OLIGOPOLY OPEC AS A CARTEL
SUBMITED TO:-
DR. Kamlesh Mishra BY:-
Bhaumit Zaveri En. Roll No.
0220113 DATE:-
29/11/2011
Oligopoly is a market structure characterized by few dominant by few firms or in simpler words Oligopoly is a market structure where there are few firms less than monopolistic competition and there are many buyers present in the market. As there are only few firms present in oligopoly, therefore by the virtue of their individual sizes are large enough to influence the market price. Products in an oligopoly industry may be homogenous or differentiated. The behaviour of any one firm in oligopoly depends to a large extent on the behaviour of other firms. Oligopoly is found in industry like cement industries, automobiles industries, petroleum industries etc. There are three different types of oligopoly models; they are The Collusion Model, The Cournot Model and The Price-Leadership Model. The Collusive Model occurs when price and quantity fixing agreement among the produces are explicit. The Cournot Model is a model of a two firm industry (duopoly) which a series of output adjustment decision leads to a final level of output between the output that would prevail if the market were organised and the output that would be set by a monopoly. The Price-Leadership Model is a form of oligopoly in which one dominant firm sets price and all the smaller firms in the industry follow its pricing policy. In an oligopoly market, firms have an enticement to coordinate their production and pricing activities. As the number of firms are less and product occasionally being homogenous, therefore, each individual firm has a small market share and profits are not so high. So as to increase their collective and individual profits by limitation market output and raising the market price, group of firms join together and form a CARTEL. A cartel is fundamentally group of firms that gets together and make price and output decision jointly. Cartel has many benefits benefi ts like by working together, togethe r, cartel members behave like monopolist monop olist behaviour by limiting their production, and therefore, causing the price to rise above it would have been if the firms would have remained in competition. Cartel benefits the companies as their income rises upwards without any competition and low prices. Also, firms are in an advantageous situation to increase their trade and also acquire uniform market condition for trade. But a coin always has two sides, which means that even cartel with benefits also has disadvantages. The most common problem is that relates to the increase in the prices of goods and services. Cartel also decreases the quality and verity of product as offering of products with higher quality would require a heavy investment from firms whereas the main reason of forming collusive oligopoly is to reduce the cost of product. Cartel also harms the customers as they are left with inferior goods of less product choice. Cartel also leads to reduce in innovation in the market, as innovation includes a huge cost; produces restrict themselves for producing many products which finally effects the long term growth of the economy. One of the prominent examples of cartel is found in OPEC (Organisation of Petroleum Exporting Countries). Case, Karl E.; Kair, Ray C. (2011). PRINCIPLES OF ECONOMICS, eight edition. 8th ed. India: Dorling Kindersley (India) Pvt. Ltd.. 310-311 Two series of event concurred to change this secure supply of cheap oil into an unsecure supply of oil. In 1960, the amount of oil which was produced worldwide was greater than the demand. Thus this resulted in the decrease in prices by the oil producing companies, resulting in the decrease in supply and revenue for the oil exporting countries. To overcome this situation, OPEC was formed with the result of decrease in price. Also, incense by autonomous cuts in oil prices by seven big oil companies led the government of big oil exporting countries to form an organisation which is called OPEC. OPEC ( Organisation of Petroleum Exporting Countries ) was formed at the Baghdad Conference on Sept 14, 1960 with the target to unify and coordinate the petroleum prices among the member countries to reduce price war. The founding member countries are Saudi Arabia, Iran, Iraq, Kuwait and Venezuela. The five member countries were later joined by Qatar, Indonesia, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador, Angola, and Gabon. OPEC started its operation with its headquarters in Geneva, Switzerland which was later moved to Vienna Austria. Thus some of the member countries nationalised the production and
refining and started earning large profits. The history of OPEC starts for the 1960`s when OPEC was formed. In 1970 OPEC rose to international fame, as member countries took control over their domestic oil producing companies and acquired a major hand in deciding the prices of crude oil in the market. With tow remarkable situation taking place in world, oil prices sharply increased in the market, thus providing OPEC a chance to enter the market with low price. OPEC describes this as a beginning of new era of world development and stability. In the late 1970`s additional countries joined OPEC member countries grew upto 13 countries. In 1980`s the oil price began to weaken and crashed in 1986. This influenced the working of OPEC as it lots its market share for the smaller oil market and its total revenue fell below a third of