Shrewd Crude
30-06-2008, 10:34 AM
Is OPEC an effective Cartel?
I Just recently finished a Major Assignment for an Industrial Organisations course, and thought Id Cut and paste it...
Read this when you have ten minutes...
All the numbers In my post come from various reports, articles, statements made by various individuals...
Its all said in my own words, (apart from the very last line, guess who said that?)....
here goes...
A cartel is a group the deliberately restricts output in an attempt to raise prices to capture bigger surpluses for the Group... This sort of behaviour only works effectively when the Cartel mambers are in co-operation with one another...The same inefficiencies can be seen In the Cartel Model, as in the Monopoly model... Both create Dead Weight Loss, as surplus is transferred from consumers to Producers...
OPEC is thought by many industry observers to be a cartel, but is OPEC really a cartel? Or does it just have characteristics of being a cartel? In my essay I will dismiss the point of view that OPEC is currently restricting output. I will justify this by explaining that their spare capacity is flawed, and therefore the group is not currently a true cartel in the sense of the word. Although OPEC has characteristics of cartel behaviour, more so historically. I will go onto briefly justify high oil prices as a phenomenon not bought on by OPEC as such, but through a complex web of market forces which OPEC has no control over which has been brewing in the market place for over five years.
Firstly, OPEC stands for Organisation of Petroleum Exporting Countries which brings together 13 major Oil Exporting countries into one collective group. Members include Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, Venezuela, and Indonesia. Indonesia is in the process of pulling out of OPEC because of Falling output and oil reserves. Every single one of these countries are reliant on oil for developing socially, politically, economically.
Last month in April 2008 OPEC pumped 32 million barrels of oil per day which represents 37% of the Worlds daily consumption of 86 million barrels of oil.
Oil prices have risen from $20 US in 2002, to $55 US in 2006, to now $139 US. The dramatic explosion of oil prices continuing this year, and more dramatically on Saturday morning New Zealand Time, 6th of June, (where oil prices had the biggest one day gain of all time). In response this week OPEC announced a plan to spend $160 billion worth of investment in hope to increase capacity 15% over 5 years. What the secretary-general of the cartel, Abdalla Salem el Badri did not say in his speech was that existing production is already tapering off into decline. Demand side destruction will gobble up spare capacity in five years anyway. Evidence suggests to me that increased capacity will mostly come from work over programs of existing OPEC fields, which is short term remedial action. Discovering new Oil fields will have to mainly come from non OPEC oil Majors drilling far offshore which is very costly.
It is claimed that OPEC have excess capacity of 2 million barrels of oil per day and that production can be increased by opening individual wellhead valves. Previously this was the case but ultimately this has serious consequences in the medium to long term as oil reservoirs begin to experience a drop in pressure from over production. Spare capacity is flawed as only a short term fix can be applied to what would become a long term problem as oil fields become exhausted, less efficient, and more costly to run, maintain, and manage. There already is a fine line between sustainable production and over production, which suggests to me that OPEC has no real spare capacity at all. Over production also leads to Oil fields becoming less efficient as more oil is left behind, notwithstanding the use of new drilling techniques. Spare capacity is also made up of Sour Crude, and I will come to this shortly.
Infact, “ OPEC supply fell 2.6% in 2007 and output now remains at 2005 and 2006 output levels”.
Without spare capacity, then no quantity output restrictions are happening to suggest that any sort of price fixing agreement is taking place or maybe more importantly being enforced by OPEC. There is currently no formal method of reducing output which is the core of a cartels operation. In the current market there is no collusion with prices! Rising market demand has now taken that excess supply away from OPEC. Markets are tightening.
There are severe conflicts of interest as some of these OPEC countries are, and have been in conflict with one another through wars and invasions historically. Language barrier’s create confusion. When OPEC countries had spare capacity they had incentives to cheat and increase production outside agreed levels so they could increase individual profits. China, India, Brazil and a few other 3rd World Countries are growing fast.
Confusion over pricing fixing also exists because oil comes in different qualities which fetch different prices. Some oil is light which is easier to refine compared to heavier crudes . Any Spare capacity is now made up of sour crudes (heavy oil), for which there is no current capacity to refine it as this process is very energy intensive. The easy to refine crude is now in rapid decline.
