The Effectiveness of OPEC

Topics: OPEC, Petroleum, Saudi Arabia Pages: 5 (1877 words) Published: March 21, 2014
In the wake of the technological age we live in, most of our daily activities consist of the usage of oil as a form of energy. This means from an economic standpoint that the demand in the market for oil is highly inelastic. This gives oil producers high incentive to produce so they can achieve large profits. Unfortunately supply for this industry is also inelastic and due to the nature of oil as a natural resource there is a limit to how much producers can produce. Due to its worldwide need, the exporting and production of oil is done at a worldwide level. Hence suppliers in the oil industry are the countries themselves, which creates an oligopoly. Oligopoly's are known for having kinked demand curves meaning that when left to the free market competitors will keep undercutting each other until neither are making the large revenue's they projected when they entered. It is at this point that OPEC, the organization for petroleum exporting countries steps in. Using strategy following game theory they control supply so that they can maintain prices at a level where member countries of OPEC can increase their individual revenue as a group. In the short term, OPEC's pricing policies increase revenue for its member countries, protect and maintain the price of oil, and reduce the rate of depletion of oil reserves. In the long term however OPEC's pricing policies lead to a decrease in world market share as non-OPEC producers increase production of oil. This seems to lead to a point where OPEC's policies will become less and less effective in controlling the market price of oil. OPEC controls and maintains oil prices by changing supply. The reason they are successful in being able to control market prices is due to their large market share in the oil industry coming from the large oil reserves in the member countries demographic. Hence they are able to succeed according to the game theory model to maximize profit and revenue for all of their members. There is though a downside to these policies as noted by OPEC members since by decreasing supply over the long term, there is incentive for non-OPEC nations to increase supply. This increase leads to OPEC further decreasing supply to balance out the market price, which further ends up to a market share drop for OPEC in the long term. Statistics show that since OPEC's policies have started to affect the market, their production has steadily dropped. Shown above, from 1970 � 2001 OPEC's production compared to the world oil industry has dropped off at a steady pace. The low point of this was the 1980's Oil Glut, which was caused due to fear of OPEC member countries that they were reducing production to a point where they were losing the market share. As shown the market share dropped from nearly 50% in the 70's to a third in the 80's. This led to Saudi Arabia increasing production decreasing the price of oil and making most OPEC member oil facilities non profitable. It was after this that OPEC members realized the importance of the price policies since as developing countries most of their funds come from the exportation of oil. Though however OPEC's policies can only be successful if their members follow them. Saudi Arabia holds the most power since they currently hold 13.5% of the world market share making them the swing producer. Hence as seen in the 1980's any steps taken by Saudi Arabia affect all OPEC members immensely. A clear representation of the effect of their production quotas policy on their overall world market share can be seen with their production change from 1978 � 2003. In 1978 OPEC produced an approximate 32 million barrels / day. This reduced to 27 million barrels / day by 2003. This decrease in production by OPEC over this span coincides with a 14 million barrel / day rise in world demand over the same period in time. This show that non-OPEC countries are filling the gap in world demand and OPEC supply resulting in a major loss in world market share for OPEC. In 2002...
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