CS - OPEC Cartel
CS - OPEC Cartel
CS - OPEC Cartel
10
OPEC – the Rise and Fall
and Rise again of a Cartel
The history of the world’s most famous cartel
OPEC is probably the best known of all cartels. It was set up in 1960 by the five major oil-
exporting countries: Saudi Arabia, Iran, Iraq, Kuwait and Venezuela. As of 2009, there were
12 members. OPEC’s stated objectives are:
The co-ordination and unification of the petroleum policies of member countries.
The stabilisation of oil markets 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.
The years leading up to 1960 had seen the oil-producing countries increasingly in conflict
with the international oil companies, which extracted oil under ‘concessionary agreement’.
Under this scheme, oil companies were given the right to extract oil in return for royalties.
This meant that the oil-producing countries had little say over output and price levels.
Sources: Nominal oil price data from Global Economic Monitor (GEM), Commodities (World Bank); Price Index
from Data Extracts (OECD).
Oil prices
The early years
Despite the formation of OPEC in 1960, it was not until 1973 that control of oil production
was effectively transferred from the oil companies to the oil countries, with OPEC making the
decisions on how much oil to produce and thereby determining its oil revenue. By this time
OPEC consisted of thirteen members.
OPEC’s pricing policy over the 1970s consisted of setting a market price for Saudi
Arabian crude (the market leader), and leaving other OPEC members to set their prices in line
with this: a form of dominant ‘firm’ price leadership.
As long as demand remained buoyant, and was price inelastic, this policy allowed large
price increases with consequent large revenue increases. In 1973/4, after the Arab–Israeli war,
OPEC raised the price of oil from around $3 per barrel to over $12. The price was kept at
roughly this level until 1979. And yet the sales of oil did not fall significantly.
After 1979, however, following a further increase in the price of oil from around $15 to
$40 per barrel, demand did fall. This was largely due to the recession of the early 1980s
(although, as we shall see later on when we look at macroeconomics, this recession was in
turn largely caused by governments’ responses to the oil price increases).
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reached $30: a tripling in price in just 12 months. With the world economy then slowing
down, however, the price rapidly fell back, reaching $18 in November 2001.
However, in late 2001 the relationship between OPEC and non-OPEC oil producers
changed. The ten members of the OPEC cartel decided to cut production by 1.5 million
barrels a day. This followed an agreement with five of the major oil producers outside the
cartel to reduce their output too, the aim being to push oil prices upwards and then stabilise
them at around $25 per barrel.
The alliance between OPEC and non-OPEC oil producers is the first such instance of its
kind in the oil industry. As a result, it seemed that OPEC might now once again be able to
control the market for oil.
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However, as we saw in Case Study B.6 prices were to fall steeply from summer 2014.
This was largely the result of the increased output in non-OPEC countries of non-
conventional deposits, such as in shale formations. Consequently, OPEC’s market share has
waned.
OPEC responded to the increased supply, not by cutting output, but by announcing that it
would retain output at current levels even if oil prices dropped as low as $40. What it was
relying on was the fact that production from shale oil wells, although often involving low
marginal costs, lasts only two or three years. Investment in new shale oil wells, by contrast, is
often relatively expensive. By OPEC maintaining production, it was hoping to use its
remaining market power to reduce supply of competitors over the medium to long term (see
the blog post A crude indicator of the economy (Part 2) on the Sloman Economics News
site).
The recent history of OPEC illustrates the difficulty of using supply quotas to achieve a
particular price. With demand being price inelastic but income elastic (responsive to changes
in world income, such as rising demand from China), and with considerable speculative
movements in demand, the equilibrium price for a given supply quota can fluctuate wildly.
Question
1. What conditions facilitate the formation of a cartel? Which of these conditions were to be
found in the oil market in (a) the early 1970s; (b) the mid-1980s; (c) the mid-2000s?
2. Could OPEC have done anything to prevent the long-term decline in real oil prices after
1981?
3. Many oil analysts are predicting a rapid decline in world oil output in 10 to 20 years as
world reserves are depleted. What effect is this likely to have on OPEC’s behaviour?