Issues Motivated for choosing the study:The importance of oil in the world market today cannot be emphasized enough.
Without oil, the world would come to a standstill. The commodity is vital all over the globe, and it affects people all over. Oil is a political staple commodity in trade. Oil is an essential raw material and primary fuel. The industry as a whole provides plenty of employment opportunity. Oil has a stake in human development and progress as well.The constant fluctuation in oil prices affects the economy as a whole, but also affects the individual consumer. Knowledge regarding the economic and social repercussions of cartels and their ability to manipulate the oil market globally is essential for the better understanding of the global economy as well as a consumer of oil.
Another important issue which motivates the study of oil cartels is that OPEC (Organization of Petroleum Exporting Countries), one of the largest oil cartels in the world, does not control enough of the world’s oil supply to be able to control the price fully, and thus non-formal members of OPEC are forming separate alliances with non-OPEC countries which produce oil and selling the oil at more competitive rates which harms the net sales of OPEC’s member countries and also affects the consumers from non-oil producing companies. Origin and nature: According to the Cambridge Dictionary, a cartel can be defined as, “a group of similar independent companies who join together to control prices and limit competition.” (Cambridge Dictionary) A cartel is not the same as a monopoly, wherein a single group is the sole producer of a good or service. However, it could be called an attempt to create a monopoly among different producers and gain monopoly power so that lower production and higher revenue can be achieved. The purpose of forming a cartel is mainly to regulate the production and influence the price of a commodity. Over the course of history there have been several cartels across various industries which have existed. In today’s day and age, one of the biggest and most powerful carters is the Organization of the Petroleum Exporting Countries, i.e.
OPEC. The creation of cartels occurs when a few large producers decide to work with one another wherein they can fix prices so as to avoid competition. A cartel is a form of an oligopoly and is most practically applicable in an oligopoly because there are a smaller number of firms and each firm has a large stake in the market.
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Being a part of a cartel increases market power. However, there is a chance that members of the cartel may not adhere to the policies set by the cartel and may try to maximize their individual profit share which may cause the dissolution of the cartel and could perhaps be the reason cartels exist in very few numbers today. Seven Sisters Oil Companies: After the Second World War, an Italian businessman called Enrico Mattei coined the phrase ‘Seven Sisters Oil Companies’ in reference to the Anglo-American oil companies which formed the ‘Consortium for Iran’ cartel. From the mid-1940s up until the 1970s, the Seven Sisters dominated the petroleum industry across the globe. The Seven Sisters dominated the global petroleum industry from the mid-1940s to the 1970s. The cartel came about due to the internal state of affairs in Iran and initially they went against what the former government’s negotiations had drawn up. Even after changing the name from Anglo-Iranian Oil Company to British Petroleum, the public opposed it, and thus British Petroleum was forced to join the international consortium of oil companies which had been established as a result of the dispute.
The Seven Sisters controlled about 85% of the world’s oil reserves until the oil crisis of 1973. OPEC: The oil cartel called OPEC, i.e. Organization of Petroleum Exporting Countries is one of the biggest cartels in the world. It consists of 12 countries (Saudi Arabia, Qatar, United Arab Emirates, Kuwait, Libya, Algeria, Indonesia – whose membership is currently suspended – Iran, Iraq, Nigeria, Gabon, Indonesia, Ecuador and Venezuela).
Not all countries which export oil are part of OPEC. It was created at the Baghdad Conference in September 1960. The current headquarters of OPEC is in Vienna, Austria since 1965. OPEC has the ability to set guidelines for the world oil prices.
The OPEC is a permanent intergovernmental organization. Officially, OPEC’s mission is to, “coordinate and unify the petroleum policies of its Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers, and a fair return on capital for those investing in the petroleum industry.” (Organization of Petroleum Exporting Countries – OPEC, Investopedia) OPEC countries work together and taking into consideration the market demand, they strive to facilitate the smooth supply of oil and regulate the prices accordingly. The OPEC Conference is the supreme authority of the organization and it generally meets twice a year.Current Situation (from 2010 till now):In the beginning of the decade, the oil market was posed with the threat of the global economy which was being weighed down by macroeconomic uncertainties and the increasing risks of the financial system.
