Oligopoly (OPEC)
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Transcript of Oligopoly (OPEC)
Oligopoly
An oligopoly is a market form in which a market or industry
is dominated by a small number of sellers (oligopolists). The
word is derived from the Greek for few (entities with the
right to sell). Because there are few participants in this type
of market, each oligopoly is aware of the actions of the
others. The decisions of one firm influence, and is
influenced by the decisions of other firms. Strategic
planning by oligopolists always involves taking into account
the likely responses of the other market participants. This
causes oligopolistic markets and industries to be at the
highest risk for collusion.
In an oligopoly, firms operate under imperfect competition
and a kinked demand curve which reflects inelasticity below
market price and elasticity above market price, the product
or service firms offer are differentiated and barriers to
entry are strong. Following from the fierce price
competitiveness created by this sticky-upward demand
curve, firms utilize non-price competition in order to accrue
greater revenue and market share.
"Kinked" demand curves are similar to traditional demand
curves, as they are downward-sloping. They are
distinguished by a hypothesized convex bend with a
discontinuity at the bend - the "kink". Therefore, the first
derivative at that point is undefined and leads to a jump
discontinuity in the marginal revenue curve.
Above the kink, demand is relatively elastic because all
other firms' prices remain unchanged. Below the kink,
demand is relatively inelastic because all other firms will
introduce a similar price cut, eventually leading to a price
war. Therefore, the best option for the oligopolist is to
produce at point E, which is the equilibrium point and,
incidentally, the kink point.
Classical economic theory assumes that a profit-maximizing
producer with some market power (either due to oligopoly or
monopolistic competition) will set marginal costs equal to
marginal revenue i.e. MC= MR.
This idea can be envisioned graphically by the intersection
of an upward-sloping marginal cost curve and a downward-
sloping marginal revenue curve (because the more one sells,
the lower the price must be, so the less a producer earns
per unit). In classical theory, any change in the marginal
cost structure or the marginal revenue structure will be
immediately reflected in a new price and quantity sold of the
item. This result does not occur if a "kink" exists. Because of
this, jump discontinuity in the marginal revenue curve,
marginal costs could change without necessarily changing
the price or quantity.
The motivation behind this kink is the idea that in an
oligopolistically competitive market, firms will not raise
their prices because even a small price increase will lose
many customers. However, even a large price decrease will
gain only a few customers, because such an action will begin
a price war with other firms. The curve is, therefore, more
price-elastic for price increases and less so for price
decreases. Firms will often enter the industry in the long
run.
Cartels
Cartels imply direct agreement among competing
oligopolists.
The aim is reducing uncertainty and maximization of
joint profits.
The firms appoint a central agency, which decides not
only the total quantity and the price but also the
allocation of production among the members of the
cartel and distribution of profits among them.
Forms of Cartels
There are two forms of cartels -
Cartels aiming at joint profit maximization.
Cartels aiming at sharing of the market.
In any cartel, success in the short run sets in motion events
which make maintaining success nearly impossible. A
successful cartel raises prices which encourage consumers
to cut demand and potential producers to enter the market.
OPEC (Organization of Petroleum Exporting Countries) is a permanent, inter-governmental
organization, established at the Baghdad Conference held in
Iraq, 10-14 September 1960, presently working with 13
nations. Its objective is to coordinate and unify
petroleum policies among Member Countries, in order to
secure a steady income to the producing countries, an
efficient, economic and regular supply of petroleum to
consuming nations; and a fair return on capital to those
investing in the petroleum industry.
In this report, we are going to analyze how the OPEC is
acting as oligopoly in petroleum industry, how OPEC has
impact on oil prices and how it impacts the economy of
world countries.
History of OPEC
Venezuela was the first country to move towards the
establishment of OPEC by approaching Iran, Iraq, Kuwait
and Saudi Arabia in 1949, suggesting that they exchange
views and explore avenues for regular and closer
communications between them.
In September 1960, at the initiative of the Venezuelan
Energy & Mines Ninister, Juan Pablo Pérez Alfonzo, and the
Saudi Arabian Energy & Mines Minister, Abdullah al-Tariki,
the governments of Iraq, Iran, Kuwait, Saudi Arabia and
Venezuela met in Baghdad to discuss the reduction in price
of crude oil produced by their respective countries.