earlier peaks, cause difficulties for many member countries. But in the latter part of the decade, prices got stable and OPEC recovered its market share. In 1990`s the prices moved less dramatically than in 1970`s and 80`s. However a good and stable recovery was noticed in the integrated oil market but many member countries left OPEC or resigned their membership. In 2000`s a pioneering OPEC oil price banned mechanism helped by strengthening and stabilising crude oil prices. But speculation and other factors transformed the situation in 2004, pushing up crude prices and instability in a well-supplied crude market. Oil was being used progressively as an asset class. In the mid-2008, prices increased to record levels, before collapsing in the emerging global financial turmoil and recession. OPEC became bulbous or prominent member in supporting the oil sector, as part of the global efforts to address the economic crisis. OPEC`s second and third summit in Caracas and Riyadh in 2000 and 2007, recognised stable markets sustainable development and environment as three guidelines and it adopted comprehensive long-term strategy in 2005. The principal aim of OPEC is to coordinate and unification of the petroleum policies of the member countries to safeguard their individual and collective interest in order to secure fair and stable prices of petroleum products and also to maintain an efficient economic and regular supply to consuming countries. To achieve its objective, OPEC, uses a unique strategy known as Quotas. Quotas or production limit restrict the production level of oil producing members for a certain year. This helps as price is maintained to a certain level. Also price celling is done in order to maintain a competitive price level for its members. For example, OPEC states that it repeatedly raised production limit in 2004 in response to rise in demand. This ensured that there was no fuel shortage in countries where demand was on a constant rise. William Jensen, eHow Contributor. (July 14, 2011). How Does OPEC Meet Its Objectives?. Available: http://www.ehow.com/info_8734011_opec-meet-its-objectives.html. Last accessed 30th November, 2011. OPEC has been providing many advantages to the member countries and to the world. But to achieve its objectives, OPEC has to face many challenges. First, the problem lies in supplying consumer. OPEC supplies to developed, developing as well as under-developed countries, therefore, OPEC regularly has to check the demand of all the countries. But OPEC being an organisation, has to look towards its profit also, so it prefers to supply oil to those part of world world where there is a high and constant demand for oil leaving behind those countries where demand is less compared to those countries. Second, continuous rise in technology along with price defence policies have increased the development of NON-OPEC oil countries to support this longstanding imbalance. In short-run, the non-members are taking away most of the market share as they can vary their prices where member countries of OPEC can`t. Third, OPEC is under constant pressure on environmental grounds and also climatic norms made by the UN. As research show that use of gas and oil will get double in 2020 which will add upto 28% and 38% respectively in the “energy mix”, eventually damaging the environment and OPEC has a huge reserve of both oil and gas. The problem lies when technology is taken under account. The technology which OPEC uses is old and emission of gas is high, therefore, OPEC has to constantly undergo technological changes which are a costly affair to meet the norms of UN and World summit for SUSTAINABLE DEVELOPMENT. Fourth,
OPEC should replace its exhausted resource on a regular basis to increase production capacity and meet the actual demand. Fifth, OPEC has to maintain large reserve of oil to meet the sudden shift in demand. Sixth, OPEC has to overcome the financial problems as producing oil needs lots of capital for investing in the project. Therefore, taking the uncertainties like changing regulation, fiscal regimes, strategic and political factor etc. countering these uncertainties require transparency, consultation, accurate planning and careful scheduling across the industry. Thus, if OPEC fails to safeguard the above challenges, than they are most likely to lose their market share to non-member oil producing countries which impose a direct competition to OPEC. Dr. Alvaro Silva-Calderón. (11 September 2003). Challenges to OPEC in the Medium & Long Term. Available: http://www.opec.org/opec_web/en/press_room/914.htm. Last accessed 30th November, 2011. OPEC controls the large proportion of crude oil supply. The member nations have all rights to raise the price of crude oil by simply reducing the production. Therefore, the short in supply would eventually increase the price of oil and also due to fear of future shortage. For instance, in April 2001, OPEC reduced its output by 1 million barrels per day, which led to increase in price of oil or gas around the world within few months. Other major players in the market which influence the price include U.S., Mexico, Canada, Equatorial Guinea, Russia and China. OPEC sets its price taking into account the prices set by theses non-member countries. gas oline?.Available: Planet Green. How does OPEC influence the price of gasoline?. http://curiosity.discovery.com/question/opec-influence-gas-pricing. Last accessed 30th November, 2011.
