OPEC

1. and the
economics of cartel
Presented by
Sanjay Gupta - Lakshmi Varma - Lakshmi Nair - Shibin T Renjith

2. 2 6/18/2013
Outlines
1. Oil – A basic necessity
2. OPEC (Information on OPEC)
3. OPEC Side Line Objectives
4. Competitive Dynamics of OPEC
5. OPEC Acting like a Cartel
6. OPEC and the economics of cartel
(Why Did OPEC Fail to Keep the Price of Oil High?)
7. OPEC and Demand & Supply
8. OPEC – A Cartel Or Oligopoly
9. Cartelisation and Its Affect
10. Conclusion

3. 3 6/18/2013
Oil – Life Blood of World Economy
 OIL - One of the life bloods of our World economy is oil.
 The impact of oil in today’s economy has been witness by
consumers many times.
 We have seen how human spending and travel got
affected as the price of oil fluctuates. In contrast almost all
energies are generated using oil, to mention few; Cars,
Trucks, railways, Plane, use oil in order to run their engine.
 Therefore if oil supply disturbed for one day we can
imagine how the Indian economy can be affected greatly.

4. 4 6/18/2013
OPEC - Introduction
 About OPEC (pronounced oh-peck) - Organization of the Petroleum Exporting
Countries - Organization of the Petroleum Exporting Countries, established in
Bagdad, Iraq in 1960. OPEC as a cartel, manipulate supply of oil in the market, in
hopes of keeping prices, and profits, high.
 It is comprised of 12 members – Algeria, Angola, Ecuador, Islamic Republic of
Iran, Iraq, Kuwait, Socialist People’s Liberian Arab Jamahiriya, Nigeria, Qatar,
Saudi Arabia, -United Arab Emirates and Venezuela with headquarters in
Vienna, Austria. according to the official website.
 Oil is the main marketable commodity and foreign exchange earner. Thus, for
these countries, oil is the vital key to development – economic, social and
political. Their oil revenues are used not only to expand their economic and
industrial base, but also to provide their people with jobs, education, health care
and a decent standard of living
 Together, the 12 member-nations control nearly 80% of the world’s oil reserves,
and 44% of the world’s daily production—a powerful force used to manipulate oil
prices around the world.

5. 5 6/18/2013
OPEC VS Non–OPEC Crude Oil Reserve

6. 6 6/18/2013
Main Purpose & Objective of OPEC
The Main purpose of OPEC is to coordinate and unify petroleum policies
among Member Countries to ensure a steady income to the producing
countries, a steady supply of petroleum to the consuming nations as well
as a fair return of capital for investors in the petroleum industry itself.
Main Objectives are
 Stable oil market, with reasonable prices and steady supplies to
consumers
 OPEC was made to make sure that the price of the oil in the world
market will be properly controlled.
 Their main goal is to prevent harmful increase in price of oil in global
market and make sure that nations that produce oil have a fair profit

7. 7 6/18/2013
Sideline Objective
 Manipulate supply of oil in the market, in hopes of
keeping prices, and profits, high by producing less oil
than the market needs.
 While OPEC always wants to maximize profits for
themselves, they also don’t want to kill the golden
goose by driving prices so high that alternative energy
exploration becomes a top priority.
 OPEC tracks the oil production of NON-OPEC nations
and then adjusts its own production to maintain its
desired barrel price.

8. 8 6/18/2013
Competitive Dynamics Of OPEC
Before 1970
 No Major Role played by OPEC
During 1970
 Power of Price setting shifted from MNC Oil Companies to OPEC
By 1973
 OPEC countries changed the Pricing System
1975-1985
 Oil Production Increase from 48% to 71%
Mid 1980
 Survival became uncertain
 Market shares fell from 52% 30% in 1985

9. 9 6/18/2013
OPEC Challenges
 Uncertainty in Global Demand
 Structural shift in demand from developed world to
developing world.
 Non-OPEC oil-producing nations (Russia , Norway,
Canada, Mexico etc.) often increase production when
OPEC cuts it.
 Russia overtook Saudi Arabia as the world’s biggest
crude supplier in 2009.
 OPEC’s share of production has gone down.

10. 10 6/18/2013
OPEC Challenge’s Contd.
 Problem of Member Cohesion within OPEC nations:-
Maintaining quota discipline within the cartel.
 Existence of factions within OPEC.
 Middle-Eastern Strife & Political instability in OPEC
oil-producing countries - Mostly authoritarian states
that use oil money as a means of sustaining political
power.
 Future technological developments in areas of
renewable energy sources

11. 11 6/18/2013
OPEC Acting like a Cartel
Quota Set by OPEC
 Production Ceiling set up was violated
 1985- Price Dropped from $ 28 to $ 12
 1990’s $30 per barrel
 1993 - $ 15 per Barrel
OPEC BASKET Price
 Price Data collected
 March 2000 – Set a price band mechanics in range of $ 22 -$ 28 per barrel
 Production adjustment on basket price
 Jan 2005 – Suspended price band mechanics
 Market was tight in its price band
 Unable to defend by cutting its production

12. 12 6/18/2013
OPEC and the economics of cartel
OPEC decides to increase OR reduce its collective production of
OIL, which leads to increase / decrease in supply, therefore it has
direct impact on demand, Supply and Price. The short supply
makes OIL prices rise, partially due to less availability and partially
due to a fear of a future shortage, which would have direct impact
on other parts of the economy.
 Short-run: supply and demand are inelastic
 Decrease in supply: large increase in price
 Long-run: supply and demand are elastic
 Decrease in supply: small increase in price