OPEC was founded in Baghdad, triggered by a 1960 law
instituted by American President, Dwight Eisenhower, that
forced quotas on Venezuelan oil imports in favor of the
Canadian and Mexican oil industries. Eisenhower cited
national security, land access to energy supplies at times of
war.
Venezuela's President, Romulo Betancourt, reacted seeking
an alliance with oil producing Arab nations as a preemptive
strategy to protect the continuous autonomy and
profitability of Venezuela's natural resource, oil.
As a result, OPEC was founded to unify and coordinate
members' petroleum policies. Original OPEC members
include Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela.
Between 1960 and 1975, the organization expanded to
include Qatar (1961), Indonesia (1962), Libya (1962), the
United Arab Emirates (1967), Algeria (1969), and Nigeria
(1971). Ecuador and Gabon were members of OPEC, but
Ecuador withdrew on December 31, 1992 because they were
unwilling or unable to pay a $ 2 million membership fee and
felt that they needed to produce more oil than they were
allowed to under the OPEC quota.
Similar concerns prompted Gabon to follow suit in January
1995. Angola joined on the first day of 2007. Indonesia re-
considered its membership having become a net importer
and being unable to meet its production quota.
The United States was a member during its formal
occupation of Iraq via the Coalition Provisional Authority.
Indicating that OPEC is not averse to further expansion,
Mohammed Barkindo, OPEC's Secretary General, recently
asked Sudan to join. Iraq remains a member of OPEC,
though Iraqi production has not been a part of any OPEC
quota agreements since March 1998.
In May 2008, Indonesia left the OPEC group because of the
soaring prices and the rising oil demand in East Asia.
Economists think that the withdrawal of Indonesia will have
little effect on OPEC and on the oil prices even though it has
a high percentage in world oil production.
OPEC has stood the test of time, and since its creation, has
proven to be one of the most prosperous and effective
industrial monopoly alliances the world has known.
Notwithstanding OPEC's success as a market controlling
power, noncompliance and cheating by members have
caused some problems along the way. In order for a cartel to
successfully control a market, there must be complete
cooperation and trust among members.
OPEC's history exemplifies and supports this statement. In
1973 and 1974, all of OPEC's member nations worked
together under the parameters established by the
organization, and in turn, were able to raise the price of oil
four-fold. Contrarily, in 1995, OPEC set a price target of
twenty-one dollars, but as a result of deception and a lack of
trust among member states, some members exceeded their
quotas and the over-production and consequent flooding of
the market caused the price to fall well below the twenty-
one dollar goal. Still, despite devious actions by some
members taking advantage of the organization, OPEC
continues to hold sway over the trading of petroleum
globally. OPEC became oligopolist, because of its
competitors.
The success of OPEC in the 1970s triggered conservation,
substitution, and new production in the 1980s. While oil
prices are currently stable, it is clear that in the history of
OPEC and demand for oil will continue to rise. Moreover,
the lack of major oil finds in the last twenty years implies
(but obviously does not guarantee) that supply will grow
only slowly. Unless a cheap alternative source of energy is
discovered in the meantime, this combination of effects will
create an environment conducive to cartelization.
Impact of OPEC on Oil Prices
This table shows us how much the OPEC countries are
depending on oil exporting compared to total exports of
country.
OPEC
Member
Country
Total Value
of Exports
(Million US
Dollars)
Value of
Petroleum
Exports
(Million US
Dollars)
Percent of Total
Exports Made
Up of Petroleum
Exports
Venezuela18543 13737 74%
Nigeria 12087 11724 97%
Algeria 11046 7008 63%
Libya 7960 7763 98%
Saudi
Arabia50183 42502 85%
Iraq 567 461 81%
Iran 18346 14944 81%
Indonesia45417 6441 14%
Kuwait 13036 12217 94%
Qatar 3610 2987 83%
United
Arab
Emirates
24028 12349 51%
Data collected from official website of OPEC
(www.opec.org)
The table shows how much oil is being exported by OPEC
countries which are compared to the total exports of the
particular OPEC country. This total export is almost 41% of
total production oil worldwide and 15% of total production
of natural gas.
In the table, Libya, Saudi Arabia, Iraq, Nigeria, Iran,
Kuwait, Qatar are the countries which are exporting 80% of
oil in their total exports. These are the countries named as
oil ores of world . These 7 countries are exporting above
50% of share of OPEC exports and 30% in total exports of
oil worldwide.
