Oil and the Politics of Cartels I. Cartel Politics & the Collective Action Problem



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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

  1. A. What is a cartel?

  2. a group of producers who collude to raise prices by holding down the supply of certain goods

  3. B. What sort of potential collective action problem do cartels face & why?

II. Oil & OPEC

  1. A. Oil before OPEC

  2. from World War I through the early 1950s, the “seven sisters” oil MNCs formed the key producers’ cartel

  3. 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

  4. they became the first vertically integrated MNCs

  5. controlling exploration, supply, transportation, refining & marketing

  6. they controlled 90% of all crude oil production outside of North America
  7. during this period, they managed supply to try to keep crude oil prices high

  8. by increasing the profits for crude, they made it less profitable for competitors to enter the refining & marketing sectors
  9. 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
  10. they were sporadically successful in managing prices in the 1920s & 1930s and fairly successful in the late 1940s

  11. during the 1950s, the emergence of new oil-producing countries and new firms outpaced the rising demand for oil

  12. this made it even more difficult for the 7 sisters to control crude oil prices

  13. the 7 sisters responded by changing tactics in the late 1950s: they began to manage supply to try to keep crude oil prices low

  14. to limit royalty payments to host governments
  15. to maximize profits on finished products made by them for which crude oil was the key input
  16. by 1968, the 7 sisters would control just 75% of crude oil production

  17. (and they would control far less after the nationalizations of the 1970s)
  18. 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

  1. FOUNDED in 1960 by 5 host countries

  2. Iran, Iraq, Kuwait, Saudi Arabia, & Venezuela

  3. by 1971, it expanded to include Algeria, Libya, Qatar, United Arab Emirates, Nigeria, & Indonesia

  4. in its first decade, OPEC failed to raise crude prices, but did help to block further reductions

  5. several OPEC members renegotiated their royalties (and made it clear that they intended to nationalize)

  6. MNCs tended to respond to shifting tides by reducing exploration in preparation for possible nationalization

  7. by 1969, OPEC accounted for 85% of crude exports

  8. 1970s: the creation of OPEC as a powerful cartel

  9. 1970: the new Qaddafi government in Libya successfully increases the price of its oil & its royalty rate in hard bargaining with Occidental Petroleum

  10. 1971: OPEC meets with the oil companies

  11. OPEC gets a 25% crude price hike along w/ annual increases tied to inflation

  12. the MNCs get a five-year commitment on production

  13. 1972: OPEC holds a new conference on nationalization of oil MNC subsidiaries

  14. Saudi Arabia, Qatar, & Abu Dhabi agree to purchase 25% now & a controlling share (51%) by 1982

  15. 1973: OPEC calls a new conference with MNCs for October 8th

  16. 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

  17. October 6th Egypt begins the 4th Arab-Israeli war

  18. October 12th the oil companies ask for a 2-week delay to consider OPEC’s proposal

  19. October 16th, Arab oil states unilaterally double the price of their crude to $5.65

  20. OPEC never returns to the table with the oil MNCs to haggle over prices
  21. December 23rd OPEC unilaterally doubles the price again to $11.65

  22. Q: Why did the 1973-74 price hike work so effectively?

  23. ECONOMIC factors: a tight oil market at the moment

  24. meant that prices could be raised with minimal cutbacks in production
  25. 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)
  26. POLITICAL factors: Arab unity in support of the war effort

  27. Saudi Arabia and Kuwait pledged to make the production cutbacks needed to support the 1973-74 price hike

II.B. (cont.)

  1. 1974-77: the rest of the major OPEC states nationalize their oil firms

  2. they use the windfall profits to buy controlling (majority) shares or, in some cases, to buy total control over MNC subsidiaries

  3. the oil MNCs still play a major role as

  4. contracted technical advisers to nationalized oil companies
  5. the key distributors of finished petroleum products on world markets
  6. 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

  7. 1978-79: the second “OPEC” price hike

  8. Iranian oil workers shut down their production (17% of world exports) in anti-Shah protests in late 1978 amid an already tight oil market

  9. the creation of the Islamic Republic of Iran in early 1979 sets off panic on short-term “spot” markets

  10. OPEC responds to instability on short-term contracts by increasing its standing contract prices in March & again in July

  11. crude went from $14/b in 1978 to $21/b in 1979 and to $33/b in 1980



  1. 1980s & 1990s: OPEC’s ability to manage prices declines

  2. ECONOMIC factors:

  3. world demand for oil fell during the early 1980s amid a world recession, oil conservation, and a shift to alternative energy sources

  4. several OPEC members acquired distribution networks in the U.S. & Europe that gave their national oil firms an interest in cheaper crude

  5. higher oil prices led to an increase in production in several non-OPEC countries with higher costs of production

  6. Brazil, China, India, Mexico, Norway, Russia, and the United Kingdom
  7. this produced rising supply in a time of falling demand
  8. the rise of non-OPEC oil (enduringly) decreased OPEC’s share of production – thereby limiting its power considerably

  9. •OPEC accounts for 40% of oil exports (& 75% of proven reserves)
  10. POLITICAL factors:

  11. divisions in the Arab community regarding the role of oil in the ongoing Arab-Israeli conflict blocked a new 1973-style agreement

  12. the Iran-Iraq war in the 1980s led both countries to push up production to maximize revenues

  13. Saudi Arabia decided in 1985 to abandon production holdbacks as futile

  14. by 1986, the price of oil was back down to $14/b

  15. in real terms, this was the lowest level since early 1974

  16. from 1987-1999, oil bounced back and forth around the price floor of 1986

  17. oil became more like other commodity markets as cartel power declined

Q: Why have oil prices risen from 2000 through 2004?

ECONOMIC factors:

  1. 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)


  2. rising world demand & uneven supply created a very tight oil market in 2004

  3. supply cutbacks in Venezuela during 2003 reducing existing stocks & they haven’t recovered

  4. rising demand in China & the U.S. (beyond expectations)

  5. fears of disruption in supply in the Middle East

  6. 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






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