13. 13 6/18/2013
Why Did OPEC Fail to Keep the Price of Oil High?
In the 1970s and 1980s, OPEC reduced the amount of oil it was
willing to supply to world markets. The decrease in supply led to
an increase in the price of oil and a decrease in quantity
demanded. The increase in price was much larger in the short
run than the long run.
 The demand and supply of oil are much more inelastic in the short run
than the long run.
 The demand is more elastic in the long run because consumers can
adjust to the higher price of oil by carpooling or buying a vehicle that
gets better mileage.
 The supply is more elastic in the long run because non-OPEC
producers will respond to the higher price of oil by producing more.

14. 14 6/18/2013
A Reduction in Supply in
the World Market for Oil
Price
Price
Demand
P2
(a) The Oil Market in the Short Run
Demand
When the supply of oil falls, the response depends on the time horizon. In the short run,
supply and demand are relatively inelastic, as in panel (a). Thus, when the supply curve
shifts from S1 to S2, the price rises substantially. By contrast, in the long run, supply and
demand are relatively elastic, as in panel (b). In this case, the same size shift in the supply
curve (S1 to S2) causes a smaller increase in the price.
(b) The Oil Market in the Long Run
S1
S2
P1
1. In the short run, when supply
and demand are inelastic, a shift
in supply. . .
2. … leads
to a large
increase in
price
P2
S1
S2
P1
1. In the long run, when supply
and demand are elastic, a shift
in supply. . .
2. … leads
to a small
increase in
price
Quantity0 Quantity0

15. 15 6/18/2013
Change in Demand Curve
 The changes in the price Oil have not kept pace with change in my income.
When market price for petrol was Rs. 50, I could afford 100 Litres, that was a
filled tank for a month commute.
 As the petrol price increased to 75 my equilibrium quantity has now 66 litres. This
is simply a movement along the demand curve, Quantity demanded is changed
due to changes in price that we have no control over.
 My commute by car has now being substituted by commuting by public
transport system

16. 16 6/18/2013
OPEC – A Cartel Or Oligopoly

17. 17 6/18/2013
Is OPEC a monopoly or an
example of a collusive oligopoly?
 OPEC can be described as an oligopoly for several reasons.
 It fits with the condition of being dominated by more than two
large firms; in this case it's Twelve.
 It also practices price rigidity as they agree on both level of
output and therefore the price of oil is influenced by the
agreement of a certain supply.
 The goods they provide are also homogenous. In oligopolies
firms also don't choose to maximise profits, and this can be
clearly shown in the OPEC case as they aim was to "secure fair
and stable prices for producers, and ensure an efficient and
regular supply of oil".

18. 18 6/18/2013
Is OPEC a monopoly or an
example of a collusive oligopoly? Contd.
 There is also barriers to entry which is described in the
case study which states that the oil industry has "high fixed
costs and risk" associated with it,
 It can be argued however, that it is also a monopoly. This is
due to the fact that OPEC has 60% of control over the oil
that it traded internationally.

19. 19 6/18/2013
OPEC is a cartel: an organization of individual
competitors that join to form a single monopolist.
1. Under competition, the price of oil is Pcomp and an individual OPEC member produces qcomp
and earns just a normal profit. With a cartel, joint profits are maximized at Popec and Qopec.
2. Since Qopec < Qcomp, qopec must be less than qcomp for each OPEC member each member is
assigned a quota, qopec.
3. At qopec, MR > MC profits rise if the country expands production. Produce at qcheat, where
MR = MC.
4. But, if all members cheat, total production rises the price of oil falls competitive outcome

20. 20 6/18/2013
OPEC countries can and do cheat
 When OPEC limits oil production, they keep the price of oil and
profits high. But those high profits give each member the incentive
to cheat a little. By producing a little more oil, an individual country
can earn more. Usually, cartels can’t last very long because of this
strong incentive to cheat.
 As you can tell by chart below, OPEC countries can and do cheat.

21. 21 6/18/2013
Cartelisation and Its Affect
 Price being affected due to Speculation
 Fluctuation due to change in Quota Decision
 1980 – OPEC made a mistake by increasing OIL price to $40 per
barrel. Result – Reduction in demand – reduction in price
 Problem with Cartel
 Maintaining the price
 Allocate sales among OPEC countries
 Growth Expectation?

22. 22 6/18/2013
Conclusion
1. OPEC Still Exists today and still has considerable influence in
determining the price per barrel of petroleum by setting quotas,
but their best days are behind them. The cartel seems to
understand that raising prices is easier in short run than in long
run.
2. Non-OPEC nations such as Russia, Canada and Mexico have
stripped the cartel of its power to single-handedly manipulate the
petroleum market
3. The World has benefited from the increased production of
petroleum by Non-OPEC nations and thus reduced their annual
imports from the OPEC countries in recent years

23. 23 6/18/2013
References
1. OPEC.Org
2. www.slideshare.net
3. OPECA Cartel (EmmaVkpanaha)
4. OPEC a Price Power (Bastam Fattoum
– Oxford Institute Of Energy Studies)
5. Gregory ManKiw – Managerial
Economics

24. 24 6/18/2013