Organization of the Petroleum Exporting Countries
(OPEC) may be the most famous cartel of the
present age, but such bodies have a long history,
making it possible to recognize the attributes of
a strong cartel and OPEC's own performance in that
The members of a cartel collude on
the level of output (assigning output levels to
each member) with the goal of manipulating price
levels and volatility.
In other words, in contrast to independent
producers operating under perfect competition,
cartel members collude on their output levels to
earn monopoly profits over time at the expense of
consumers. Obviously a cartel needs at least two
i. Unity is key to making a
cartel strong. Unity is needed to
demonstrate to members and perspective members
that they can gain by joining and colluding. OPEC
failed in this regard throughout the 1960s but
managed to unite to extract the Tehran Agreement
from the companies in 1971 and was united in
1973/74, achieving further gains.
contrast, the oil companies were united throughout
the 1940s, '50s and '60s, and it was not until the
early 1970s that Libya managed to drive a wedge
between the independent oil companies and the
The danger for OPEC, as for any
cartel, has been that members will agree to
production quotas but then cheat; or not agree to
production quotas at all; or afford non-member oil
producers the benefits of their collusion without
the cost of having to restrict their output level
(getting a free ride on the back of OPEC, that is,
benefit from higher prices with no obligation to
limit output levels).
characteristics help to define a cartel's
effectiveness. It helps if the product is
essential - which oil is; and has no ready
substitute, which again is the case with oil when
it comes to its use in transportation. Along the
same line, it helps if the product has a low price
elasticity of demand (that is as prices go up,
demand does not go down to a lower rate); and if
the product is hard to store and has a high
storage cost (buyers cannot store for emergency
and thus have more negotiating power).
iii. Market share (production and
especially exports. The higher the market
share of cartel members, the higher their market
power to set prices. OPEC market shares, while
falling for a number of years beginning in the
mid-1980s, have recovered and will continue to
grow for the foreseeable future.
A cartel of sellers benefit from numerous buyers
and their disunity. Again, oil fits the
bill and supports the OPEC position.
v. Cartel members do not want to
blink first. Members should have the
financial means to forego sales longer than buyers
can do without the product. The financial strength
of members, or their ability and willingness to
support each other financially through periods of
revenue shortfalls, is an important factor for
unity and cohesion, and in turn for the ability to
negotiate with the buyers of their product.
In the 1950s, none of the countries that
later became OPEC members were in a sound
financial position. In the 1960s, only Kuwait was
in a sound position with a significant level of
financial reserves to finance import needs for a
number of months. Saudi Arabia was in dire
financial straits and King Saud was effectively
replaced by his half-brother Faisal in order to
restore financial stability. The other countries,
though not bankrupt, were not in great financial
After the Tehran Agreement on
prices with oil companies in 1971, and especially
after the price hikes of 1973/74, financial
conditions improved rapidly for all members, even
though some, such as Iran, went on wild shopping
sprees buying everything imaginable, including
expensive military hardware.
Then came the
Iranian Revolution and the onset of the Iran-Iraq
War. As oil prices soared to their highest level
in real terms ever, the financial position of all
OPEC countries, except that of the two combatants,
But the earlier price rises
of 1973/74, coupled with the increases of 1979/80,
took a toll on worldwide demand for oil, and
especially for OPEC oil, accompanied by more
non-OPEC crude coming online.
At the same
time, in 1980 the US Federal Reserve finally
addressed the inflationary pressures that had been
building up in the 1970s by raising interest rates
to historic highs, inducing an economic recession
and further lowering demand for OPEC oil.
By 1986/87, Saudi Arabia was running
budget deficits and had to resort to borrowing;
Iran and Iraq were essentially in dire financial
straits. Only the sparsely populated Persian Gulf
countries of Kuwait, Qatar and the United Arab
Emirates (UAE) remained financially strong.
In desperate need of revenues, most OPEC
members cheated on their agreed production quotas,
with further downward pressure on prices. Not only
did they simply cheat, the Gulf Cooperation
Council (GCC) countries - founded in 1981 by the
UAE, Bahrain, Saudi Arabia, Oman, Qatar and Kuwait
- cheated (notably Kuwait) with the aim of
reducing revenues for their two perceived
adversaries - Iran and Iraq.
continued to stay in the doldrums more or less
continuously from 1986 to the turn of the 21st
century, as some countries that had spare capacity
and were not subject to sanctions such as those on
Iraq cheated while Saudi Arabia adjusted its
production level to meet market needs and keep
prices stable (serving as a swing producer).
