The Organization of Petroleum Exporting Countries (OPEC) was founded in 1960 as a cartel of the world’s biggest oil suppliers to help them to control the oil price and their own share and profit (Mankiw, 2014, p. 356). Nowadays the organization consists of 12 countries: “Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela” (Smith & Habiby, 2010, para. 25). OPEC members possess about three-fourths of the world’s oil reserves and produce about 40% of the world’s oil (Smith & Habiby, 2010, para. 3; Krauss, 2011, para. 24). The influence that this cartel can have on the oil price is, therefore, immense.
However, OPEC has proved to be rather ineffective. While agreeing on certain quotas (that are changed over time as the demand for oil grows), the OPEC countries tend to break their own arrangements and produce more oil than they are supposed to in order to increase their market share and profit (Krauss, 2011, para. 24). What is more important, all the OPEC members appear to be involved in this cheating. As a result, for example, in the year 2010 OPEC exceeded its own quotas for an average of 1.934 million barrels per day (Smith & Habiby, 2010, para. 2).
The behavior of OPEC countries could be explained with the help of the so-called “prisoners’ dilemma”. It is a term of the game theory that describes the psychology of decision-making which is applicable to the situation. In short, cooperating and abiding by the agreements would bring most positive results only in case all the participants of the market play fair. At the same time, breaking an agreement may bring even better results to the one who breaks it in case the rest of the participants choose to play fair. Apart from that, the cheating strategy will minimize the damage in case other participants decide to break the rules as well. As a result, breaking the agreement becomes the dominant strategy for the market players, that it, the strategy that brings positive results regardless of the actions of other participants (Mankiw, 2014).
It is obvious that the dominant strategy for the OPEC countries consists in increasing their production and decreasing their prices. It has been concluded, that OPEC countries tend to define their strategies more and more independently and pursue their own goals and profit (Krauss, 2011). It proves that cooperation is indeed difficult to maintain despite the fact that the prisoners’ dilemma is being repeated over and over in this case. The situation on the market can, therefore, be described as a constant search for equilibrium. A Nash equilibrium is “a situation in which economic actors interacting with one another each choose their best strategy given the strategies the others have chosen” (Mankiw, 2014, p. 354). It is a natural occurrence for countries where antitrust laws do not allow oligopolistic companies to reach agreements on their prices through negotiations. At the same time, while OPEC countries could have achieved a more profitable equilibrium by collaborating, they seem to end up searching for the Nash equilibrium by taking into account the changing and independent strategies of their peers.
Therefore, the control that OPEC has over its own members is rather weak. At the same time, the world’s oil market appears to be interested in OPEC raising quotas or exceeding them (Smith & Habiby, 2010; Krauss, 2011). Apart from that, the behavior of OPEC countries distances the situation from that of a monopolistic market. As a result, the lack of agreement between OPEC countries becomes beneficial for the consumers (Mankiw, 2014).
References
Krauss, C. (2011). Split by Infighting, OPEC Keeps a Cap on Oil. The New York Times.
Mankiw, N. (2014). Principles of microeconomics (7th ed.). Stamford, CT: Cengage Learning.
Smith, G., & Habiby, M. (2010). OPEC Cheats Most Since 2004 as $100 Oil Heralds Supply. Bloomberg Business. Web.