Supply and demand of oil was affected by social unrest in several parts of the world. Between 2011 and mid-2014, the prices were stable, after which speculation and oversupply caused a fall in the prices. The world began to focus on environmental issues a lot more, and looked to the United Nations Organization to form agreements regarding climate change and other environmental issues. OPEC at that point was trying to find some sort of stability in the market and attempting to forge relations with non-OPEC oil producing and exporting countries. Existing Scholarly Work: Title: Political Constraints on Government Cartelization: The Case of Oil Production Regulation in Texas and Saudi Arabia Authors: Libecap, G.
D. and Smith, J. L. Date: 27th June, 2001Supported by: International Center for Economic ResearchSummary: This paper examines government cartelization efforts in crude oil production. This offers us two different perspectives using Texas and Saudi Arabia as viewpoints. The concept of cartels is illegal is the United States of America and the political constraints which affect the market there have been analyzed.
Saudi Arabia’s role as a part of OPEC gives an insight as to how a cartel is affected by individual countries and the political pressures from them. The information provided in this article provides much information about the Texas Railroad Commission (state regulatory agency) and talks about various reasons and explains the low-cost and high-cost production aspects. The difference between governmental cartelization and private cartels is also highlighted. Title: An analysis of OPEC’s strategic actions, US shale growth and the 2014 oil price crash Authors: Behar, A. and Ritz, R.
A. Date: July 2016 Summary: This paper is an analysis of the oil market in 2014, when OPEC had announced a new market strategy which basically wanted to push out from the market high-cost producers such as US shale oil. The paper looks at two strategies which OPEC can use against non-OPEC countries, i.e.
‘accommodate’ which means that they will have higher prices which allows non-OPEC countries to remain profitable and the second is ‘squeeze’ which means that they will increase production and reduce the prices which will force non-OPEC countries to exit the market. They emphasize on a ‘regime switch’ and have put forward a theory which shows that market-share strategy would be a more attractive option for OPEC. The model created by the authors is used as a platform to put forward the concepts of how the market responds to OPEC’s strategy and how the strategy plays out. This paper, as believed by the authors, is the forefront of papers which provides readers with a model which explains OPEC’s shift in strategy and the repercussions of this shift through an economic model.
There is plenty of available literature which talks about the crash in price of oil in 2014, and this paper reviews that data and compares it to the data they provide. The model is presented to the readers and the strategies are analyzed with the help of the model, and the results seemed to show that the ‘squeeze’ option seemed to be a more attractive option. The authors believe that their model can be applied to other energy sectors as well.
While the paper gives us an insight into the topic from the perspective of the model created by the authors, there seems to be a lack of substantiation of the model. Overall, the concept of OPEC’s strategy with relation to it being a cartel and how it influences the market seems to be thoroughly explained and simplifies understanding of the process. Reference: IMF Working Paper Title: OPEC’s Oil Exporting Strategy and Macroeconomic (In)Stability Authors: Aguiar-Conraria, L. and Wen, Y. Date: May 2011Summary: This paper talks about economic instability which arises from dependence on foreign oil and is affected by the price determination by cartels. The literature provided by the article allows an insight into the reasoning provided by the authors, who argued that macroeconomic instability of the country which imports oil increases when the cartel which exports the oil fixes the price of oil. The concept of ‘equilibrium indeterminacy’ is explained in the paper, and the authors introduce a model to substantiate their claims. The authors showed that economic instability was a function of market strategy of the countries which export the oil.
Title: OPEC: What Difference has it Made? Authors: Fattouh, B. and Mahadeva, L. Date: January 2013 Summary: This paper explains how the power of OPEC to influence the price of oil in the market is constantly changing and due to the varying behavior, multiple models are used to explain the fluctuation. The paper explains how, over its 50-year history, OPEC has been the cause of price wars, and how there is a lack of consistency in OPEC. The short term and long term power struggle is explained and some struggles of OPEC are highlighted.
The position of OPEC in the oil market can be affected by several factors and collusion, which has not been an easy path for OPEC, can be hard for them to sustain. This literature review provides us with a detailed insight into OPEC’s inner workings and empirical evidence is provided, which shows us that the different models used to explain OPEC’s position cannot be collaborated into one due to its unpredictable behavior patterns and the models may conflict with one another. Title: Cartel formation and oligopoly structure: a new assessment of the crude oil marketAuthors: Bockem, S. Date: 2004 Summary: The interrelation and empirical link between cartels and oligopolistic market structures are studied in this paper.
