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Thursday, December 12, 2019

ANALYSIS/OPINION:

In 1960 five countries, mostly poor at the time, met in Baghdad and agreed to “the inalienable right of all countries to exercise permanent sovereignty over their natural resources in the interest of their national development.” This is code for, “let’s rig the oil market and fix prices.” OPEC — the Organization of Petroleum Exporting Countries — was born.

Other oil-producing countries soon saw the wisdom in banding together and challenging the Western “seven sisters” oil companies that dominated petroleum. The OPEC club soon grew to 10 members, then 13. Economists laughed at this effort, claiming that cartels are inherently unstable and always implode.


But then 1973 happened.

U.S. support for Israel in the Yom Kippur War incensed the Arab nations, and OPEC stopped oil deliveries to the West. The Arab oil embargo saw gasoline prices, which hadn’t moved more than a penny per gallon for more than a decade, double in the United States. Shortages caused waits of hours in lines at stations, and suddenly OPEC had its wings. 

But, once again, economists said it still couldn’t last.

However, far from fading away, this new-found power strengthened the group. Economists had always reasoned that cartels ultimately all fail because of the incentive for members to cheat. Groups like OPEC control price by controlling supply. They set production quotas on their members to limit the supply and drive prices up. The incentive to cheat — to deliver more than a country’s quota at the artificially inflated market price — is just too great to ignore, so almost everyone does it and the cartel fails.

In the 1990s two countries, Ecuador and Gabon, quit the club because they felt the restrictions on production were too harsh for their respective economies. While they were two of the smallest producing members, pundits had a field day. “The end is near,” they screamed across the media landscape. However, a funny thing happened. Wars, invasions and terrorist attacks saw the Middle East oil supply disrupted and OPEC responded by increasing its production quotas to supply the West. The enemy of my enemy …

In the next decade, when markets returned to a semi-normal state, OPEC member countries saw oil prices drop and clambered for production cuts. Breaking with the powerhouse of Saudi Arabia, the group voted to limit their world supply, but behind the scenes the kingdom said it wouldn’t, and continued shipping more than its quota. This time the big dog was cheating and economists again said the end is near. It had taken 50 years, but now collapse seemed imminent. 

It wasn’t.

By the middle of that decade, Iraq and Iran had returned to near full production, and the United States, with its newly found petroleum independence due to fracking technology, saw OPEC regularly exceeding its stated output with most members cheating. Gasoline prices, after spiking, declined precipitously and the Saudis this time led the charge to limit production. Poorer member countries agreed, but still cheated to continue feeding their struggling economies.  

This brings us to the present. After nearly 70 years, OPEC is still around, but has seen two member countries leave the group recently due to the reduced production quotas. Its power over the oil market has peaked and ebbed many times. Its members, large and small, cheat at times — or often — yet it still persists. Last week, the OPEC member countries agreed to cut production even more. Russia, not an OPEC member but a “partner,” pushed for the action and, backed by Saudi Arabia, cajoled an additional 500,000-barrel-per-day reduction in output. It was a contentious meeting.

Many countries staggering under a sluggish market for oil, and a global slowdown in trade, balked at the cuts. A party on a yacht was even cancelled, along with a planned press conference. But, in the end, OPEC forged an agreement and everyone went on their way. Many member countries continue their cheating, and many member countries are struggling financially with reduced oil sales burying their economies. It’s happened before. The sky is always falling.

• Kevin Cochrane teaches business and economics at Colorado Mesa University, and is a visiting professor of economics at The University of International Relations in Beijing.


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