Issues commodity is vital all over the globe

Issues Motivated for
choosing the study:

The importance of oil in
the world market today cannot be emphasized enough. Without oil, the world
would come to a standstill. The commodity is vital all over the globe and is an
essential raw material and primary fuel. The industry as a whole provides
plenty of employment opportunity. Oil has a stake in human development and
progress as well. The constant fluctuation in oil prices affects the economy as
a whole, but also affects the individual consumer. Knowledge regarding the economic
and social repercussions of cartels and their ability to manipulate the oil
market globally is essential for the better understanding of the global economy
as well as a consumer of oil.

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Another
important issue which motivates the study of oil cartels is that OPEC
(Organization of Petroleum Exporting Countries), one of the largest oil cartels
in the world, does not control enough of the world’s oil supply to be able to
control the price fully, and thus non-formal members of OPEC are forming
separate alliances with non-OPEC countries which produce oil and selling the
oil at more competitive rates which harms the net sales of OPEC’s member
countries and also affects the consumers from non-oil producing companies.

 

 

Origin and nature:

 

According
to the Cambridge Dictionary, a cartel can be defined as, “a group of similar
independent companies who join together to control prices and limit
competition.” (Cambridge Dictionary) A cartel is not the same as a monopoly,
wherein a single group is the sole producer of a good or service. However, it
could be called an attempt to create a monopoly among different producers and
gain monopoly power so that lower production and higher revenue can be
achieved. The purpose of forming a cartel is mainly to regulate the production
and influence the price of a commodity. The creation of cartels occurs when a
few large producers decide to work with one another wherein they can fix prices
so as to avoid competition. A cartel is a form of an oligopoly and is most
practically applicable in an oligopoly because there are a smaller number of
firms and each firm has a large stake in the market. Being a part of a cartel
increases market power. However, there is a chance that members of the cartel
may not adhere to the policies set by the cartel and may try to maximize their
individual profit share which may cause the dissolution of the cartel and could
perhaps be the reason cartels exist in very few numbers today.

 

Seven
Sisters Oil Companies:

After
the Second World War, an Italian businessman called Enrico Mattei coined the
phrase ‘Seven Sisters Oil Companies’ in reference to the Anglo-American oil
companies which formed the ‘Consortium for Iran’ cartel. From the mid-1940s up
until the 1970s, the Seven Sisters dominated the petroleum industry across the
globe. The Seven Sisters dominated the global petroleum industry from the
mid-1940s to the 1970s. The cartel came about due to the internal state of affairs
in Iran and initially they went against what the former government’s
negotiations had drawn up. Even after changing the name from Anglo-Iranian Oil
Company to British Petroleum, the public opposed it, and thus British Petroleum
was forced to join the international consortium of oil companies which had been
established as a result of the dispute. The Seven Sisters controlled about 85%
of the world’s oil reserves until the oil crisis of 1973.

 

Over
the course of history there have been several cartels across various industries
which have existed. In today’s day and age, one of the biggest and most
powerful carters is the Organization of the Petroleum Exporting Countries, i.e.

OPEC.

 

OPEC:

The
oil cartel called OPEC, i.e. Organization of Petroleum Exporting Countries is
one of the biggest cartels in the world. It consists of 12 countries (Saudi
Arabia, Qatar, United Arab Emirates, Kuwait, Libya, Algeria, Indonesia – whose
membership is currently suspended – Iran, Iraq, Nigeria, Gabon, Indonesia,
Ecuador and Venezuela). Not all countries which export oil are part of OPEC. It
was created at the Baghdad Conference in September 1960. The current headquarters
of OPEC is in Vienna, Austria since 1965. OPEC has the ability to set
guidelines for the world oil prices. The OPEC is a permanent intergovernmental
organization. Officially, OPEC’s mission is to, “coordinate and unify the
petroleum policies of its Member Countries and ensure the stabilization of oil
markets in order 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.” (Organization of
Petroleum Exporting Countries – OPEC, Investopedia) OPEC countries work
together and taking into consideration the market demand, they strive to
facilitate the smooth supply of oil and regulate the prices accordingly. The
OPEC Conference is the supreme authority of the organization and it generally
meets twice a year.

