OPEC and the Difficulties of Collusion

The petroleum cartel OPEC has shown how difficult it is to accomplish the requirements a cartel demands. OPEC stands for the Organization of Petroleum Exporting Countries. OPEC is an international organization that is made up of Saudi Arabia, Iraq, Kuwait, Libya, Nigeria, Qatar, Venezuela, and some other main countries that export petroleum.

Together these countries control most part of the supply of petroleum in the world, in a way that they constitute of an oligopolist industry with only a few companies. Given that there are only a few companies, they have the possibility of forming a cartel and trying to produce the amount a monopoly would produce and obtain the benefits a monopoly would obtain, however, are they successful at doing so?

In general they are not successful at doing so. Although it is true that they negotiate agreements on the production of petroleum, these agreements are constantly violated. Lets imagine for example that the product level of a monopoly that maximizes the collective benefits of the OPEC is of 20 million barrels a day and that at that product level the price of the petroleum is of $60 per barrel.

In order to achieve that combined production amount, OPEC has to agree together about the production quota of each country. For example, Kuwait might have a quota of 3 million barrels while Qatar might have a quota of 1 million barrels and so forth, perhaps all the rest of the countries together might have 16 million barrels a day as a quota, all distributed amongst them.

Unfortunately for OPEC though, there is really no way for them to make everyone accomplish or go along with the quotas. In reality there is not any way for Kuwait to extract a couple million barrels more a day and sell the rest in the world petroleum markets. Almost all the countries in the OPEC cheat in this way and produce above their quota.

The reason they do this is that the high price of petroleum is too tempting. For example, if all the other countries go according to the agreement and increase the price of petroleum, one of the countries might find it just a bit too tempting and produce above the quota because each additional barrel will produce great amounts of money.

Unfortunately each country faces the same type of temptation and this means that almost all of them produce above their quota limit. The increase in the supply caused by all this cheating floods the market and reduces the price very under that which the countries could have received if they had gone along with their respective quotas.

To say this in other words, cartels have incentives to destroy themselves and they create a temptation for cheating. In the case of the OPEC, the temptations are so strong that only occasionally has there been an effective cartel.