Existing in March 1998 and averaging around

Existing scholarly work– Literature Review (5 related literatures with proper in text citation andreferences)      I.        Introduction:Since the 1973 oil price shock, thehistory, behaviour, and pricing power of the Organization of PetroleumExporting Countries (OPEC) have all received considerable attention in theacademic literature. One view which prevails is that although OPEC has survivedfor more than 50 years, it has had little effect on either the oil price or oilmarket dynamics. Rather, for some, the oil price is seen as being determined ina globally competitive market.

An alternative view is that OPEC has beensuccessful in cartelizing the oil market and in using its power to raise theoil price above competitive levels by restricting output. On the other hand,there is the view that OPEC pricing power is not constant, and tends tofluctuate depending on the interaction among OPEC members and on oil marketconditions.2 The swing in pricing power became very apparent in the events thatsurrounded the oil price collapse in 1998, which saw the Dubai price, thebenchmark for exports to Asia, decline from around $20 per barrel in earlyNovember 1997 to less than $12 per barrel in March 1998 and averaging around$10 per barrel in December 1998. At that time, OPEC seemed to have lost itsability to defend oil prices, and many analysts predicted its demise. This viewof an ineffective OPEC was, however, reversed only a few months later, and manyobservers consequently regarded the events of 1998 to have ushered in a new eraof cooperation among its members.

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During March 1998 and March 1999, OPECembarked on two production cuts in an attempt to put an end to the slide in theoil price. These production cuts were implemented with a high level ofcohesiveness among members, contradicting the view that OPEC was not able tocollude. By the end of 1999, the Dubai price had risen to $23 per barrel.

The divergent views about OPEC pricingpower have resulted in a wide range of OPEC models. These range from classictextbook cartel, to wealth-maximizing monopolist (Pindyck, 1978a), tothree-block cartel (Eckbo, 1976), 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 (Griffin, 1985), to residual firmmonopolist (Adelman, 1982), to bureaucratic cartel (Smith, 2005), tocompetitive models (MacAvoy, 1982; Cre?mer and Salehi-Esfahani, 1989, 1991).Many of these models were developed to explain key historical events, and inresponse to changes in key producers’ behaviour. The OPEC price war in 1985–6resulted in many of the 1970s models – those that considered OPEC as a rationalwealth-maximizing monopolist or as a monolithic group – being revised. Themodels of the 1980s and 1990s had to incorporate new elements such as theinteraction between OPEC members, price wars, output sharing, the issues ofcheating and coordination, the conditions under which OPEC members can collude,and the special role of Saudi Arabia within OPEC.3 In the 2000s, the entry offinancial players in massive numbers, and the increasing role of futuresmarkets in the price formation process, prompted some studies to consider thesignalling role of OPEC. One of the objectives of this paper is toreview the evolution of OPEC models and to link this evolution to some keyevents in the oil market. Our main conclusion is that OPEC’s pricing power isnot constant and tends to vary over time.

There are many instances in whichOPEC can lose the power to influence oil prices. Such changes in pricing powerare brought about by market conditions and can occur both in weak and tightmarket conditions. A second conclusion is that because of OPEC’s varyingconduct, there is no single model that fits its behaviour and hence analystshave been forced to choose from a wide range of models to explain certainepisodes. The empirical literature has not been successful in narrowing the gapbetween the various competing models (Smith, 2005). Griffin’s (1985)observation in the mid-1980s that empirical studies tend to ‘reach onto theshelf of economic models to select one, to validate its choice by pointing toselected events not inconsistent with that model’s prediction’ stilldominates the empirical approach to studying OPEC’s behaviour.

 One of the challenges faced by anycollusive behaviour is the issue regarding entry of new competitors. AlthoughOPEC as an organization does not coordinate its members’ investment plans, manyOPEC countries have been protected by strong barriers to entry, which stem fromownership and control of the bulk of low-cost oil reserves. By limitinginvestment in their oil sector, OPEC members can control the future flow of oilsupplies into the market. They also shift the burden of meeting the demand forthe marginal barrel onto high-cost producers. Another objective of this paperis to analyse how OPEC members’ investment decisions can affect the oil marketstructure and the behaviour of the oil price. Driven by energy security and climatechange concerns, many consuming countries have been pursuing policies todecrease the carbon content of their energy mix.