In saying all of this, OPEC does still have characteristics of a cartel. These characteristics include a large market share (which is a form of market power), and oil consumers have a relatively inelastic demand curve which means they will not easily change their quantity demanded when there is a change of price. But, as they are unable to decrease output it reaffirms in my mind that no cartel exists other than the image that this creates through speculators in the market place.
Saudi Arabia is the worlds leading oil producing country with output of approximately 9.25 million barrels of oil per day. This make’s up almost one third of total OPEC output. The problem in Saudi Arabia is 85-90% of their total production comes from five super giant oil fields which have been in production for between four to six decades, (one major offshore oil field). Every oil field will eventually peak, and these aging giants are no different. Saudi Arabia’s aging giants are already in decline and “ Saudi Petroleum Ministry now admits that 800,000 barrels per day of added oil output is needed to replace declines from maturing fields”.
So why are oil prices so high? If its not OPEC then what is it?
OPEC and non OPEC countries are struggling to maintain production levels in the face of rapid growing demand. Demand is coming from China in particular, India and other growing third world countries. China, alone is putting 10,000 new cars on their roads, EVERYDAY.
(Furthermore, I read that There are 2.6million cars on the road in Beijing, this is expected to grow 40% by the end of 2010)...
Any excess supply that may have existed is now gone. The World is faced with tight Oil markets. Volatile market conditition’s run the risk of excess supply being tipped to excess demand. This mechanism has to happen to price some consumers out of the market, as not enough can go around. The International Energy Agency (IEA) predict this to happen in 2012, based on forward looking assumptions of supply versus demand without unforeseen major events such as War, natural disasters (eg hurricanes, earthquakes, Terrorists, political instability.
In conclusion,
OPEC is not a cartel because they have no spare capacity.
The fact that they have meetings to discuss their strategy, the fact that oil is an inelastic good, the fact that OPEC has a large market share is immaterial if they cannot in force (or are not in forcing restriction of output). Therefore no real cartel exists.
“The only way to avoid an inevitable crisis is to invest in alternatives”
World total oil supply is headed for decline and World demand is headed up. OPEC will become a thing of the past as they no longer control excess supply in oil markets, demand does.
We have squandered OIL
A PRECIOUS FINITE RESOURCE
thankyou...
I Just recently finished a Major Assignment for an Industrial Organisations course, and thought Id Cut and paste it...
Read this when you have ten minutes...
All the numbers In my post come from various reports, articles, statements made by various individuals...
Its all said in my own words, (apart from the very last line, guess who said that?)....
here goes...
A cartel is a group the deliberately restricts output in an attempt to raise prices to capture bigger surpluses for the Group... This sort of behaviour only works effectively when the Cartel mambers are in co-operation with one another...The same inefficiencies can be seen In the Cartel Model, as in the Monopoly model... Both create Dead Weight Loss, as surplus is transferred from consumers to Producers...
OPEC is thought by many industry observers to be a cartel, but is OPEC really a cartel? Or does it just have characteristics of being a cartel? In my essay I will dismiss the point of view that OPEC is currently restricting output. I will justify this by explaining that their spare capacity is flawed, and therefore the group is not currently a true cartel in the sense of the word. Although OPEC has characteristics of cartel behaviour, more so historically. I will go onto briefly justify high oil prices as a phenomenon not bought on by OPEC as such, but through a complex web of market forces which OPEC has no control over which has been brewing in the market place for over five years.
Firstly, OPEC stands for Organisation of Petroleum Exporting Countries which brings together 13 major Oil Exporting countries into one collective group. Members include Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, Venezuela, and Indonesia. Indonesia is in the process of pulling out of OPEC because of Falling output and oil reserves. Every single one of these countries are reliant on oil for developing socially, politically, economically.
Last month in April 2008 OPEC pumped 32 million barrels of oil per day which represents 37% of the Worlds daily consumption of 86 million barrels of oil.
Oil prices have risen from $20 US in 2002, to $55 US in 2006, to now $139 US. The dramatic explosion of oil prices continuing this year, and more dramatically on Saturday morning New Zealand Time, 6th of June, (where oil prices had the biggest one day gain of all time). In response this week OPEC announced a plan to spend $160 billion worth of investment in hope to increase capacity 15% over 5 years. What the secretary-general of the cartel, Abdalla Salem el Badri did not say in his speech was that existing production is already tapering off into decline. Demand side destruction will gobble up spare capacity in five years anyway. Evidence suggests to me that increased capacity will mostly come from work over programs of existing OPEC fields, which is short term remedial action. Discovering new Oil fields will have to mainly come from non OPEC oil Majors drilling far offshore which is very costly.