A detailed literature review was provided using previously developed models and comparisons revolving around OPEC to show that OPEC does not follow any specific behavior which matched the economic concept of a cartel. The paper provides an explanation of price-leader cartels as a model, which seemed to be the best fitting description which did not cause any contradiction. Lessons Learned:The study of oil cartels from different aspects allows for an all round understanding of what place it holds in the economy, i.e. what type of market can it be classified as, what social, economic and political repercussions they have. Different perspectives of studying cartels through different economic models allows us to understand the real effect of OPEC, one of the major cartels on the world oil market. One of the basic learnings was that cartels have to be careful while playing the price determination game.
Increasing the price of oil will only make the sales drop, encourage research into alternate forms of oil and production, and this will mean the beginning of the end of the cartel. When individual members of a cartel are tempted to cheat and not adhere to the prices fixed by the cartel as a group, they stand to make a profit. If one member cheats, it may not cause much of a problem. However, if everyone begins to cheat then the restrictions placed on production would have been breached and no one stands to gain anything. All this teaches us is that if everyone works together in harmony and does as they ought to, smooth functioning is ensured. However, the more members that cheat and indulge in foul play, the easier it makes it to fall apart.
This quite simply put, is a classic example of the statement, ‘cheaters never prosper’. Recommendations for the future:From the knowledge gathered in the course of this study, it can be concluded that oil cartels should not cut down on production only due to personal rivalry as it not only affects the economy of several countries directly, but also reflects greatly in the demand and supply of oil all over the world, which affects the economy and global oil market. Non-members of OPEC should try, to the best of their abilities, to maintain an average rate of sales as compared to OPEC as an excess in demand or perhaps even a shortage in demand of oil supplies affects the environment in the long run. Where OPEC’s behavioral inconsistencies are concerned, it may be suggested that implementation and enforcement of policies which regulate not just the behavior of OPEC as a whole but also those of individual member countries should be regulated more thoroughly so as to avoid the possibility of the cartel’s eradication. https://dictionary.cambridge.
org/dictionary/english/cartel”Organization of Petroleum Exporting Countries – OPEC.” Investopedia. https://www.
investopedia.com/terms/o/opec.asp”The Consortium Agreement of 1954.” Iran Review. 12th September, 2016. Retrieved from: http://www.
iranreview.org/content/Documents/The-Consortium-Agreement-of-1954.htmOrganization of the Petroleum Exporting Countries. http://www.opec.org/opec_web/en/about_us/24.htm”An analysis of OPEC’s strategic actions, US shale growth and the 2014 oil price crash.” IMF Working Paper.
July, 2016. Retrieved from: https://www.imf.org/external/pubs/ft/wp/2016/wp16131.pdf”Political Constraints on Governmental Caterlization: The Case of Oil Production Regulation in Texas and Saudi Arabia.” 27th July, 2001. Retrieved from: https://poseidon01.
ssrn.com/delivery.php?ID=405072103003095094080084085088126098050009066012037092123120116070026068053018002013098127047102019003065115031012038082059050085087122122104009003018103086022047013126094005104117115093084029020094112113005025113022081092067008005022116094026&EXT=pdf”OPEC’s Oil Exporting Strategy and Macroeconomic (In)Stability.” Research Division, Federal Bank Reserve of St. Louis. May 2011.
Retrieved from: https://files.stlouisfed.org/files/htdocs/wp/2011/2011-013.pdf”OPEC: What Difference has it Made?” The Oxford Institute for Energy Studies. January 2013. Retrieved from: https://pdfs.semanticscholar.org/ff75/76049fdc2c7151e39caba27063f4a67af163.
pdf”Now OPEC Faces The Problem Of All Economic Cartels: Enforcement.” Forbes. 1st December, 2016. Retrieved from: https://www.
forbes.com/sites/timworstall/2016/12/01/now-opec-faces-the-problem-of-all-economic-cartels-enforcement/#6c97d7c448be “Cartel formation and oligopoly structure: a new assessment of the crude oil market.” Applied Economics. 2004.
Retrieved from: http://www-personal.umich.edu/~twod/oil/NEW_SCHOOL_COURSE2005/articles/research-oil/cartel_formation_a_oligopoly_new_assess_oil_mkt_appl-econs_36_2004.pdf
