OPEC Pricing Power


The Need for a New Perspective
by Bassam Fattouh




1. INTRODUCTION
Since the 1973 oil price shock, the history and behaviour of the Organization of Petroleum Exporting Countries (OPEC) have received considerable attention both in the academic literature and in the media.1 Many conflicting theoretical and empirical interpretations about the nature of OPEC and its influence on world oil markets have been proposed. The debate is not centred on whether OPEC restricts output, but the reasons behind these restrictions. Some studies emphasize that production decisions are made with reference to budgetary needs which in turn depend on the absorptive capacity of the domestic economies (Teece, 1982). Others explain production cuts in the 1970s in terms of the transfer of property rights from international oil companies to governments which tend to have lower discount rates (Johany, 1980; Mead, 1979).

Others explain output restrictions in terms of coordinated actions of OPEC members. Within the literature, OPEC behaviour ranges from classic textbook cartel to two-block cartel (Hnyilicza and Pindyck, 1976), to clumsy cartel (Adelman, 1980), to dominant firm (Salant, 1976; Mabro, 1991), to loosely co-operating oligopoly, to residual firm monopolist (Adelman, 1982) and most recently to bureaucratic cartel (Smith, 2005). Others have suggested that OPEC oscillates between various positions but always acts as a vacillating federation of producers (see for instance Adelman, 1982; Smith, 2005). The existing empirical evidence has not helped narrow these different views. Griffin’s (1985) observation in the mid-1980s that the empirical studies tend to “reach onto the shelf of economic models to select one, to validate its
choice by pointing to selected events not inconsistent with model’s prediction” still dominates the empirical approach to studying OPEC behaviour and its pricing power.2 In this paper, we examine OPEC’s ability to influence oil prices. As in any other issue related to OPEC, there are divergent views regarding its pricing power.

More importantly, there seem to be switches in perceptions shifting from one end where OPEC is perceived to play no role or a very limited role to the other where it is perceived to be a price-setter. These switches in perception became very apparent in the events that surrounded the oil price collapse in 1998 3 and the oil price hike in 2004. In 1998, when the Dubai price approached $10 per barrel, many observers claimed that OPEC had lost its ability to defend oil prices with many observers predicting its demise.

This view of an ineffective OPEC was however reversed only a few months later with many observers in the media considering the events of 1997 as inducing great cooperation among members and ushering in a new era.4 During March 1998 and March 1999, OPEC embarked on two production cuts in an attempt to put an end to the slide in oil prices. These production cuts were implemented with a high level of cohesiveness among members, contradicting the view that OPEC is not able to implement cuts.5 In the high oil price environment of 2004, there was another switch in perception were doubts re-emerged about OPEC’s pricing power. But unlike ....









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