It is claimed that OPEC have excess capacity of 2 million barrels of oil per day and that production can be increased by opening individual wellhead valves. Previously this was the case but ultimately this has serious consequences in the medium to long term as oil reservoirs begin to experience a drop in pressure from over production. Spare capacity is flawed as only a short term fix can be applied to what would become a long term problem as oil fields become exhausted, less efficient, and more costly to run, maintain, and manage. There already is a fine line between sustainable production and over production, which suggests to me that OPEC has no real spare capacity at all. Over production also leads to Oil fields becoming less efficient as more oil is left behind, notwithstanding the use of new drilling techniques. Spare capacity is also made up of Sour Crude, and I will come to this shortly.
Infact, “ OPEC supply fell 2.6% in 2007 and output now remains at 2005 and 2006 output levels”.
Without spare capacity, then no quantity output restrictions are happening to suggest that any sort of price fixing agreement is taking place or maybe more importantly being enforced by OPEC. There is currently no formal method of reducing output which is the core of a cartels operation. In the current market there is no collusion with prices! Rising market demand has now taken that excess supply away from OPEC. Markets are tightening.
There are severe conflicts of interest as some of these OPEC countries are, and have been in conflict with one another through wars and invasions historically. Language barrier’s create confusion. When OPEC countries had spare capacity they had incentives to cheat and increase production outside agreed levels so they could increase individual profits. China, India, Brazil and a few other 3rd World Countries are growing fast.
Confusion over pricing fixing also exists because oil comes in different qualities which fetch different prices. Some oil is light which is easier to refine compared to heavier crudes . Any Spare capacity is now made up of sour crudes (heavy oil), for which there is no current capacity to refine it as this process is very energy intensive. The easy to refine crude is now in rapid decline.
In saying all of this, OPEC does still have characteristics of a cartel. These characteristics include a large market share (which is a form of market power), and oil consumers have a relatively inelastic demand curve which means they will not easily change their quantity demanded when there is a change of price. But, as they are unable to decrease output it reaffirms in my mind that no cartel exists other than the image that this creates through speculators in the market place.
Saudi Arabia is the worlds leading oil producing country with output of approximately 9.25 million barrels of oil per day. This make’s up almost one third of total OPEC output. The problem in Saudi Arabia is 85-90% of their total production comes from five super giant oil fields which have been in production for between four to six decades, (one major offshore oil field). Every oil field will eventually peak, and these aging giants are no different. Saudi Arabia’s aging giants are already in decline and “ Saudi Petroleum Ministry now admits that 800,000 barrels per day of added oil output is needed to replace declines from maturing fields”.
So why are oil prices so high? If its not OPEC then what is it?
OPEC and non OPEC countries are struggling to maintain production levels in the face of rapid growing demand. Demand is coming from China in particular, India and other growing third world countries. China, alone is putting 10,000 new cars on their roads, EVERYDAY.
(Furthermore, I read that There are 2.6million cars on the road in Beijing, this is expected to grow 40% by the end of 2010)...
Any excess supply that may have existed is now gone. The World is faced with tight Oil markets. Volatile market conditition’s run the risk of excess supply being tipped to excess demand. This mechanism has to happen to price some consumers out of the market, as not enough can go around. The International Energy Agency (IEA) predict this to happen in 2012, based on forward looking assumptions of supply versus demand without unforeseen major events such as War, natural disasters (eg hurricanes, earthquakes, Terrorists, political instability.
In conclusion,
OPEC is not a cartel because they have no spare capacity.
The fact that they have meetings to discuss their strategy, the fact that oil is an inelastic good, the fact that OPEC has a large market share is immaterial if they cannot in force (or are not in forcing restriction of output). Therefore no real cartel exists.
“The only way to avoid an inevitable crisis is to invest in alternatives”
World total oil supply is headed for decline and World demand is headed up. OPEC will become a thing of the past as they no longer control excess supply in oil markets, demand does.
We have squandered OIL
A PRECIOUS FINITE RESOURCE
thankyou...