Such policy measures can havelarge impacts on long-term oil demand and hence on the share of rent capturedby OPEC producers. The literature often ignores the impact of such policies onOPEC behavior. Another objective of this paper is thus to analyse the optionsthat OPEC faces in dealing with oil substitution policies and with thelong-term effectiveness of such options.  Study 1:OPEC: The Myth and the Reality byWilliam O’KeefeThe review demonstrates that OPEC no longer fits the model of aneffective cartel and that it does not exert influence beyond the norm on oilprices. The belief that OPEC remains powerful is used by advocates to promoteparticular energy policies, making OPEC’s power more political than real. Study 2: Organization of the Petroleum ExportingCountries (OPEC) OPEC, as an international organization and forum which facilitatescollaboration among the major oil and gas producing countries, is nowincreasingly being pulled into the institutional structure of the globaleconomy with myriad intricate international economic law rules traversing theenergy sector. There will have to be give-and-take on both sides (consumers andproducers alike) to conclude a successful harmonization in tandem withnational, regional and global economic imperatives. OPEC fulfils, unlike the more hostile sentiments in the 1970s, asilently important function for both domestic producers and international oilcompanies by being the organization most keen, and most potent, to assist instabilizing prices by helping producers to manage production.

If this ability,which was not evident in the 1980s and 1990s, is maintained or will fade againis beyond our ability to forecast. Sustainable development would require, amongst others, greaterapplication of energy efficiency, minimization of emissions harmful for theglobal (and localized) climate and possibly restrictions on the supply, anduse, of hydrocarbons. Such policies, eagerly pursued by mostly Western NGOs and the EU,for example, are unlikely to succeed if proper account is not taken of OPEC,the major international organization of the major oil producing countries. Thisanalysis suggests that there may be more compatibility than meets the eye orwhich is intuitively implicit in the conventional reference, however right orwrong, to the OPEC cartel.

We suggest thatan overall deal is possible, but requires a more active and creative effort atidentifying commonalities of interest and much stronger leadership with thepolitical will in pursuing and negotiating them on both sides. An arrangementcould require some concessions by OPEC in terms of managing the oil price as acontribution to a stabilizing world monetary policy (e.g. lower prices in arecession, higher in a boom). It would require better guarantees of security ofsupply to concerned parties (e.

g. US, EU, China) as well as security of demandto major oil producing countries. Surely, the world cannot justifiably requiremajor oil producing countries to divert development funds to increasing theirspare capacity when the major consumers are heavily investing in alternativesto oil. Oil prices could also be linked to import prices for the producing countries.In exchange,there could be some examination of the very high excise taxes on gasoline andsome other developed country policies affecting the producer states. A higherprice for oil together with a discipline on supply could be in the interest ofthe OPEC countries, the environmentalist community and consumer countries’long-term interests in a stable and secure oil supply. An unfettered global oilmarket is probably not in the interests of anybody – contrary to recurrentallegations, or conventional thinking, particularly in the US.

Historically, anunfettered oil market without political influence never existed, even in theUS’ domestic petroleum industry. On the international scene, it would drivedown oil prices to very low levels, close down most non-OPEC production(including in the US), counter current Kyoto and energy efficiency objectives,discourage development of renewable energy and would very likely result inextreme and therefore, for the global economy, detrimental, swings of the oilprice.  Study 3: OPEC PricingPower The Need for a New Perspective byBassam Fattouh Although there isplenty of room for OPEC to influence the oil price in the current oil pricingsystem, this influence is not unconstrained. In this paper, we have argued thatthe recent changes in the international oil pricing system have diminished OPECpricing power, especially when compared to the previous administered oilpricing system. We have also emphasized that OPEC pricing power is not constantand varies according to oil market conditions. Finally, we question theproposition that OPEC in general and the Middle East in particular are bound tohave a greater influence on the oil market as they develop their reserves andgain a greater share of the market. Although thepaper’s focus has been on economic factors, it is important to stress that OPECdoes not operate in a political vacuum.

