Covid-19: Vivacity of OPEC

Organization of Petroleum Exporting Countries [OPEC] is a fascinating acronym to economics’ students in the example of oligopolistic market structure and in the illustration of price setting through collusion helping several producers to earn a reasonable mark up over the cost of production. The alternative is price war where rivalries force competitors to banish from the market. The success of OPEC as a cartel depends on several factors. The most important are the demand elasticity of the commodity, competing –supply elasticity of the substitutes and the total market share of the cartel member. A product with inelastic demand and over 60 percent of the market share is a binding requirement for an effective cartel.

Fadhil J. Chalabi, Secretary General of OPEC from 1983-88 wrote a premature obituary on OPEC in 1990 citing the heydays and the danger inherent in its operations and commitments. The triumph was on the OPEC’s bold decision in October 1973 in setting price of oil unilaterally in defiance of the Seven Sisters and the Arab oil embargo to protest Western support for Israel during the Yom Kippur War. That was the First Oil Shock; the world observed two more shocks; second oil shock in 1979 during the Iranian revolution when a general strike against Shah Mohammad Pahlavi led to an acute shortage of oil and the current Third Oil Shock during COVID-19.

OPEC during its six decade of existence faced several debacles and triumphs and still today showing its vivacity as an effective cartel, now with OPEC +   constituting 23 countries. Indeed, OPEC + counteract other nations’ capacity to produce oil that could baffle OPEC’s ability to control supply and price.  It is through the output rationalization of the individual member countries and an honest commitment in sticking to quota that helps to cling at the predetermined or exploiting price.  However, there are incidents when members cheat on different plea and overproduction forced the price to fall. Thus cheating on production quota often brings debacle in the mission.   Though forces of supply and demand determine equilibrium price yet with excess production from outside nations such as U. S. and Canada; the OPEC predetermined price may falter.  Again, when major producers failed to reach an agreement about quota or production cut in the face of excess supply; the price may drop at a level below the production cost.  To cite an example, the case of retaliatory measures by Saudi Arabia, the largest exporter of OPEC and Russia, the second most important member in OPEC + at the initial stage of COVID-19 [ March 2020] caused oil prices to drop nearly 20 years low.   

The pandemic had a harmful effect on the world economy and on the energy sector through the transmission mechanism of the price of oil. Oil price had a free fall at the outset but through Declaration of Cooperation [DoC] both OPEC and OPEC + countries in three Ministerial Meetings between April and June, 2020 and subsequently in the 179th Meeting of the OPEC conference on June 6, 2020 explored possible avenues to reduce market volatility, reaffirming the countries’ commitment to a stable oil market. The stability of the oil market is sine qua non for recovery and thus require continued commitment and intensified efforts from DoC Participating Countries.  

The leadership role of OPEC in consolidating recovery from COVID-19 pandemic was espoused by White House on August 11, 2021 with an urge to boost oil production as planned increases are insufficient as countries around the world seek to emerge from the Covid-19 pandemic. National security adviser Jake Sullivan emphasized that the recent planned production increases by OPEC would “not fully offset previous production cuts” made by OPEC and its oil-producing allies during the pandemic. “At a critical moment in the global recovery, this is simply not enough”.  Oil prices have experienced volatility in recent days due to concerns over the Delta variant of Covid-19.

This turnabout by the current administration from Joe Biden’s predecessor, Donald Trump who withdrew from the Paris Climate Accord to champion U.S. - based drillers. Trump had threatened to withdraw military support from OPEC's largest supplier, Saudi Arabia over output, which at the time he thought was too high and hurting U.S.-based drillers. The Biden Administration’s respect for Paris Climate Accord and to secure global leadership in the fight against climate change reverses the situation who prefer increased oil production to generate soothing effect on recovery from COVID-19 pandemic.  Global benchmark Brent crude gained more than 1% to over $71 a barrel on August 11, 2021; though lower than the prices above $77 in early July, but still represents an increase of nearly a third from the beginning of the year. A request to investigate whether illegal practices were contributing in higher gasoline prices by Federal Trade Commission [FTC] entrusted to monitor anti-competitive behavior in domestic U.S. markets highlight the merit of price issue. The American Petroleum Institute criticized the actions as a "return to the days of relying on OPEC to meet our supply needs" and called the request to the FTC "a distraction." Frank Macchiarola, the senior vice president affirms that “Rather than requesting investigations on markets that are regulated and monitored on a daily basis or pleading with OPEC to increase supply, let’s lift restrictions on U.S. energy right away.” Biden has set a goal to decarbonize the U.S. economy by 2050 and has paused new drilling lease auctions on federal lands pending a review of its environmental and climate impacts”. Greg Gianforte, Montana Governor also holds an opposite view and labeled the current energy policies as “horrendous” move to request OPEC to produce more oil at the cost of self-sufficiency.  

The decade wise assessment of OPEC as a cartel in price manipulation presents a diverse picture of wave that resonates exactly the ups and downs of oil price. Historically, OPEC was also favored by U.S. between 1974 and 1981 through policies that raised dependence on oil. The final word despite substitutes and technological innovation, oil price till today exerts dominant pressure in the world economy.   

The writer is the Treasurer and a Professor, School of Business and Economics, United International University.