The price of crude has fallen significantly over the past few weeks on signs of continually eroding demand. OPEC, not surprisingly, is unhappy about this (see the bottom half of that article). But so far, their modest attempts to react to the falling prices have not worked.
From the linked article:
Now it seems to me that a cartel that controls so much of the world’s oil production could simply decide to create an artifical shortage to keep oil trading over $100/bbl or whatever price their happy with. They could easily cut production to whatever it takes to get the market to react. With other goods, cutting supply to raise prices doesn’t always increas profits because you’ll crush demand and sell fewer units. But with oil, the demand is fairly inelastic. The world will, for the most part, buy what it needs regardless of the price. Demand may go up or down due to a lot of external forces, but much of that behavior is independent of price. If that’s the case, one would think that OPEC would try to take advantage of the inelastic demand.
So, logically, something must be keeping OPEC from fabricating an oil shortage, and causing them to resort to moderate corrections in output in response to falling prices. What are those influences? And what is the likelihood of them doing just that in the face of those pressures—that is, getting desperate, cutting production drastically, and trying to get the price of crude back up to $150/bbl sometime down the road?
They aren’t the sole suppliers of oil. If they cut production too much, then their own incomes suffer and their populations get restless. It’s better for everybody if they can sell their oil, no matter what the price.
Well first of all there are lots of countries with lots of oil that don’t belong to OPEC. Second most of the OPEC countries are virtually dependent on oil. They have to sell that oil to fund their own activities. Think of a strike, sure the company can’t produce but the striking workers aren’t getting paid either. Third a lot of the oil money is invested in the West in developed nations. If you hurt the Western Economy you are also hurting your own investment. You can only create so much shortage before people start using substitutes. Germans were not rich in oil during WWII but they put up on heck of a fight using oil substitutes.
And finally wars are usually faught for resources. If you refuse to sell oil, the nations may find themselves attacked and conquered or have the government replaced by a more friendly government. Or at minimum the other nations will fund resistance groups in the OPEC nations to distrupt OPEC economies.
They have scheduled a meeting to discuss the very thing. The word is they will cut 1 million barrels a day to prop up prices. Yep supply and demand at it again.
OPEC, like every cartel, suffers from a collective action problem. It is in every members best interest for production as a whole to be low. It is also in every member’s best interest for their production to be high. The more the other countries comply the higher the temptation to cheat is. My own theory is that the purpose of OPEC is to frighten people but that it holds very little control over the supply of oil.
OPEC doesn’t have the influence it used to. Not only are there alternative oil suppliers outside of the cartel and its influence, such as Russia, its internal coherence has been shattered. Iran, Iraq and Saudi don’t play nice with each other any more.
And as has been stated, there is a collective action problem - it’s a big Prisoner’s Dilemma game. In the past it was a stable game - Saudi was big enough and rich enough to act as the policeman. They could flood the market if anyone cheated, and absorb the damage of lower prices much better than the other members because their pockets were essentially bottomless. That’s not the case any more. There’s no policeman, the members hate each other, and so there is the possibility of rampant cheating on any quotas. And if you know there is no way of preventing your colleagues cheating, it behooves you to cheat as well.