 

 

Existing Scholarly Work:

  

Title:
Political Constraints on Government Cartelization: The Case of Oil Production
Regulation in Texas and Saudi Arabia

Authors:
Libecap, G. D. and Smith, J. L.

Date:
27th June, 2001

Supported
by: International Center for Economic Research

Summary:
This paper examines government cartelization efforts in crude oil production.

This offers us two different perspectives using Texas and Saudi Arabia as
viewpoints. The concept of cartels is illegal is the United States of America
and the political constraints which affect the market there have been analyzed.

Saudi Arabia’s role as a part of OPEC gives an insight as to how a cartel is
affected by individual countries and the political pressures from them. The
information provided in this article provides much information about the Texas
Railroad Commission (state regulatory agency) and talks about various reasons
and explains the low-cost and high-cost production aspects. The difference
between governmental cartelization and private cartels is also highlighted.  

 

Title:
An analysis of OPEC’s strategic actions, US shale growth and the 2014 oil price
crash

Authors:
Behar, A. and Ritz, R. A.

Date:
July 2016

Summary:
This paper is an analysis of the oil market in 2014, when OPEC had announced a
new market strategy which basically wanted to push out from the market
high-cost producers such as US shale oil. The paper looks at two strategies
which OPEC can use against non-OPEC countries, i.e. ‘accommodate’ which means
that they will have higher prices which allows non-OPEC countries to remain
profitable and the second is ‘squeeze’ which means that they will increase
production and reduce the prices which will force non-OPEC countries to exit
the market. They emphasize on a ‘regime switch’ and have put forward a theory
which shows that market-share strategy would be a more attractive option for
OPEC. The model created by the authors is used as a platform to put forward the
concepts of how the market responds to OPEC’s strategy and how the strategy
plays out.

This
paper, as believed by the authors, is the forefront of papers which provides
readers with a model which explains OPEC’s shift in strategy and the
repercussions of this shift through an economic model. There is plenty of
available literature which talks about the crash in price of oil in 2014, and this
paper reviews that data and compares it to the data they provide. The model is
presented to the readers and the strategies are analyzed with the help of the
model, and the results seemed to show that the ‘squeeze’ option seemed to be a
more attractive option. The authors believe that their model can be applied to
other energy sectors as well.

While
the paper gives us an insight into the topic from the perspective of the model
created by the authors, there seems to be a lack of substantiation of the
model. Overall, the concept of OPEC’s strategy with relation to it being a
cartel and how it influences the market seems to be thoroughly explained and
simplifies understanding of the process.

Reference:
IMF Working Paper

 

Title:
OPEC’s Oil Exporting Strategy and Macroeconomic (In)Stability

Authors:
Aguiar-Conraria, L. and Wen, Y.

Date:
May 2011

Summary:
This paper talks about economic instability which arises from dependence on
foreign oil and is affected by the price determination by cartels. The
literature provided by the article allows an insight into the reasoning provided
by the authors, who argued that macroeconomic instability of the country which
imports oil increases when the cartel which exports the oil fixes the price of
oil. The concept of ‘equilibrium indeterminacy’ is explained in the paper, and
the authors introduce a model to substantiate their claims. The authors showed
that economic instability was a function of market strategy of the countries
which export the oil.

 

Title:
OPEC: What Difference has it Made?
Authors: Fattouh, B. and Mahadeva, L.

