OPEC’s Problem: Why it has failed to increase the price of Crude

OPEC or the Organization of Petroleum Exporting Countries was a cartel formed in the early 1960s. Though only 35.6% of the international crude production is by its 12 member states, yet it is extremely powerful in determining price. When it comes to free trade, forming Cartels is forbidden, but then when you think of it even the EU or signatories of the NAFTA and even Asia and Africa form cartels at WTO negotiations. So not wasting too much time talking about the right to OPEC’s existence lets come down to the point. The fact is that OPEC is the supreme power when it comes to determining global crude prices but the only question is why can’t this supreme power do anything about the crude prices atleast for the time being?

Remember when the international oil price hovered at USD 147 a barrel, the Libyan Oil Minister who was also the OPEC General Secretary – Abdallah Salem el-Badri said that oil prices might even rise to USD 200. In effect he raped the already strained consumer with oil prices seeing their biggest, strongest and most prolonged rally in history. At that time Saudi was the only sensible OPEC member that agreed to increase output. But maybe it’s Karma or maybe it’s just pure economics that’s hit back hard and literally made the OPEC powerless.

There are some key terms that need to be understood before you go through the Paradox:

1. OPEC countries and their dependence on the export of oil:
Its biggest member is Saudi Arabia which receives 90% of export earnings and 75% of its Budget revenues directly from oil while the smallest in terms of output is Algeria which depends on oil exports for 95% of its export earnings. The point is that OPEC countries depend heavily on the export of crude oil and sharp dips in revenue collections from the export of oil can hurt their economy really badly (By either a fall in price or volumes).

2. OPEC’s quota system:
OPEC sets quotas which all 12 member states need to voluntarily abide to. The percentage increase and decrease in the production of oil is generally reflected uniformly amongst Quotas of all member states. An increase in quota leads to reducing prices while a reduction leads to increased oil prices.

3. US Crude inventories:
After OPEC the only other force strong enough in terms of determining international crude prices is the US crude inventories report. These weekly reports determine how much of crude inventory does the biggest consumer of crude have. The greater the inventory the lesser is the perceived demand for crude and hence the crude prices fall and ofcourse vice verse is also true.

OPEC’s Problem:

Enter the Perfect Market: When the OPEC countries reduce their output by say x%, they need the price to go up by more than x% to maintain their already scarce revenues from the export of oil. As of now the forecast for economic growth is so grim that the average price rise after an OPEC decision to cut production isn’t even as much as x% and thus atleast some of the OPEC countries go beyond their quotas. This is quickly reflected in the weekly US crude inventory details. This quickly causes a correction in the price of crude bringing it back to supply-demand equilibrium. The result is inevitable, a long drawn bout of low crude prices and there won’t be much the OPEC could possibly do as of now. There is baseline below which OPEC can’t reduce its output atleast at the current crude prices and maybe we’re already at that point.

It’s sad that to keep the growth engines of the world going, we need to be held ransom by the OPEC. But then maybe there is a force stronger than the OPEC and ofcourse that is the force of economics.