Priyanka Kanwar

CASE STUDY OF OPEC

THE IMPLICATIONS OF ITS SUCCESS ON THE WORLD OIL MARKET

Firms in perfect competition are ‘price takers’, i.e. they cannot influence the price. They must accept whatever price is determined by the industry and then adjust their level of output to maximize their profits. At times, they collude amongst themselves to restrict output and force the price to increase. This combination or collection of individual firms is known as a cartel. If all firms in the industry join the cartel, it assumes the form of a monopoly. However, in general, while most of the firms join the cartel, some remain outside. Therefore, cartels are mostly successful in creating an oligopoly. The firms constituting this oligopoly are often successful in raising prices and restricting output, with a view to maximize the profits of individual members forming the cartel. At the same time, there is a strong incentive for individual firms to cheat, because the cheating firm stands to gain more if it cheats, while other members cooperate. The best example of such a cartel is the Organization of Petroleum Exporting Countries (OPEC). This organization was originally formed in 1960 to benefit the oil exporting countries. It consisted of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Eight other nations joined by 1973, raising the total number of members to thirteen. However, 2 of them left later, reducing the number to 11.

As per the article, in its 47 years of existence, OPEC has not fulfilled its role as a cartel in the oil industry, as its members breached the production quotas regularly, except for the period from 1973-1980. Due to output restrictions imposed by OPEC, the price of crude oil rose sharply. However, pressures on the cartel started being felt due to increasing world supply, declining world demand and difference among the cartel members. Gradually, OPEC’s control on members’ production quotas considerably waned and crude oil prices dropped. However, since 1999, the annual oil revenues for OPEC countries have quadrupled and OPEC as a cartel seems to be realistically working. Now, what might be the causes of OPEC’s success as a cartel since 1999?

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CAUSES OF OPEC’S SUCCESS

  1. In 1999, the oil prices had fallen to about $10/barrel. This was largely due to the Asian financial crisis that led to a fall in demand, while supply was largely unregulated, due to OPEC’s inability to check the quotas of its members. Fearing collapse of oil revenues, Saudi Arabia negotiated with other major OPEC and non-OPEC members to cut production sharply and since then, compliance with output quotas has been considerably good.

  1. Since 1999, the world demand for oil has ...

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