Recently, the decline in oil prices is not only due to
economical crisis around the world but due to impact of
U.S.A. on Kuwait, which is one of OPEC country. Due to sub-
prime crisis, U.S.A. faced lack of liquidity cash, and then it
forced Kuwait to increase the crude oil production, which is
against the rules of OPEC, then the price of one barrel
reduced almost to $ 75 from $ 147.
Factors Affecting Oil Prices
There are so many factors which influence oil prices.
Industrialization, globalization, scarcity of crude oil
resources are some factors.
Now we are going to analyze the availability of (capacity)
crude oil resources and the demand for oil worldwide.
Source: Outlook Profit, Sep. 2008, Supplementary on OIL &
GAS Reckoner
The graph explains the capacity of crude oil from oil
exporting countries (including non-OPEC). In the graph, the
blue line indicates what the demand of oil from 2001 to 2008
is and the bars indicate the capacity of OPEC and non-OPEC
countries. From the graph, we can say that the demand for
oil is going on increasing but the capacity of production of
crude oil is comparatively less, which will cause increase in
the oil prices.
But in recent times, the crude oil price is reducing because
of stagflation worldwide, so the availability of liquid cash is
less, and the purchase capability of industries is reduced
due to the fluctuating economic conditions around the
world.
Impact of Oil Prices on Countries' Economies
Oil price has its own impact on global economy and
individual countries' economy.
Changes in oil prices have been associated with major
developments in the world economy, and are often seen as a
trigger for inflation and recession. The increase in oil prices
in 1974 and then again in 1979 were important factors in
producing a slowdown in the world economy at a time when
inflation was rising. Recent increases in oil prices have
caused concern.
The Effects of a $ 10 Permanent Oil Price Increase on
Long Rates (Percent Points Different from Baseline)
Source: Outlook Profit, Sep. 2008, Supplementary on OIL &
GAS Reckoner
The above graph shows how the higher oil prices affect
output. In the long run, output falls in the US, Europe and
the Euro Area. The short run output effects are largest in
the US in part because of its higher oil intensity, and also
because the inflation effect is larger, and hence, the
monetary response is more immediate. As a result, real long
rates rise rather more than in the Euro Area.
Impact of Oil Prices on Pakistan Economy
Energy demand in Pakistan grew by 9.2 percent during
2004-05. Supplies from nuclear and LPG also showed slight
increase. The share of natural gas in primary energy during
2004-05 reached upto 50.4% followed by oil 29.4%and LPG
0.4%.
Petroleum products and gas consumption accounts for
approximately 70 percent of modern energy supply in
Pakistan. Electricity (15 percent), LPG and coal account for
the balance. The transport sector is the largest user of
petroleum products (61.5 percent), followed by power (23.5
percent); industry accounts for about 10.5 percent, and the
balance is used in other sectors – including the residential
sector. In the case of natural gas, the power sector is the
largest consumer (43.7 percent), followed by industry,
fertilizer and residential sectors (about 52 percent);
commercial and transport sectors account for the balance.
The large dependence of the power sector on petroleum
products results due to fuel oil-based Independent Power
Plants (IPP).
Petroleum Products Supply and Demand
The petroleum products account for approximately 40
percent of modern energy consumption in Pakistan.
Consumption of petroleum products grew sharply during the
1980s at about 7 percent per annum, but slowed to about
2.5 percent during late 1990s and has gained a momentum
in 2004-05 of 9.31%. Oil products consumption is highly
skewed, with nearly 83 percent in the form of high speed
diesel (HSD) and fuel oil (FO). Only 18 percent of the liquid
fuel supplies are met from local sources, and the balance is
imported in the form of either crude oil or finished products.
Natural Gas50.4%
Oil29.4%
Hydel11.0%
LPG0.4%Coal
7.6%
Nuclear1.2%
Over the past three years, gross imports of liquid fuels have
averaged 23.1million tons (MMT) per annum, generating an
import bill of some US$5.8 billion.