It has been argued elsewhere thatpricing systems in the past reflected the balance of power at those times andthis present system is no exception (Fattouh, 2006a). For many, the balance ofpolitical power can have an impact on OPEC behaviour. For instance, Doran(1980) hypothesizes that there are limits on how much Saudi Arabia can increaseits oil price because very high oil prices can be “damaging to their owninterest because of the danger to the world economy and to their largercommercial involvements and because of the incentive to outside militarypressure by distraught consumer governments” (p.91).

He also argues that ‘politicaland cultural similarity’ has facilitated Saudi Arabia’s role in formingcoalitions regarding price preferences. Others have attributed importantepisodes in oil history to political factors. For instance, some argue that thedecline in oil prices in 1986 might have been orchestrated between Saudi Arabiaand the USA to undermine the financial position of the USSR. There is no harmin incorporating some (but not all) of these ideas into the analysis of OPECpricing power. However, it is important to stress that the impacts of suchpolitical factors are not independent of the oil market. For instance, the oilprice rise in 1973 would not have occurred in slack market conditions and thecollapse of oil prices in 1986 would not have happened in tight oil marketconditions. Similarly, the oil price shock in 1990, owing to the Iraqi Invasionof Kuwait, would have had a much bigger impact if it had occurred in the tightmarket conditions of 2004. Similarly, imposing oil embargoes is more feasiblewhen oil prices are low and markets are well supplied.

These and other examplessuggest that although oil is a political commodity, it is still a commodity andlike any other, in the long run its price responds largely to economic forces.   Study4: OPEC in the Epoch of Globalization:An Event Study of Global Oil Prices byCyrus Bina and Minh Vo  Thisarticle confirms that OPEC is neither a cartel nor exhibits any sign of marketdomination, market control, or monopoly. This confirmation is also in accordwith the pioneering account of the competitive differential oil rents formedacross the global industry since the crises of the 1970s. The methodologyutilized in this study is known as the event-study, an innovative econometricmethod which attempts to investigate the possible influence of OPEC decisionson output upon the global oil spot and futures prices during the period of1983-2005. The significance of this investigation is due to the fact that theapparent “lumpiness” of OPEC has to have no bearing on a priori acceptance of”perfect competition” as opposed to “imperfect competition”—a tautologicalhallmark of neoclassical theory utilized in the bulk of both orthodox andheterodox literature on oil. And, by implication, neither has the neoclassicalparlance of rent, as “market imperfection” and/or “market power,” any bearingon the globally competitive differential oil rents earned by the rentierstates. OPEC is reflective of the competitive differential oil rents earned byits members; and, contrary to both the right and the left, and theirobfuscating echo in the media, it rolls with the heavy-handed punches of globalmarket in the present epoch.

This study is rather a posteriori investigationthat deals with the reality of competition in the Schumpeterian framework—areality that, far from the fiction of textbook competition, is neither perfectnor imperfect.  Study 5:The Real Oil Problem byM. A. ADELMANU.

S.oil policies are based on fantasies not facts: gaps, shortages, and surpluses.Those ideas are at the core of the Carter legis- lation, and of the currentEnergy Bill. The Carter White House also believed what the current Bush WhiteHouse believes — that, in the face of all evidence, they are getting bindingassurance of supply by opec, or by Saudi Arabia.

That myth is part of thelarger myth that the world is running out of oil. Conclusion:  Therationale OPEC gave when it decided to defend market share in 2014 wasthat it wasn’t fair that their production restraint was helping prop up thehighest-cost producers (i.e., marginal shale oil producers). This is a validargument.

In most businesses, high-cost producers tend to get squeezed out ofthe market. OPEC was, in fact, propping up these producers by restrainingproduction and helping maintain elevated oil prices. Butfair or not, there were real consequences to OPEC’s strategy.

 Theysqueezed a few high-cost shale producers out of the market, but oil prices havedropped by more than 50% from the first half of 2014. Attempting to make things”fair,” in my opinion, was a TrillionDollar Miscalculation on OPEC’s part. The comments from theSecretary General may just mean that OPEC is hedging its bets. In its newlyreleased Monthly OilMarket Report, the cartel has again raised its demand forecast for2018. That is the third consecutive upward revision in OPEC’s 2018 demandforecast. The report even raised the possibility of a global supply deficit in2018 unless oil output is increased. Self-serving?Yes, but probably accurate.

And U.S. shale oil producers stand to benefit.


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