This increase or decrease of supply of oil by OPEC, influences the price of oil in many indirect ways. If the amount of oil is decreased, the prices of crude increase. Also, the gas refining companies, which are responsible for refining and then selling of crude oil may get nervous due to of decrease of quantity of crude oil coming from OPEC because they may fear of losing their market share. Thus to protect their profits for the future, they may rise the price of refined oil and thus creating a price hike on all petroleum products. The determination of OPEC is to maintain a stable oil prices and to prevent any sudden, extreme changes in oil price. If one country is not producing at the level set by OPEC, other countries should try compensating that country`s production and bring stability in the market, as they are responsible to keep the gas prices as low as possible normally trying to avoid prices below $50 per barrel. The members meet twice in a n year, in March and September, and discuss about the pricing problem and world economy and petroleum products rates. In those meetings, new policies may be approved, new members are brought in. Each member country sends in a governor to the meeting. The governor is the representative of their respected countries and cast their votes on the bases of the needs of their country. OPEC may also call special meetings at time of crises, if there is a problem which needs to be immediate solution. Higher oil or gas price also affects the automobile industry. If the gas prices are high, the prices of automobiles automatically increase because automobiles and gas are complementary products. This effects the industry as there will be a decline in sales of automobiles as less number of people would be in position to afford higher price cars, fewer families can afford to travel and thus affecting the tourism and transportation industry of the country.
There are many other non-member countries like U.S., Mexico, Canada, Equatorial Guinea, Russia and China which produce oil. They help in decreasing in the influence of OPEC on price of oil as they pose a direct competition to OPEC. So if OPEC increases the cost, they would eventually lose their market share to these “new players” with low oil prices as the technology present with them enables them to produce crude oil at a low price. Margo Upson, Bronwyn Harris. (2011). How Does OPEC Influence Gas Prices?. Available: http://www.wisegeek.com/how-does-opec-influence-gas-prices.htm. Last accessed 1/12/2011. Is OPEC a successful organisation? No not as successful as believed. The reasons for not delivering the benefits which was expected by OPEC to maintain the price stability and frequent variation in prices. This frequent variation were due to arouse of the 1979 Iranian upheaval and in market anticipation of a possible destruction of substantial reserves in the 1990 – 1991 1991 and 2003 Gulf wars, there was a stagnant fall of oil prices from 1974 through 2003. Again during 2004 to 2005, OPEC failed to maintain prices instability, as upsurge was seen in international markets. This was due to OPEC could not meet the demand form Asian countries as well as constant threat from terrorist to some member countries. But the counter part is that, many economist believe that the rise in price during the above mentioned years were due to production problems faced by Venezuela, Nigeria and many other oil producing countries. Thus the above reasons give a strong reason of failure of OPEC to control price and to bring price stability in international market. To overcome this problem, OPEC has to rapidly increase its technology as upgrading the technology would reduce the wastage in extraction of crude oil, which will eventually increase the output and thus increasing the sales for OPEC. Thus with increase in sales, OPEC would would be in a better position to meet its demand. Also with the innovation in technology would reduce the cost of production and ultimately decrease in the price of crude oil in international markets. This will proved OPEC an extra edge from its competitors in the world market share. Benjamin Zycher. OPEC. Available: http://www.econlib.org/library/Enc/OPEC.html. http://www.econlib.org/library/Enc/OPEC.html. Last accessed
