Contrary to what many people think, it’s not always easy being a monopolist. It’s even harder being an oligopolist.
That’s the lesson Iraq is going to learn from Saddam Hussein’s announcement earlier this week that his country will halt crude oil sales for 30 days to protest Israeli actions and U.S. policy in the Middle East.
Yes, Iraq’s halt of oil sales did increase prices for a day or two this week. The fact that political turmoil in Venezuela may curtail crude output there was another factor pushing up price. And we certainly may see more fallout from the Israeli-Palestinian conflict affecting oil markets.
It is important to keep simple economics in mind, however.
Monopoly (only one seller) or oligopoly (only a few sellers) situations do give producers some price-setting power. But it’s limited, particularly for a commodity like crude oil that’s traded in efficient global markets. One oligopolist can move markets in the short run but usually pays a heavy financial price in the longer run.
Yes, I know that Saddam Hussein is far from a rational, profit-maximizing entrepreneur. He’s a murderous thug, fighting for his life.
But while craziness and irrationality can have political and diplomatic uses, Iraqi oil amounts to 2 or 3 percent of total world output. In all but the short run, that does not matter much.
Here are some realities to keep in mind.
The 1973 oil embargo and subsequent price spikes gave many people the idea that OPEC is a powerful monopolist. It’s not a true monopoly, and it’s not very powerful. If it were, oil prices would be higher now, adjusted for inflation, than they were in the past. They are not.
OPEC is a classic cartel, a group of oligopolists trying to act as a monopoly by mutual agreement and coordination. But cartels are wracked with conflicting incentives, particularly ones with many members, such as OPEC and particularly ones where the members are governments and face very different domestic and international political forces.
A cartel as a whole can benefit if all members cooperate and limit sales so as to raise prices. But at the same time, once the cartel experiences any success in raising prices, the incentive for any individual member to cheat — by selling more than the agreed on amount — rises proportionately. OPEC and other international cartels, such as those attempted in coffee and tin, always suffer from cheating.
Members that don’t share common cultural bonds or political objectives with the majority of members are particularly likely to take advantage of higher prices by surreptitiously selling in excess of their agreed-on quota.
Nigeria and Venezuela, for example, probably have cheated more often than they have complied in the last 30 years. The oil market is huge and complex, and it is virtually impossible for any institution to track every tanker on the oceans and capacity usage on every pipeline.
Major players in a cartel also can sell more than their quota to drive down price and discipline other members of the group.
When a cartel is weak, as OPEC is, a producer like Iraq, with only 2 percent of total world output, may face what economists call a “kinked demand curve.” If it cuts output to raise price (or signal diplomatic displeasure) it sells a lot less product for only a slightly higher price. Both revenues and net profits will evaporate.
If, on the other hand, a small-producer oligopolist openly cuts prices to sell more, other competing oligopolists immediately match the cuts to punish the offender and to avoid their own loss of market share. The offender doesn’t increase sales very much, and price per barrel plummets. Again, total revenues and profits shrink.
It’s very true that if other Arab countries follow Iraq’s lead, short-term price increases could be substantial. They would be even more substantial if Islamic, but non-Arab, producers such as Iran and Indonesia joined in.
But OPEC members know that every sharp action they have taken from 1973 to the present has cost them market share and reduced the value of their oil reserves in comparison to the world economy.
OPEC is much weaker now than in 1973, 1979, or any time in the 1980s or 1990s. If they had been able to sell their oil reserves at prevailing prices in 1975 and had put that money into U.S. or British government bonds they would be twice as rich as they are having kept the oil.
The first OPEC actions led to development of oil fields in the North Sea and offshore Mexico and Brazil. Now oil exploration in Russia and Central Asia is poised for dramatic growth. As attractive as a joint action in support of the Palestinians might be to many Arabs and other Muslims, it would be suicidal in economic terms.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.