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Oil and the Politics of Cartels
I. Cartel Politics & the Collective Action Problem
II. Oil & OPEC
I. Cartel Politics & the Collective Action Problem
• A. What is a cartel?
– a group of producers who collude to raise prices by holding down the supply of certain
goods
• B. What sort of potential collective action problem do cartels face & why?
II. Oil & OPEC
• A. Oil before OPEC
– from World War I through the early 1950s, the “seven sisters” oil MNCs formed the key
producers’ cartel
• British Petroleum, Gulf (now part of BP), Mobil, Royal Dutch Shell, Standard Oil of
California (now Chevron), Standard Oil of New Jersey (now Exxon), & Texaco
– they became the first vertically integrated MNCs
• controlling exploration, supply, transportation, refining & marketing
– they controlled 90% of all crude oil production outside of North America
• during this period, they managed supply to try to keep crude oil prices high
– by increasing the profits for crude, they made it less profitable for competitors to
enter the refining & marketing sectors
– by locking in royalty arrangements and land rights in key host countries, they hoped
to keep competitors from getting into the exploration & crude supply sectors
– they were sporadically successful in managing prices in the 1920s & 1930s and fairly
successful in the late 1940s
– during the 1950s, the emergence of new oil-producing countries and new firms outpaced
the rising demand for oil
• this made it even more difficult for the 7 sisters to control crude oil prices
• the 7 sisters responded by changing tactics in the late 1950s: they began to manage
supply to try to keep crude oil prices low
– to limit royalty payments to host governments
– to maximize profits on finished products made by them for which crude oil was the
key input
• by 1968, the 7 sisters would control just 75% of crude oil production
– (and they would control far less after the nationalizations of the 1970s)
– the host governments most tied to the seven sisters vigorously complained about the new,
cheap-crude strategy and organized to pressure for change
II.B. A Capsule History of OPEC
• FOUNDED in 1960 by 5 host countries
– Iran, Iraq, Kuwait, Saudi Arabia, & Venezuela
• by 1971, it expanded to include Algeria, Libya, Qatar, United Arab Emirates, Nigeria,
& Indonesia
– in its first decade, OPEC failed to raise crude prices, but did help to block further
reductions
– several OPEC members renegotiated their royalties (and made it clear that they intended to
nationalize)
• MNCs tended to respond to shifting tides by reducing exploration in preparation for
possible nationalization
– by 1969, OPEC accounted for 85% of crude exports
• 1970s: the creation of OPEC as a powerful cartel
– 1970: the new Qaddafi government in Libya successfully increases the price of its oil & its
royalty rate in hard bargaining with Occidental Petroleum
– 1971: OPEC meets with the oil companies
• OPEC gets a 25% crude price hike along w/ annual increases tied to inflation
• the MNCs get a five-year commitment on production
– 1972: OPEC holds a new conference on nationalization of oil MNC subsidiaries
• Saudi Arabia, Qatar, & Abu Dhabi agree to purchase 25% now & a controlling share
(51%) by 1982
–
1973: OPEC calls a new conference with MNCs for October 8th
• rising demand for oil is pushing up market prices but the 1971 agreement has not been
adjusted sufficiently because the US dollar is falling on FX markets
th th
• October 6 Egypt begins the 4 Arab-Israeli war
th
• October 12 the oil companies ask for a 2-week delay to consider OPEC’s proposal
th
• October 16 , Arab oil states unilaterally double the price of their crude to $5.65
– OPEC never returns to the table with the oil MNCs to haggle over prices
rd
• December 23 OPEC unilaterally doubles the price again to $11.65
– Q: Why did the 1973-74 price hike work so effectively?
• ECONOMIC factors: a tight oil market at the moment
– meant that prices could be raised with minimal cutbacks in production
– the demand for oil is largely inelastic in the short run (even though the price hike
did lead to some foregone consumption & substitution in the medium run)
• POLITICAL factors: Arab unity in support of the war effort
– Saudi Arabia and Kuwait pledged to make the production cutbacks needed to
support the 1973-74 price hike
II.B. (cont.)
