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Cooperative and Non-Cooperative Behavior of Opec

Cooperative or Non-Cooperative Behavior of OPEC Is OPEC a classic example of an effective cartel?? What happens to world oil prices when OPEC practices cooperation?? Organization of Petrol Exporting Countries(OPEC) • Inter-governmental organization formed in 1960 by Iraq, Iran, Kuwait, Saudi Arabia and Venezuela • Currently has 12 members including Qatar Socialist People’s Libyan Arab Jamahiriya ,the United Arab Emirates , Algeria , Nigeria , and Angola . Objectives of OPEC To formulate policies in the interest of the member countries.

To regulate the world oil price and avoid harmful fluctuations. To maximize the profits for the producing countries. To ensure a healthy return on investments for the firms investing in oil exploration and production in the member countries as well as a regular supply to the customers. Why study OPEC OPEC-Annual Statistical Bulletin 2008. Why Study OPEC? • 79. 3% of proven oil reserve • 51. 1% reserves of natural gas • Produces 45. 6% of crude oil and 18. 5% of natural gas • Accounts for 60. % of total world crude oil exports • Thus OPEC being a dominant player in the oil industry indeed has assets to influence the market as a cartel OPEC-Annual Statistical Bulletin 2008. Evolution of OPEC and its policies Phase 1(1960-1970) Tax Reforms : • defined the goal of increasing the governments share from 50% to 80% through administrative and tax reforms Phase 2: 1970-1982 Market Fluctuations due to Wars and Nationalization Drive : • worked towards increasing the low oil prices set in from the end of the Second World War. • OPEC official price reached $11. 25 per barrel from the $2. 8 • influence of multinational companies was greatly reduced – enabled OPEC to sell the oil to customers willing to pay the official price Phase 3: (1982-Current) Individual Production Ceilings : • Individual production ceilings were introduced for the member countries. • A reference basket of oil was introduced which enables pricing of oil by the weighted sum of the oil types included in the basket. Prices soared to record levels in mid-2008 Barriers to effective Cartel 1. Non-Homogeneous Composition of OPEC. 2. Assigning Production Quotas. 3. Inefficient provision of finding and punishing the defaulters.

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Indonesia Nigeria Algeria Iran Venezuela Iraq Libya Saudi Arabia Qatar UAE Kuwait GDP($ per Capita) 1290 752 3113 2863 5240 1063 6618 12931 45937 29367 27028 Oil Reserve bbl/capita 20 275 373 1986 2990 3989 7084 11029 18455 21733 36775 OPEC annual statistical bulleton 2005 General Equilibrium Relationship : (Almoguera and Herrera ,2007) ???? 1 + ???? = ???? ???? ???? ?????? ????? ??? = ?????? where: ? = ?? ????? ???? ????? ???? : Ratio of OPEC and Non OPEC production ???? = ???? : Fraction of OPEC oil produced by ith member ?????? =0 ? it = si ? it = si/so

Perfectly Competitive Industry Cournot competition with a competitive fringe Cournot competition without a competitive fringe ?it = 1. 0 ?it = 1/s0 Efficient Cartel with a competitive fringe Efficient Cartel without a competitive fringe Econometric Model (Almoguera and Herrera ,2007) Demand Function: ?????????????? = ?? 0 + ?? 1 ???????? + ?? 2 ?????????? + ?? 3 ln(???????????? ) + ?? 4 ?????????????? ?? + ?? 1?? Supply Function(derived from the equilibrium relationship): = 1 for Cooperation = 0 for Non-Cooperation ???????? = ?? 0 + ?? 1 ?????????????? + ?? 2 ???????? + ?? 3 ???? + ?? 4 ???????????? + ?? ???????????????? + ?? 2?? Function of ?????? Hypothesis tested for the Model Hypothesis 1: ?? = 0 for Perfectly Competitive Behavior ?? = H ? 0. 08 for Cournot behavior with a fringe ?? = H/?? 0 ? 0. 19 for Cournot behavior without a fringe ?? = 1 for a perfectly collusive cartel with a fringe ?? = 1/?? 0 ? 2. 43 , for an efficient monopolistic cartel without a fringe. H= ?? 2 ? 0. 08 and assume ?? t = ?? for all t, ?? Hypothesis 2: If ? 3 > 0 then switches between collusive and non-cooperative behavior led to equilibrium prices being higher during collusive periods. POt Collusive behavior variable Cooperative 0 POt 0 Non-cooperative Oil Price Chronology of the U. S. Department of Energy (Energy Information Agency, 2007) Input Variable Used • Recall supply function: ???????? = ?? 0 + ?? 1 ?????????????? + ?? 2 ???????? + ?? 3 ???? + ? • 3-SLS – It = POt – POt data can estimate if collusive behavior affects production • MLE – POt used as an initial guess sequence for It – PNt the final collusive behavior variable is estimated using the E-M algorithm Results 3SLS with break Variables Demand Supply 6. 0161 constant 23. 2311 ln(???????? ) ln(?? ) -0. 2675 MLE with break Demand 21. 5946 Supply 1. 6773 -0. 2351 0. 6116 0. 790 -0. 5324 – -0. 4697 -0. 9486 0. 1161 0. 1761 0. 6457 0. 2838 -0. 3713 – ln(?????????? ) -1. 0990 war I break ? 0. 05243 Inferences 3-SLS • Price elasticity of demand: MLE – Negative at -0. 2675 – OPEC does not maximize profits as a dominant firm • Price shifts – 18% higher during cooperative periods – 61% higher when an OPEC country is involved in a war – 53% lower after the price decontrols in 1981 • Price elasticity of demand: – Negative at -0. 4697 – OPEC does not maximize profits as a dominant firm • Price shifts – 28% increase during periods of collusion – 65% higher when an OPEC country is involved in a war

Results from MLE contd… • ? = 0. 1161 at 1% level – roughly consistent with Cournot behavior with a competitive fringe (? ? 0. 08) • cannot reject the null that ? = 0. 08 at 5% level – on average over the 1974-2004 period, OPEC has not been effective in raising prices Cooperative periods • 11. 6% decrease in production • 14. 9% higher revenues Periods of war • 24. 4% decrease in production • 37. 2% increase in total revenue 3-SLS Vs MLE Almoguera and Herrera ,2007 • Probability of OPEC being in a cartel (19742004) – 3-SLS technique > POt > 0. 338 – MLE technique > PNt > 0. 352 Cartel or Cournot ?

Ceilings, OPEC Annual Statistical Bulletins; Actuals, U. S. Energy Information Administration Summary • Despite collusive behavior of OPEC at times, OPEC cannot be viewed as an effective cartel for the whole time period – Collusive behavior only 34% of the times • The world oil market (on an average from 19742004) can be described as Cournot competition with a competitive fringe (non-OPEC members) – Output is larger than in cartel but lower than in perfectly competitive market – Low price elasticity of demand Presentation byM Mayank Archit Garg D. Krishna Mohan Karan Singh Kathiar 06007036 07D10004 09302013 09302027

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