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To understand how the world works, pay attention to energy markets

Upon hearing that Rex Tillerson, the former CEO of the world’s biggest energy company ExxonMobil, had been nominated by US President Donald Trump to become his secretary of state, an astute Saudi diplomat appeared pleased. “No one understands politics and international relations better than oil executives,” he told me.

It is difficult to argue with the validity of that assertion. The confluence of politics and economics at the center of global energy markets indeed offers a cross section of how truly interconnected our world is.

It is debatable whether people around the globe still appreciate the impact oil has had on both oil-importer and exporter nations. As far as many people in oil-exporting countries are concerned, high prices are associated with prosperity, while the reverse is true in oil-importing countries such as the US, where lower oil prices mean lower gasoline prices and higher disposable income.

But the reality is that the global political economy of oil has played a key role in the development of advanced industrialized countries. At the same time, oil-exporting countries, some of which earn as much as 90 percent of their export earnings from oil sales, have also used these revenues to transform their countries very quickly.

How oil and gas are extracted, how much countries decide to produce, and how prices are set around the globe, are keys to understanding the varied dynamics that fall under the rubric of international political economy.

For much of the 20th century, developing countries with rich hydrocarbon deposits were content to defer to the “big seven” Western oil companies that dominated international oil markets. These countries were satisfied if Western oil companies helped them discover oil deposits, help them extract it and sell it to importers worldwide. This asymmetric relationship started changing slowly as oil producers began asserting more control over ownership.

In 1960, the Organization of the Petroleum Exporting Countries (OPEC) was created by founding members such as Venezuela, Iran, Iraq, Kuwait and Saudi Arabia. Several other nations have since joined.

But it was the Arab oil embargo of the US in 1973, for its support of Israel in its war with its Arab neighbors, that marked a turning point not only in the history of international energy markets, but in relations between what some at the time characterized as “North-South relations.”

Critics said oil exporters were deploying oil as a “weapon” to exert pressure on the US. Others started referring to OPEC as a “cartel.” The embargo, followed by price increases, had an almost immediate impact on American consumers, who endured long lines at gas stations.

While many saw 1973 as a triumph for oil producers, oil importers took measures to mitigate the impact of the embargo and lessen their dependence on “foreign oil.” Some of these measures included stressing the importance of conservation.

The challenges that face producers were outlined by many of the speakers at CERAWeek in Houston last week. The subject was how to control oversupply.

Fahad Nazer

Critics portrayed OPEC as a cartel that was artificially trying to manipulate the market. But in the eyes of many in the developing world, oil provided them with an opportunity to even the playing field and bring balance to what many in these countries saw as an asymmetric relationship with the West predicated on “dependency.”

Many observers have long awaited the demise of OPEC. A plethora of reasons accounted for this skepticism. For starters, member countries have rarely had an easy time agreeing on production levels, which is the primary means by which they keep energy markets stable. Even when agreement on production levels is reached, there is the issue of non-compliance or “cheating” as countries continue to produce more than the amount they were allotted.

In addition, some countries — primarily those with low reserves who have a shorter time view — are considered price hawks. Others are oil doves, with large reserves who want to maintain balanced markets for the long term.

Then there is the binary between low-cost producers such as Saudi Arabia and high-cost producers such as Venezuela. If that was not complicated enough, some major oil producers remain outside OPEC, the most important being Russia.

Over the years, more variables have entered into this already complex picture. Investment in renewable sources of energy such as solar and nuclear has increased over the years to lessen the overreliance on hydrocarbons. Relatedly, the concern over environmental degradation, and the adverse impact of carbon pollution on climate change and global warming, has added scrutiny to the activities of the energy sector globally.

Many companies now believe they have an ethical obligation to pursue socially responsible policies that not only limit harm to the environment, but encourage sustainable development and improve communities in which these companies establish a presence.

Over the past few years, a technological innovation known as fracking has allowed the extraction of once economically prohibitive shale oil to completely change intentional energy markets.

Shale production in the US expanded dramatically over the past few years, and the oversupply that resulted led to a dramatic drop in oil prices beginning in the summer of 2014, when the benchmark price of a barrel of oil was $114, to under $30 in early 2016. Now, for oil prices to stabilize, OPEC countries must agree among themselves, convince non-OPEC members to join, then have a separate conversation with shale producers.

Last week, the US city of Houston held what is considered the most important gathering of oil executives in the world. The guests at CERAWeek included oil executives from just about every major company in the world, as well as senior government officials, including Canadian Prime Minister Justin Trudeau and Saudi Minister of Energy, Industry and Mineral Resources Khalid Al-Falih.

The challenges that face producers were outlined by many of the speakers. The subject was how to control oversupply. Long gone are the days when the theory of “peak oil” — the notion that oil reserves worldwide were on the verge of depletion — was on everyone’s mind.

And while it may not seem like it at first, the decisions and policies articulated at venues such as this and at OPEC meetings will likely have an impact the next time you fill up your car with gas. You will feel it one way or another.

• Fahad Nazer is an international affairs fellow with the National Council on US-Arab Relations. He is also a consultant to the Saudi Embassy in Washington, but does not represent it or speak on its behalf. His writing has appeared in the New York Times, Foreign Affairs, Foreign Policy, CNN, The Hill and Newsweek, among others.