OIL PRICE WAR STIRS FEUD WITHIN OPEC

By Kristopher Klein
Staff Writer

What happens to a cartel when there is substantial competition from outside? The answer depends on patience.

The Organization of Petroleum Exporting Countries (OPEC) has been the most influential component of setting oil prices since their founding in 1960. As an organization OPEC has helped raise the price of oil above $100 per barrel for the past near-decade. Large importers of oil, such as the United States, have put up with rising prices, unable to stop OPEC from colluding in their own interest. However with the recent rise in competition from North American shale oil producers, that era has come to a swift and decisive end.

Any college-level economics course will review the concept of collusion among cartel members and the decision each cartel member makes about whether to remain in the cartel or to go out on their own.

The difference between these strategies is a matter of weighing short-term profit versus long-term profit. If the cartel remains intact, producers will be able to collude to raise prices to artificially high levels and thereby make more profits. However, if a producer leaves the cartel they can lower their price and temporarily receive a larger share of the market (i.e. more customers) and thereby make a lot of profit in the immediate future.

But the betrayal of the second strategy has consequences. If the integrity of the cartel is undermined, greater competition between all members will force producers to charge a fairer price and lose the profits they could have made through continuing to collude to raise prices.

Thus, it is a matter of patience and how soon a cartel member needs to receive their profits that determines strategy. A member who is very eager to receive short-term profits is a greater risk of leaving than a member who can afford to wait for higher profits in the long-term.

Competition from outside this cartel lowers prices and raises the risk of a cartel member, in a pinch from lower profits, making a quick dash for more revenue (either per unit or overall) by either cutting production in order to raise the price or increasing production to gain market share.

The United States has been increasing its production of shale oil since a jump in production in late 2014. Greater supply of oil, combined with slower growth in the economies of Europe and East Asia, has created a global supply glut and falling prices.

In late December the United States decided to lift its ban on the export of oil. But the United States imports more oil than it exports, so what effect could that really have? As it turns out, the United States is one of the only countries capable of refining the crudest oil into a product for the global market, so a lot. John Auers, executive vice president at Dallas-based Turner Mason & Co was quoted as saying that, “U.S. refineries built out their capacity to run heavy barrels. Refineries in the rest of world aren’t built to run heavy barrels.” That means lifting the ban on exporting oil has allowed the United States to begin refining very crude oil from around the world before then exporting refined gasoline back around the world at a price that can compete with the OPEC cartel.

The result of competition from the United States has led to a collapse in the price of oil from above the $100 per barrel level that OPEC loves so much, to around $45 per barrel today. Some OPEC members are seriously hurting. If the pain does not end soon, political turmoil could arise from within OPEC.

OPEC member Venezuela calculated its 2015 budget on the idea that oil prices would remain at about $60 per barrel and that any excess revenue would be used to help run social programs. With the price of oil now just above $45 per barrel, Venezuela looks to run a deficit this year, which will force them to limit funding to social programs.

On January 10, Venezuelan President Nicolas Maduro and Iranian President Hassan Rouhani vowed to cooperate to stabilize falling oil prices. Five days later, Maduro and Russian President Vladimir Putin, whose country is not a member of OPEC, held a “detailed discussion” about the global oil market, without releasing any details.

Saudi Arabia has repeatedly rejected calls from OPEC members for the cartel to cut production in order to defend the price of oil. Saudi Arabia has saved much of the revenue it earned from higher oil prices and now has a reserve large enough to wait a while before cutting production, a move they hope will lead to a cut in production from North American shale oil producers.

However, not every member of OPEC has the reserves that Saudi Arabia and its neighbors on the Arabian Peninsula have built up over time. Without a rise in the price of oil very soon those countries, such as Venezuela and Algeria, will come under significant pressure to find a means of changing their fortunes.

Could this fall in the price of oil and Saudi Arabia’s refusal to cut production endanger the cohesiveness of OPEC as a price-influencing entity, or perhaps even mean a collapse of the cartel altogether? It very well may. In fact, OPEC seems already to be losing its control of prices that at one time were to the penny. According to Kuwaiti Oil Minister Ali Saleh al-Omair, “OPEC would have to accept any market price for oil, whether it were $100, $80 or $60 per barrel.”

North American competition has, at least for a time, defanged OPEC and clipped the wings of global oil prices. If the American market can sustain production and OPEC is forced to proceed as a price-taker rather than price-maker, OPEC members will begin to wonder why they participate in the cartel at all.

Image by Iguanasan

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One response to “OIL PRICE WAR STIRS FEUD WITHIN OPEC

  1. Pingback: VENEZUELANS DESERVE THE WORLD BUT GET MADURO | Prospect Journal·

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