The consumption of petroleum products in the country
during 2003-2004 was 14.3 million tones. The drop in
consumption compared to previous year is mainly due to
lower demand of Furnace Oil because of conversion of
thermal power plants on gas and availability of additional
Hydel power. The demand is expected to increase around 17
million tones per annum by the year 2010-11. Thereafter, it
is expected to further increase to around 19 million tones by
the year 2017-18. The production of refined products by the
local refineries during the year 2003-04 was 10.27 million
tons. The deficit products import were 5 million tons in
2003-04 while it will remain around 5-6 million tons per
annum up to year 2010-11. Thereafter, it is expected to
increase to a level of around 8.0 million tons per annum by
the year 2017-18.
The long term petroleum products demand/supply scenario
is indicated in the following table:-
PROJECTED DEMAND OF PETROLEUM PRODUCTS
(In million tones)
2003-
20042004-05 2010-11 2017-18
Demand of
Petroleum
Products
14.3 15.0 17.0 19.0
Production from
Local Refineries10.3 12.0 11.3 11.8
Surplus
Naphtha / Motor
gasoline available
for exports
1.3 1.3 0.8 0.8
Deficit of HSD
and FO5.0 5.0 6.5 8.2
Source: Ministry of Petroleum & Natural
Resources
PETROLEUM PRODUCTS CONSUMPTION BY SECTOR (In tones)
Sector 2005-06 2006-07 2007-08 2008-09Growth
Rate
Domestic 334,501 282,521 231,459 192,750 -16.1%
Industrial 1,611,995 1,604,068 1,493,080 1,542,398 -6.1%
Agriculture 225,742 196,747 183,506 142,062 -13.5%
Transport 8,018,777 8,082,273 8,464,042 9,024,783 1.7%
Power 6,305,419 6,019,958 2,739,763 3,452,581 -11.1%
Other Govt. 463,654 266,387 309,263 316,686 -1.8%
Total
Consumption
16,960,08
8
16,451,95
4
13,421,11
3
14,671,26
0-3.8%
Source: Energy Book 2009, Hydrocarbon Development
Institute of Pakistan.
IMPORT OF CRUDE OIL & PETROLEUM PRODUCTS(In million tones)
2003-
04
2004-
05
2005-
06
2006-
07
2007-
08
2008-
09
Import of
Crude Oil 4.45 7.03 7.07 7.14 7.84 8.28
Import of
Petroleum
Products 11.87 10.03 9.02 8.43 5.17 5.62
Total Imports 16.3 17.06 16.09 15.57 13.01 13.90
Value in
million US $ 2,783 3,326 2,655 3,096 3,119 4,534
Source: Energy Book 2009, Hydrocarbon Development
Institute of Pakistan.
4.457.03 7.07 7.14
7.84 8.28
11.87
10.03 9.02 8.43
5.17 5.62
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
Import of Crude Oil Import of Petroleum Products
EXPORT OF CRUDE OIL & PETROLEUM PRODUCTS (In
tones)
2005-
06
2006-
07
2007-
082008-09
Export of Crude Oil238,60
6
240,44
4
110,00
040,599
Export of
Petroleum Product
339,84
6
394,73
1
755,96
9955,754
Total Exports 578,45
2
635,17
5
865,96
9996,353
Value in million
US$114.95 160.55 203.78 354.92
Source: Energy Book 2009, Hydrocarbon Development
Institute of Pakistan.
355,881
433,425
238,606 240,444
110,00040,350
126,485
353,469
578,452 635,175
865,9691,011,995
0%
20%
40%
60%
80%
100%
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
Export of Crude Oil Export of Petroleum Products
Source: Energy Book 2005, Hydrocarbon Development
Institute of Pakistan.
Conclusion
From all the above discussions and data analysis, we
conclude that OPEC is an inter-governmental organization
which controls the major oil producing countries. Even
though the non-OPEC countries are also present but these
are not working under one umbrella which is causing
competition with each other, and there is no scope for other
countries to enter into the market because the crude oil
resources are limited.
Even the experts say that OPEC is monopoly, but due to the
presence of non-OPEC countries which will also affect the
oil prices and cause competition to affect fixing prices of
crude oil, which will shows us that OPEC is probably the
best example of oligopoly.
References
www.opec.org
Outlook Profit Supplementary September 2008 Edition,
which is published on OIL & GAS
The Economist
Organization of the Petroleum Exporting Countries
Monthly Oil Market Report, July 2008
www.google.com
www.wikipedia.com
www.worldbank.org
www.hdip.com.pk
www.dawn.com