Date:
January 2013

Summary:
This paper explains how the power of OPEC to influence the price of oil in the
market is constantly changing and due to the varying behavior, multiple models
are used to explain the fluctuation. The paper explains how, over its 50-year
history, OPEC has been the cause of price wars, and how there is a lack of
consistency in OPEC. The short term and long term power struggle is explained
and some struggles of OPEC are highlighted. The position of OPEC in the oil
market can be affected by several factors and collusion, which has not been an
easy path for OPEC, can be hard for them to sustain. This literature review
provides us with a detailed insight into OPEC’s inner workings and empirical
evidence is provided, which shows us that the different models used to explain
OPEC’s position cannot be collaborated into one due to its unpredictable
behavior patterns and the models may conflict with one another.

 

Title:
Cartel formation and oligopoly structure: a new assessment of the crude oil
market

Authors:
Bockem, S.

Date:
2004

Summary:
The interrelation and empirical link between cartels and oligopolistic market
structures are studied in this paper. A detailed literature review was provided
using previously developed models and comparisons revolving around OPEC to show
that OPEC does not follow any specific behavior which matched the economic concept
of a cartel. The paper provides an explanation of price-leader cartels as a model,
which seemed to be the best fitting description which did not cause any
contradiction.

 

 

Current Situation (from
2010 till now):

 

In
the beginning of the decade, the oil market was posed with the threat of the
global economy which was being weighed down by macroeconomic uncertainties and
the increasing risks of the financial system. Supply and demand of oil was
affected by social unrest in several parts of the world. Between 2011 and
mid-2014, the prices were stable, after which speculation and oversupply caused
a fall in the prices. The world began to focus on environmental issues a lot
more, and looked to the United Nations Organization to form agreements
regarding climate change and other environmental issues. OPEC at that point was
trying to find some sort of stability in the market and attempting to forge
relations with non-OPEC oil producing and exporting countries.

 

In
November 2017, OPEC forecasted for the year 2018 a larger deficit for the
global market due to the deal between OPEC and other producers to cut output
was causing a reduction of excess oil in storage. The use of oil across the
world was said to grow at a faster pace than previously expected due to the strength
of the world economy. As of November 2017, oil prices were almost as close to
the highest that they had been since 2015.

 

 

Lessons Learned:

 

The
study of oil cartels from different aspects allows for an all round
understanding of what place it holds in the economy, i.e. what type of market
can it be classified as, what social, economic and political repercussions they
have. Different perspectives of studying cartels through different economic
models allows us to understand the real effect of OPEC, one of the major
cartels on the world oil market.

 

One
of the basic learnings was that cartels have to be careful while playing the
price determination game. Increasing the price of oil will only make the sales
drop, encourage research into alternate forms of oil and production, and this
will mean the beginning of the end of the cartel.

 

When
individual members of a cartel are tempted to cheat and not adhere to the
prices fixed by the cartel as a group, they stand to make a profit. If one
member cheats, it may not cause much of a problem. However, if everyone begins
to cheat then the restrictions placed on production would have been breached
and no one stands to gain anything. All this teaches us is that if everyone
works together in harmony and does as they ought to, smooth functioning is
ensured. However, the more members that cheat and indulge in foul play, the
easier it makes it to fall apart. This quite simply put, is a classic example of
the statement, ‘cheaters never prosper’.

 

 

Recommendations for the
future:

 

From
the knowledge gathered in the course of this study, it can be concluded that oil
cartels should not cut down on production only due to personal rivalry as it
not only affects the economy of several countries directly, but also reflects
greatly in the demand and supply of oil all over the world, which affects the
economy and global oil market.

 

Non-members
of OPEC should try, to the best of their abilities, to maintain an average rate
of sales as compared to OPEC as an excess in demand or perhaps even a shortage
in demand of oil supplies affects the environment in the long run.

 

Where
OPEC’s behavioral inconsistencies are concerned, it may be suggested that
implementation and enforcement of policies which regulate not just the behavior
of OPEC as a whole but also those of individual member countries should be
regulated more thoroughly so as to avoid the possibility of the cartel’s
eradication.