In conclusion, the behaviour, survival and continuous development of cartel like OPEC would not be possible in any the other market forms except oligopoly. OPEC had to face and are still facing many challenges for its survival, but due to its oligopolistic behaviour, it has overcome or concurred every possible challenges. Also OPEC faces a constant threat from other non-members oil producing countries and the main competitor to them is United States of America. U.S.A. has a large reserve of crude oil which they would be probably using when OPEC faces a shortage of oil and will ultimately eat away the market share of OPEC. But till date it has managed to have a successful market share in the international market and is the largest oil producing “organisation.” ALEXANDRA CEL MARE-IRIMIE. (19 ianuarie 2008). The O.P.E.C. Cartel and its struggle to survive. Available: http://econosofia.w http://econosofia.wordpress.com/2008/01/19/the-opec-cartel-and-its-s ordpress.com/2008/01/19/the-opec-cartel-and-its-struggletruggleto-survive/. Last accessed 1/12/2011
Today, Global Warming has affected each and every part of the globe which has cause serious problems to the environment. Also the availability of crude oil is decreasing and it is expected that in next 30 years, the crude oil would completely be vanished from the earth, thus people are moving towards smatter and better choice like using of natural gas as fuel for their automobiles, better quality of petroleum products. This affects OPEC as it only produces crude oil and as expected it would lose its operations in next 30 years. Thus long-term market forces and the shortage of crude oil suggest that OPEC will soon get wiped out. Benjamin Zycher. OPEC. Available: http://www.econlib.org/library/Enc/OPEC.html. http://www.econlib.org/library/Enc/OPEC.html. Last accessed
REFERENCES:http://www.articlesbase.com/ask-an-expert-articles/collusive-oligopoly-and-the-formation-of-cartels228386.html http://www.ecofine.com/strategy/Cartel.htm http://www.cliffsnotes.com/study_guide/Cartel-Theory-of-Oligopoly.topicArticleId-9789,articleId9779.html http://www.opec.org/opec_web/en/about_us/24.htm http://www.scribd.com/doc/24319278/OPEC%E2%80%99S-ORGANIZATIONAL-STRUCTURES-ITSSTRATEGIC-AIMS-OBJECTIVES-PRODUCTION-QUOTA-INCOHESION-WITHIN-OPEC ( main ) http://www.saudinf.com/main/d54.htm Case, Karl E.; Kair, Ray C. (2011). PRINCIPLES OF ECONOMICS, eight edition. 8th ed. India: Dorling Kindersley (India) Pvt. Ltd.. 310-311 William Jensen, eHow Contributor. (July 14, 2011). How Does OPEC Meet Its Objectives?. Available: http://www.ehow.com/info_8734011_opec-meet-its-objectives.html. Last accessed 30th November, 2011. Dr. Alvaro Silva-Calderón. (11 September 2003). Challenges to OPEC in the Medium & Long Term. Available: http://www.opec.org/opec_web/en/press_room/914.htm. Last accessed 30th November, 2011. ga soline?.Available: Planet Green. How does OPEC influence the price of gasoline?. http://curiosity.discovery.com/question/opec-influence-gas-pricing. Last accessed 30th November, 2011.
Margo Upson, Bronwyn Harris. (2011). How Does OPEC Influence Gas Prices?. Available: http://www.wisegeek.com/how-does-opec-influence-gas-prices.htm. Last accessed 1/12/2011. Benjamin Zycher. OPEC. Available: http://www.econlib.org/library/Enc/OPEC.html. http://www.econlib.org/library/Enc/OPEC.html. Last accessed
Benjamin Zycher. OPEC. Available: http://www.econlib.org/library/Enc/OPEC.html. Last accessed
