OPEC: The big pretender

With the oil price taking a tumble over the past few weeks, there is increasing chatter about what role the Organisation of Petroleum Exporting Countries (OPEC) might play in stabilising prices. There's an easy answer in this analyst's view; none.

OPEC is a cartel, not a monopoly. It relies on the cooperation of its 12 member countries to supposedly 'fix' the oil price. This means that all 12 members agree to produce at lower levels than they otherwise would to keep prices high.

The problem, though, is that no one can verify that individual countries are sticking to their quotas. And since no individual country has enough reserves to influence global prices – with the possible exception of Saudi Arabia – every member knows that it can quietly exceed its quota without facing lower prices.

Every member faces the same incentive to 'cheat' the cartel. Of course, if all members pump out more than their quota, the oil price will begin to fall and the cartel might fall apart. This pattern of behaviour isn't just a reflection of OPEC, but of all cartels. Because the incentive to cheat by individual members is so strong, and the ability of the cartel to enforce compliance so weak, cartels have historically produced more than they say they do. Consequently, they don't usually have a great deal of influence in markets without a policing mechanism.

The massive reserves of Saudi Arabia have historically acted as a stick to encourage quota compliance. In the past, the Saudis, armed with massive oil reserves and high levels of spare production capacity, have threatened to flood the market with oil and cut its price. Boasting the world's cheapest production costs and plenty of spare capacity, it wasn't an empty threat. But things have changed.

The protective buffer afforded by excess production capacity has vanished, and there's a lack of confidence in the sustainability of Saudi Arabia's largest fields. Any threats to flood the market with cheap oil would amount to a bluff, and the other OPEC members know it.

OPEC goes to a great amount of trouble to keep up the charade that it can influence prices, including holding ceremonial meetings where it ordains new production targets. But it's hard to believe that OPEC countries are purposefully limiting production. When oil prices rise, so does the cost of sticking to the quota. So while it's possible to maintain a cartel when prices are low, you can bet your life that each member is pumping out as much crude as it possibly can when prices are high.

Though member countries have a financial incentive to pump more oil at higher prices, there's also another more important reason why they will always opt to. OPEC's members are mostly authoritarian states that use oil as a means of securing and holding on to political power. Oil receipts help buy the support of friends and keep enemies at bay, which is how OPEC regimes stay in power. Seen in this light, oil is the backbone behind regimes that would otherwise be wobbly.