The escalation of oil demand and the rapid
increase in prices beginning around 2004/2005 has
been the most prolonged boom in OPEC history.
Current account surpluses have been significant
and should continue for the foreseeable future;
financial reserves are at historic highs; the oil
market is tight, with only Saudi Arabia, followed
distantly by the UAE and Kuwait, having any
significant excess oil production capacity.
Looking at OPEC's record, what should we
conclude can we conclude that OPEC been an
effective cartel; that it can blackmail the world?
In the past, OPEC has rarely acted as an
effective cartel, with members restricting their
output to support a given price goal. Its members
cooperated in the 1970-1973 period as they tried
to wrestle some control away from the major oil
companies, but towards the end of 1973, when Arab
oil exporters boycotted oil exports to the US and
The Netherlands, non-Arab Iran increased its
output order to benefit from the tight market.
OPEC members have had regular and
emergency meetings to discuss the oil market and
to set price targets and individual quotas, but it
has been largely a facade. There have been short
periods of coordination and cooperation but much
of the time most members have not had any excess
capacity, some were under United Nations or other
sanctions, and Saudi Arabia was adjusting its
output up or down in order to achieve its own
targets. One country acting as a "swing producer"
can hardly be called a cartel.
and its members appear to have more power than
ever - a growing market share, vast and growing
financial surpluses, declining oil production
outside of OPEC and a world increasingly concerned
with global warming (that is, opposition to coal)
and nuclear power safety.
But OPEC has its
own political problems as never before. It would
appear that the GCC, and especially Saudi Arabia,
see Iran and Iraq as existential threats.
Relations between Iran and Iraq on the one hand
and the GCC on the other are as bad as they have
been in recent memory. For the GCC, economic
failure and backwardness in Iran and Iraq would
appear to be a more important goal than OPEC
cohesion, especially now that the GCC countries
are flush with cash for the foreseeable future and
have the only significant excess capacity in OPEC.
While Iraq may be able to increase its
installed capacity greatly over the next 10 years
to rival Saudi Arabia, it needs political
stability and hundreds of billions of dollars of
Iran could expand its oil
capacity somewhat, repair its existing fields and
especially increase its natural gas output to
rival Qatar's if it could achieve a measure of
economic prosperity, shed economic sanctions and
attract vast inflows of capital.
now, the GCC rules and OPEC cohesion is a mere
facade with Iran and Iraq as the enemy. For the
foreseeable future, OPEC is a gathering point to
talk, with little relevance for the oil market. It
is the GCC and Saudi Arabia that matter now.
Even so, given past and current conditions
can OPEC, or a smaller group within OPEC,
blackmail the world with its oil weapon? And here,
it should be noted that the word "blackmail" may
not be appropriate.
The US embargoes
exports to and imports from certain countries in
order to change their policies. The US calls these
economic sanctions. Would unilateral action by one
or more OPEC countries be any different?
Whether export sanctions on oil by one or
more OPEC members would be effective depends
mainly on market conditions. Namely, if oil
markets were generally tight, or tight for a
particular grade of crude, then whether such
action would be effective would depend on the
level of available excess capacity around the
world and the level of strategic reserves.
If existing excess capacity (and strategic
reserves) was 1 million barrels a day (MBD), then
any country whose exports exceeded 1 MBD could
cause havoc in the market, and more havoc the
larger the country's exports. Today, Saudi Arabia
or Russia alone could bring the world economy to a
halt; or a combination of two other OPEC members
among the major exporters (such as Iran and Iraq)
could do the same.
Recall that in 1973,
OAPEC (an Arab OPEC) made a half-hearted attempt
at such a move - half-hearted because it said it
was embargoing exports to the US and the
Netherlands (the major European destination for
Middle East oil) but it did not cut output, so
Iranian oil initially went to these countries
while Arab oil was routed to other markets! Iran
even expanded its output.
recognizing this loophole, OAPEC began reducing
output in steps to pressure the US, but Saudi
Arabia continued to secretly sell fuel to the US
Sixth Fleet for the Vietnam War. Before OPEC can
effectively coordinate its policies, members have
to implement what they profess.
NEXT: OPEC and the sanctions
Hossein Askari is
Professor of Business and International Affairs at
the George Washington University.