 1998 the Russian government and main oil companies decided to reduce oil exports by 2.3% and product
exports by 3.2%.
Russia wants to demonstrate to OPEC its readiness to co-operate and wishes to establish good relations with
OPEC countries. In general, it seems to us that this step will not influence oil prices much. Thus, Russia is
rendering a psychological support to OPEC in its struggle to raise oil prices. Political disagreements should step
aside before the economic problems. Russia has been losing billions of dollars due to the fall of prices and the
problem of integration between countries producing oil to avoid a further fall is getting urgent. In this regard
Russia and Kazakhstan should act jointly with OPEC countries and other main oil producers. However, the
events of the summer 1999, when there was another crisis in the Russian oil products market, demonstrated that
despite good intentions of the government, leading oil companies and resellers of crude oil, so-called ‘givers’
negatively influence the government’s trials to stabilize oil exports. Recently the oil prices again abruptly
increased, mainly due to the activity of OPEC and other countries-oil producers. Thus, in Russia there is a sharp
misbalance between internal prices of oil products and export prices, which are used by companies and
mediators. Once again Russia demonstrated its weakness in control for export and shortsightedness of Russian
exporters, who are interested in just a momentary profit.
A last political benefit from joining OPEC might be as a counter balance to corruption in the Kazakhstani oil
market. With more external visibility and monitoring of production, it might be less likely that great volumes of
oil will disappear as has happened in some non-OPEC Central African countries.
Disadvantages: The high prices resulting from OPEC are the result of reduced production. If Kazakhstan joins
OPEC, it will have to restrict output. A better scenario is for Kazakhstan to become a free rider enjoying the
benefits of higher oil prices without having to bear any of the cost. However, this scenario only works if OPEC
is strong enough to keep prices high. The higher is Kazakhstani output, the more likely it can destabilize world
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oil markets, the less likely it can be a free rider, and the more likely it will economically benefit by becoming a
member. Events in 1998 suggest that OPEC has not, until recently, had the cohesion to keep prices up but it did
cause some non-OPEC producers to pledge production cuts along with OPEC in a March meeting.
Another disadvantage is the $1.8 million dollar fixed fee for being a member and all the administrative costs of
maintaining a membership such as expenses for maintaining and sending a delegation and a minister to the two
annual OPEC meetings and special meetings.
Joining OPEC may also inhibit foreign direct investment. Western firms see Kazakhstan as a high cost area but
with lots of potential and no restrictions on production. If Kazakhstan joins OPEC and has to restrict production
it looks less desirable. Why not invest in lower cost OPEC countries? This might be especially true for China,
which is a potentially large market for Kazakhstani oil. At the present time, China produces about 2.87 million
barrels a day and purchases about 600,000 barrels a day. By 2005 China is projected to buy about 2 million
barrels per day. Some of this might well be from Kazakhstan. The Chinese National Oil Company has already
pledged, but no firm plans have been made, to build a 300,000 to 400,000 b/d pipeline from W. Kazakhstan to
China, which would be one of the longest in the world. A quota on Kazakhstani oil might well jeopardize or at
least delay this project.
Conclusions
The issue regarding Kazakhstan’s membership in OPEC has no simple answer. Kazakhstan has an interest in oil
market stability because it is a potentially large producer, with plans to achieve a production volume of 3 million
barrels per day. This production, would make them a middle level OPEC producer. As oil is one of
Kazakhstan's three most exportable goods, along with steel and copper, Kazakhstan is eligible to join OPEC.
From an economic point of view, Kazakhstan joining OPEC has both positive and negative aspects. If joining
strengthens OPEC and firms prices, it will benefit Kazakhstan. Few oil exporters would want the world oil
markets to became freely competitive with oil prices falling below ten dollars per barrel. This would mean that
low cost Persian Gulf countries would totally dominate the world oil market. Kazakhstan with high production
and transport costs could no longer compete. Even the USA with all its high minded rhetoric about free markets
would probably not want to see its oil industry totally devastated because of the implications for national
defense and energy security.
However, at current production and reserve levels Kazakhstan is probably too small to make much of a
difference. If economics is the only criteria it is probably better to remain outside of OPEC only contributing to
voluntary production cuts when called upon during weak markets. Better not to have the quotas and other costs
associated with membership. Better not to discourage foreign direct investment, which the economy so
desperately needs. If reserve and production levels progress as the most optimistic envision and Kazakhstan
approaches reserves of 80 billion and production of 3 million barrels, then the issue should be revisited.
The second advantage is political using the OPEC connection to offset the power of the other players. A
pipeline through Iran would weaken the power of the US, W. Europe, Russia, and Turkey on the Kazakhstan oil
market. Alternatives always help to soften the monopoly powers of an opponent. However, the cost might be
high in terms of the powers given up to OPEC. A quota can lower revenues, investment, and might put off the
7
day that the huge Chinese market is open to Kazakhstan. Better to improve the attractiveness of foreign
investment in Kazakhstan and encourage as many pipeline alternatives as is economically feasible to weaken the
hold of any one player.
Corruption is a serious problem for Kazakhstan, which as an independent country is still in its youth. Hopefully,
corruption is just a growing pain that will be outgrown and its elimination will be acheived. Whether joining
OPEC would decrease corruption in Kazakhstan's oil industry is debatable. Even if it did, it would seem better
to attack corruption domestically by developing institutions that would reduce corruption, not just in the oil
market, but across the board making Kazakhstan for the majority of the population a better place to live and do
business.
So is the game worth the candles? At this point we would say nyet. But that is not to say that in the future as
more candles are added and more barrels are found the answer might one day be da.
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