Located in one of the most beautiful promenades in
Europe, the headquarters of the Organisation of
Petroleum Exporting Countries (OPEC) must rank as
one of the worst looking buildings in the world. On
the banks of the Danube in the heart of Vienna, it
is white, squat and devoid of any aesthetics —
almost as poor as the organisers pseudo art deco
This ugly building houses the globe’s most powerful
cartel. OPEC was formed as a permanent
inter-governmental organisation in September 1960.
From its inception, OPEC’s objectives have been
explicitly cartel-like, and I quote:
“OPEC’s objective is to co-ordinate and unify
petroleum policies among member countries, in order
to secure fair and stable prices for petroleum
producers; an efficient, economic and regular supply
of petroleum to consuming nations; and a fair return
on capital to those investing in the industry.”
OPEC has 13 member countries. It began with five:
Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.
Subsequently, others joined the organisation: Qatar,
Indonesia, Libya, the UAE, Algeria, Nigeria, Ecuador
There is no doubt that over the last couple of
years, the OPEC has become an incredibly successful
cartel. From end-January 2007, it has kept global
crude prices higher than $50 per barrel; from April
2007, at levels higher than $60; from September
2007, at above $70; from the second half of October
2007 at above $80; from late February 2008, at over
$90; and from 14 March 2008 at over $100 per barrel.
As I write this article, the OPEC’s weighted average
basket was quoting at $111.66 per barrel. More
ominously, on 28 April, the OPEC president, Chakib
Khelil, Algeria’s oil minister, warned of the
prospects of crude at $200 per barrel.
Applied game theory explains why it is very
difficult to maintain successful price or quantity
cartels over long periods. More often than not,
cartels tend to fail because of ‘free-rider’
problems. Even when all members informally agree to
restrict supplies to obtain a high price, a few
always have incentives to quietly deviate. A small
producer is tempted to produce a bit more than what
was agreed to, assuming that he can free-ride on the
price and also not get detected.
Moreover, the punishment to deviations is very
difficult to implement and, hence, not credible. The
classical response to free-riding is for every other
member, especially the big producers, to immediately
increase output, drop prices and hurt the deviant.
But the act of doing so hurts all non-deviants as
well. That makes the cure more painful than the
disease — and explains why cartels historically live
with some free-riding in good times, and face
difficulties in reaching quantity / price fixing
agreements in periods of poorer demand.
In fact, until 2007 the OPEC was not viewed as a
price gouging cartel. Barring 1973 and 1979, it has
see-sawed between cutting and raising quantities.
Till September 1999, crude was ruling at below $20
per barrel; and it remained below $30 right up to
March 2004. So, what has made the OPEC so successful
in not only maintaining hard prices, but steadily
stepping these up to over the $110 mark?
Economists will tell you about the rising demand
from India and China, uncertainties in supplies, and
the role of commodity speculators. These are valid.
But to my mind, the biggest factor of them all is a
man called George W. Bush.
If Bush had only alienated Hugo Chavez of Venezuela,
the oil consuming world would have breathed easier.
But he has put off Iran, the UAE and, most
importantly, its biggest oil producing ally, Saudi
Arabia. Gone are the days when the President of the
US could have a quiet word with the King, and have
the Saudis exercise restraint on the OPEC. Not so
long ago, Bush’ father, George W.H. Bush, was
welcomed as an honoured guest of King Fahd at
Riyadh. Today, King Abdullah doesn’t feel the same
about the son or his emissaries. For instance, Dick
Cheney’s last visit to Saudi Arabia was only
politeness. The Saudis are irritated with Bush’
confrontational style; with the US upsetting their
neighbourhood, and not bothering to consult with
them in any substantive way.
Thus, Thanks to Bush’ bellicose body language, the
Saudis watch from the sidelines. Not once since
September 2007 has the largest producer in the OPEC
spoken of increasing supplies to dampen prices. With
the Saudis remaining quiet, every other producer is
making hay, including US-haters like Mahmoud
Ahmedinejad of Iran and Hugo Chavez.
The US has become public enemy number one in the
Middle East. And we are all paying the price. Long
Published: Business Standard, May 2008