Why OPEC Is A Classic Cartel And Could Regain Its Power Over Oil Markets
Investing.com | Jan 16, 2020 10:01
Is OPEC a cartel? The Saudi oil minister, Prince Abdulaziz bin Salman, says no.
In a speech at a petroleum technology conference in Dhahran, he pushed back against this long-held assumption, explaining that the media formulated the notion of OPEC being a cartel and that it "in no way has the connotations of a cartel.”
The argument that OPEC is not a cartel is based primarily on the organization’s several historical failures to set oil prices. However, the group indeed operates as a cartel. Even during times when OPEC is largely ineffectual, it’s valuable for traders to recognize the scenarios in which it could manipulate prices—in the near and long-term.
h2 Does The Definition Fit?/h2A cartel is formed when two or more producers of a product collude in order to restrict supply or set prices.
OPEC is often considered a classic example, seemingly fitting this definition. In the 1970s, the producing countries that made up OPEC controlled over 70% of the global oil supply and by conspiring to restrict it, they increased the price of oil. The group exhibited quintessential traits of a cartel, like coordination and working in concert to limit production and lift prices.
For example, in the weeks preceding the oil shocks in 1973, OPEC countries negotiated as a single entity with major international oil companies for a set oil price. When they were unsuccessful in their negotiations, OPEC decided to assign prices unilaterally. In 1973, OPEC actually set the price that its members would charge, not only the amount of oil produced or exported.
At the time, some OPEC producers sought the highest price they could attain while others campaigned for a more reasonable number. Then Saudi oil minister, Zaki Yamani, argued that it was in the organization's best interest to keep prices somewhat appropriate because if they were too lofty they risked discouraging global economic development and even potentially causing a recession in which less oil would be purchased.
He argued that prices that were too high could also urge more competitors to arise when they saw the opportunity to produce and sell non-OPEC oil at equally high prices. Zaki Yaman ultimately lost that argument, and instead of establishing prices at $7 or $8, OPEC set the price at $13 per barrel.
h2 Successful Price Manipulator? /h2Historically, many OPEC producers have cheated on their quotas and over-produced in order to increase their country’s revenue. This is one of the arguments used to suggest that OPEC is not a cartel, but it is actually typical behavior and a key reason it is so difficult to maintain a cartel, especially when there are no real consequences for over-producing.
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In the case of a drug cartel made up of criminal organizations, coordinating to set global drug prices, members are theoretically kept in-line with threats of violence. Since OPEC does not employ these measures, the greatest threat the group has in its arsenal is expulsion.
Today 40% of global oil production is ruled by OPEC countries. Challenges to OPEC’s status as a cartel arise from its historically increase supply in order to slash prices rather than reduce supply to boost prices.
The fact that OPEC doesn't always succeed does not mean that it isn't designed to function as a cartel. Moreover, intentionally increasing production and dropping the price is a cartel strategy, as it was in 2014 when then Saudi oil minister Ali al-Naimi led a plan to flood the market with OPEC oil and regain some of the group’s position of strength amid the shale revolution in North America. In 2014, OPEC caused the price of oil to drop, but it was working as a successful cartel to do so.
Today, OPEC oil ministers generally refuse to answer when asked what price they would like to see for oil. Saudi Arabia and the UAE, two of the most powerful countries in OPEC, sustainable oil market and don’t have price targets.
These published statements do not necessarily reflect the private meetings between ministers. OPEC has an especially bad public image in much of the world, in part because of the role its oil shocks played in sending the developed world into a recession in the 1970s, in part because its activities are contrary to free market ideology, and, in part, because its member countries generally operate under non-democratic governments.
OPEC is less effective at managing and manipulating the oil market today than it once was, although it wasn’t able to achieve precise control even in its best years. Today, smaller producing countries see fewer benefits in belonging to the organization and are leaving to pursue their own production policies. After all, if OPEC succeeds in raising prices, even the producers that do not belong to the group can prosper.
Perhaps this is part of the reason the Saudi oil minister is so concerned about rebranding the organization. He recently said that he believes OPEC should be seen as a group of “responsible producers” rather than a cartel.
Don’t be fooled by OPEC’s shift towards a more inclusive brand. OPEC is actively seeking to increase its membership and bolster the compliance rates of participating members with the ultimate goal of improving its ability to manipulate global oil prices.
h2 Why Pay Attention?/h2Its decisions are still important to the oil market even if it cannot influence prices as effectively as it sometimes did in the past. Some of OPEC’s decisions today have most impact in the very short term, as an announcement from Vienna can still move the market at the moment.
Yet the market appears quite skeptical that OPEC and its current partners, like Russia, are really succeeding at manipulating supply in any meaningful way. However, change is inevitable and as most large oil firms have decreased investment in exploration and production of new sources of oil, it is key to note that in the not-too-distant future OPEC might again control over 50% of the global oil market. Then, we will likely see a more powerful OPEC cartel again.
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