Does OPEC matter?

When OPEC announced it would not cut oil production in response to falling prices, oil markets shuddered. The reaction appeared to confirm the dominance of OPEC and has been interpreted as a sign of the cartel’s strength.

So how much influence does OPEC really have on prices? In my view, none.

OPEC isn’t a monopoly that can simply set the oil price. It's a coalition of 12 oil producers who, together, control about 40% of global production. For OPEC to exert influence, all members must limit their own output. That is possible in theory but, in practice, unlikely.

Let’s assume OPEC comes to an agreement to raise prices. That means each member agrees to a production quota to limit output below optimum levels. There are two problems with this: no one can verify whether individual countries are sticking to their quota and no individual member, by themselves, can influence prices.

Each member knows it can quietly produce more oil than its quota without getting caught or influencing prices. The incentive to cheat the cartel is overwhelming, especially when you consider to dire state of member countries budgets and the role oil revenues play in them. For most members, oil revenues are a means of buying authority or enforcing it. Falling oil revenues are a political as well as a financial problem.

Of course, when all members cheat and exceed their quota, the cartel fails. Members who comply know they are limiting their own revenue to benefit cheating members or non OPEC producers. The incentive to comply is weak.

Throughout it’s history, OPEC has rarely been effective. In fact, cartels generally are rarely effective because the interests of the cartel are contrary to the interests of members. OPEC often makes grand statements about controlling prices or influencing the oil market. Don’t be fooled. The organisation is largely powerless and, as a force in markets, it is meaningless.

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