International Oil Market

Part one

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Main Points
◼ Developments in the oil industry.
➢ Pre-OPEC era.

➢ OPEC era.

◼ Analysis of OPEC behavior

➢ Cartel model

➢ Limit Pricing model

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Developments in the Oil Industry
◼ Oil was discovered by Colonel Drake and
William A. Smith in 1859.

◼ The oil industry has undergone four distinct

phases between 1859 and 1960, when
OPEC was formed.

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 Pre-OPEC Era
◼ Phase 1: Oil Rush and Intense
Competition (1859–1870)
◼ Phase 2: Monopoly of Rockefeller
company (1870 and 1911)
◼ Phase 3: Internationalization of Oil
Industry (1911–1928)
◼ Phase 4: Rise of the Seven Sisters(1928-
1960)

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OPEC ERA

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 Members of OPEC

◼ The Organization of the Petroleum Exporting Countries (OPEC) is

a permanent, intergovernmental Organization, created at the
Baghdad Conference on September 10–14, 1960, by Iran, Iraq,
Kuwait, Saudi Arabia and Venezuela.
◼ The five Founding Members were later joined by ten other
Members.
◼ Currently, the Organization has a total of 13 member Countries
(Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Libya, United Arab
Emirates, Algeria, Nigeria, Angola, Congo, Gabon and Equatorial
Guinea) as some countries terminated their members as Qatar.
◼ OPEC had its headquarters in Geneva, Switzerland, in the first five
years of its existence. This was moved to Vienna, Austria, on
September 1, 1965.
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 Objective
To co-ordinate and unify petroleum policies
among Member Countries, in order to secure :
◼ Fair and stable prices for petroleum
producers.
◼ An efficient, economic and regular supply of
petroleum to consuming nations.
◼ A fair return on capital to those investing in
the industry.

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 The 1960s
◼ OPEC’s formation by five oil-producing
developing countries in Baghdad in September
1960 occurred at a time of transition in the
international economic and political landscape,
with extensive decolonization and the birth of
many new independent states in the
developing world.
◼ OPEC developed its collective vision, set up its
objectives and established its Secretariat, first
in Geneva and then, in 1965, in Vienna.
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 The 1970s
◼ OPEC rose to international prominence during this decade,
as its Member Countries took control of their domestic
petroleum industries and acquired a major say in the
pricing of crude oil on world markets.
◼ On two occasions, oil prices rose steeply in a volatile
market, triggered by the Arab oil embargo in 1973 and the
outbreak of the Iranian Revolution in 1979.
◼ OPEC addressed the plight of the poorer nations and
called for a new era of cooperation in international relations
for the interests of world economic development and
stability.
◼ This led to the establishment of the OPEC Fund for
International Development in 1976.
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 The 1980s
◼ After reaching record levels early in the
decade, prices began to weaken,
responding to a big oil glut.
◼ OPEC’s revenue dropped below a third of
earlier peaks, causing severe economic
hardship for many Member Countries.
◼ Environmental issues emerged on the
international energy agenda.

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 The 1990s
◼ The Iraqi invasion of Kuwait in 1990 that
resulted in a significant loss of oil supply
capacity.
◼ The Asian economic crisis in 1997 and
its contagion effect in the rest of the
world severely dampened the growth
of oil demand.

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 The 2000s
◼ OPEC’s second and third summits in
Caracas and Riyadh in 2000 and
2007 established stable energy
markets, sustainable development
and the environment as three guiding
themes.

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 2010

◼ Prices were stable between 2011 and mid-

2014, before an oversupply caused them to fall
in 2014.
◼ Trade patterns continued to shift, with demand
growing further in Asian countries and generally
shrinking in the OECD countries.
◼ The world’s focus on multilateral environmental
matters began to sharpen.

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 During Covid-19
◼ when Covid 19 started, there was a decline in
economic activity and demand for crude and
producers were adjusting production levels.
◼ Furthermore, there was uncertainty about
how severe the economic crisis would be and
how long it would last.
◼ These compounding factors have pushed oil
prices to very low levels not seen in decades,
and there was even a short period of time
when oil prices fell as low as $40. 14
 2022
◼ The average annual price of Brent crude oil
increased to $91.82 per barrel in February
2022 and is rising to exceed $100 per barrel,
the first time since 2014, and this is more than
$20 higher than the annual average for 2021,
coinciding with the Russian- Ukrainian war.

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OPEC share of world oil reserves
◼ According to current
estimates, 80.4% of the
world's proven oil reserves
are located in OPEC
Member Countries, with the
bulk of OPEC oil reserves in
the Middle East, amounting
to 67.1% of the OPEC total.

OPEC Member Countries

have made significant
additions to their oil reserves
in recent years, for example,
by adopting best practices in
the industry and realizing
intensive explorations.
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Analysis of the OPEC
Behavior

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 Cartel Model
◼ Cartel occurs when a group of firms or
organizations enter into an agreement to control
the market by fixing price and/or limiting supply
through production quotas.
◼ A cartel may work as if there is a single
monopoly producer or with market sharing
agreements.
◼ The objective is to reduce competition and
thereby generate higher profits for the group.
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Cartel as a monopolist

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 Cartel as a monopolist
◼ In the absence of any agreement, the
competitive market conditions will prevail and
the price pc and quantity qc will be obtained.
◼ However, if the producers enter into an
agreement to enforce a monopoly price (pm) in
the market, they will have to agree to reduce
supply to qm in such a way that the marginal
revenue equals the marginal cost.
◼ Each member of the cartel then receives a
higher price for the output.
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 Cartel as a monopolist
◼ Producer will be interested to participate only if it can extract
more benefits compared to a competitive environment.
◼ As long as this condition is satisfied, members will be happy
to support the collusive behavior.
◼ But each member would have the tendency to increase its
output based on its marginal cost of supply so that its
individual profit is maximized.
◼ This tendency to cheat will lead to an overproduction (qs)
and the market will see a return of the competitive market
price.
◼ This represents a natural threat for internal cohesion of any
cartel.
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 Problem
Suppose demand for a commodity is given by
Q=100-P. There are only two possible firms
that can produce this commodity and
summation of their MC= 4Q.
Suppose the two firms form a cartel. Find The
profit maximizing total output and price.

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 Answer
You have to apply the condition MR=MC
First: To get MR you have to get inverse D-C then
double the slope
Inverse D-C: P=100-Q
Then, MR= 100-2Q
Second: you have to apply the rule
100-2Q=4Q
Then Q =16.6666
And P=83.33

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Answer

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 Problems Cartel faces:
1) In most jurisdictions it is illegal for firms to enter into
such a collusive behavior.
(But OPEC as a group of sovereign nations escapes from this
argument).
2) The tendency to cheat by members for individual gains .
3) In order to control the market, the group must have
accurate information about the shape of the demand and
supply curves, elasticity of demand, and actual production
by members. Often this information is not readily
available although some generic idea may be available.

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 Factors for stability of Cartel
Stability of any cartel then depends on a number of factors:
1) Group size: A small group is better placed to have a tighter control than a large
group.
2) Group characteristics: Homogeneous group members acting on a product with
less elastic demand is more likely to succeed than a heterogeneous group.
3) Dispersed, large number of buyers: Widely dispersed consumers will have little
chance of colluding with each other. This is an essential requirement for a cartel
4) Member gains: Each member of the cartel must benefit from the
action—otherwise, there is no incentive to join the group.
5) Policing: Any cartel being vulnerable to cheating would need an
effective policing mechanism to detect cheating.
Clearly, these requirements are difficult to satisfy in reality.

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