Is OPEC about to break-up?

OPEC is an organisation made up of 12 oil-producing countries which operates as a cartel to try to control oil prices. It was formed in 1960 by Iran, Iraq, Kuwait, Venezuela and Saudi Arabia, with most of the rest of the members joining through the 1960s

The Venezuelan president Hugo Chavez has recently been saying that some OPEC members may be violating their quotas and producing too much oil. This pushes down the price of oil and reduces profits for those that stick to their quotas.

Cartels always run the risk of breaking up because once one member breaks from the cartel then the group will usually quickly fall apart. Each member always has the temptation to produce more to make a greater short-term profit, at the expense of a longer-term gain. The future needs to matter more to all the members to keep a cartel together, once someone takes a short-term view the cartel falls apart.

One of the factors that is important in keeping a cartel operating is that it is possible to know quickly when someone has started to break the rules. When there are more than just a few members this gets more difficult.

So how has OPEC managed to stay together with as many as 12 members?

Figures from about 2005 show the actual production of each country, compared to their quota. What is significant is that nearly every country, apart from Saudi Arabia, is operating near to their capacity. Even if they wanted to break ranks and produce more oil then they don’t have the capacity to do so. The only player that can significantly change the game is Saudi Arabia but they have no reason to do so.

OPEC is strong in this situation because most of the members are at their capacity anyway and have no real power. They cannot choose to break ranks and produce more to get a bigger profit in the short-term.

This can be contrasted with the 1980s when there was less demand for oil. This meant that each country would have been required by OPEC to reduce its output to maintain prices. This didn’t happen and for a period OPEC lost control and prices fell.

Cartels with more than a few members are very difficult to police. OPEC has 12 members but most of then have very little power which is why the cartel holds together in good times.

As oil prices are currently dropping there is a greater temptation for an individual country to maintain its production rather than cutting to hold prices up. If demand continues to drop we will see more division in OPEC.

 

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