–
1974-77: the rest of the major OPEC states nationalize their oil firms
• they use the windfall profits to buy controlling (majority) shares or, in some cases, to
buy total control over MNC subsidiaries
• the oil MNCs still play a major role as
– contracted technical advisers to nationalized oil companies
– the key distributors of finished petroleum products on world markets
• the real price of oil fell slightly in this period as Saudi Arabia’s moderate stance led to
price hikes smaller than (rising) world inflation rates
– 1978-79: the second “OPEC” price hike
• Iranian oil workers shut down their production (17% of world exports) in anti-Shah
protests in late 1978 amid an already tight oil market
• the creation of the Islamic Republic of Iran in early 1979 sets off panic on short-term
“spot” markets
• OPEC responds to instability on short-term contracts by increasing its standing contract
prices in March & again in July
– crude went from $14/b in 1978 to $21/b in 1979 and to $33/b in 1980
• 1980s & 1990s: OPEC’s ability to manage prices declines
– ECONOMIC factors:
• world demand for oil fell during the early 1980s amid a world recession, oil
conservation, and a shift to alternative energy sources
• several OPEC members acquired distribution networks in the U.S. & Europe that gave
their national oil firms an interest in cheaper crude
• higher oil prices led to an increase in production in several non-OPEC countries with
higher costs of production
– Brazil, China, India, Mexico, Norway, Russia, and the United Kingdom
– this produced rising supply in a time of falling demand
– the rise of non-OPEC oil (enduringly) decreased OPEC’s share of production –
thereby limiting its power considerably
– •OPEC accounts for 40% of oil exports (& 75% of proven reserves)
– POLITICAL factors:
• divisions in the Arab community regarding the role of oil in the ongoing Arab-Israeli
conflict blocked a new 1973-style agreement
• the Iran-Iraq war in the 1980s led both countries to push up production to maximize
revenues
• Saudi Arabia decided in 1985 to abandon production holdbacks as futile
– by 1986, the price of oil was back down to $14/b
• in real terms, this was the lowest level since early 1974
– from 1987-1999, oil bounced back and forth around the price floor of 1986
• oil became more like other commodity markets as cartel power declined
Q: Why have oil prices risen from 2000 through 2004?
ECONOMIC factors:
•as the dollar fell on currency markets, all players in the oil industry looked to raise their
prices (NOTE: the dollar lost 25% of its value between 2001 & 2003)
• rising world demand & uneven supply created a very tight oil market in 2004
•supply cutbacks in Venezuela during 2003 reducing existing stocks & they
haven’t recovered
• rising demand in China & the U.S. (beyond expectations)
• fears of disruption in supply in the Middle East
• the demand for oil is largely inelastic in the short run (even though the 2004 price hike
may lead to some foregone consumption & substitution in the medium run)
POLITICAL factors:
•Venezuela led efforts to pursue stable supply policy to increase the price w/o cutbacks
• political unity of OPEC is buttressed by prevalence of anti-U.S. rhetoric in member countries
table on commodity prices 1993-2004
Table A25
Export prices of prim ary com m odities, 1993-04
(Indices 1995=100)
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Q1 Q2
Food and beverages 87 95 100 105 100 89 78 77 78 79 84 95 98
Cereals 79 84 100 119 93 79 69 67 70 80 81 90 94
Meat 115 106 100 116 109 93 93 101 109 103 106 116 130
Seafood 98 102 100 90 88 86 85 88 77 67 70 73 75
Sugar 79 91 100 92 87 73 58 66 67 57 62 60 64
Bananas 100 99 100 106 117 111 84 95 131 119 84 108 126
Oranges 81 77 100 93 86 83 82 68 112 106 129 154 166
Coffee 45 98 100 76 106 82 64 50 35 35 39 45 45
Cocoa beans 78 97 100 102 113 117 79 63 76 124 122 109 99
Tea 113 112 100 108 144 145 142 151 121 109 118 120 112
Agricultural raw materials 88 97 100 96 92 76 77 81 77 78 81 85 85
Timber 105 106 100 102 95 80 89 88 81 80 83 87 93
Cotton 59 81 100 82 81 67 54 60 49 47 64 75 69
Wool 62 90 100 85 94 70 70 79 75 96 111 106 100
Rubber 53 71 100 89 64 46 40 44 36 48 69 83 87
Hides and skins 91 99 100 99 100 87 82 91 96 92 78 79 72
Minerals and non-ferrous metals 71 83 100 89 90 74 73 82 74 72 81 107 107
Copper 65 79 100 78 78 56 54 62 54 53 61 93 95
Aluminum 63 82 100 83 89 75 75 86 80 75 79 91 93
Iron ore 103 93 100 106 106 109 97 101 105 103 111 133 133
Tin 83 88 100 99 91 89 87 88 72 66 79 111 148
Nickel 65 77 100 91 84 56 73 105 73 82 117 178 152
Zinc 93 97 100 99 128 99 104 109 86 76 80 104 99
Lead 65 87 100 123 99 84 80 72 76 72 82 133 128
Uranium 86 81 100 134 104 89 86 71 74 84 96 153 153
Total of above 82 91 100 98 95 82 76 80 76 77 82 97 98
Crude petroleum 98 93 100 118 112 76 105 164 141 145 168 187 207
Coal 79 82 100 96 89 75 66 68 85 70 74 114 149
All primary commodities 89 92 100 107 102 79 88 116 106 106 120 136 146
