Organization of Petroleum Exporting Countries

If oil is the most important strategic commodity in the world, OPEC is the world’s most important cartel. Given the amount of control that the members of OPEC exert on the commodity markets over the world and thereby on the world economy, it would not be an exaggeration to call it the most powerful cartel in the world. The only other cartel that may provide some sort of competition is the diamond cartel.

It is said that when OPEC sneezes, commodity markets world over catch the cold. Hence it is imperative for any commodity investor to ensure that they understand what OPEC is and why was it formed.

What is OPEC ?

The organization of petroleum exporting countries is an international organization. This organization initially started with as little as 5 countries as their member. However, now they have close to 13 countries as their members. The number 13 may sound small and insignificant. However, that is not the case. Consider for instance, the fact that OPEC controls over three quarters of the world’s oil reserves and OPEC starts to look like a scary cartel that has the power to jam the wheels of the world economy whenever they wish to.

It is said that OPEC is both an economic body as well as a political one. It is effectively a cartel of countries that control the most strategic commodity and use this control to their advantage.

Is OPEC a Cartel ?

The word cartel has an extremely negative connotation in economics. This is because cartels are thought of as being greedy organizations that would bleed their customers to increase their profits. Time and again, OPEC has had such allegations leveled against them. Here are some of the characteristics that make OPEC a cartel.

  • Strategic Commodity: OPEC is in control of the world’s oil reserves. Had OPEC been in control off another insignificant commodity, let’s say, wheat, it would not have been such a prominent cartel. In the short run, the world comes to a grinding halt without enough oil. If on the other hand, there was a wheat shortage, people can always grow more barely or corn to offset the loss. Control over strategic resources ends up building dominating tendencies in organizations and is one of the reasons why OPEC behaves like a bully that it is often claimed to be.

  • Control and Shelf Life: Since OPEC can move the markets like nobody else can, OPEC has virtually unparalleled control over the oil markets. Oil has a limited shelf life. However, OPEC has the technology required to extend this limited life. Therefore, OPEC can afford to hold on for much longer than the consumers of oil can. This gives it unparalleled bargaining power. Exercising this bargaining power is what makes OPEC a powerful organization.

  • Barriers to Entry: Oil is a rare natural resource. Countries either have oil or they do not. At the present moment, there are no viable alternatives to oil either. Therefore the countries that do possess oil are in a commanding position and this position cannot be easily replicated making OPEC a powerful cartel.

Why is a Cartel Needed ?

Many consumer states argue that OPEC is detrimental to the oil industry. However, producer nations disagree. They believe that OPEC is not only an essential part of the marketing of oil but is absolutely necessary.

The foremost reason cited is the dependence of these countries on oil. Countries that produce oil almost exclusively produce only oil. They have very little other natural resources. Therefore, the entire economy revolves around the price of oil. When private companies engage in price manipulation, they end up impacting the livelihoods of millions of people as well as the GDP’s of entire nations. The price of oil has caused unrest in many nations and civil war has broken out as a result. To prevent this situation, these countries feel the need for a body that will regulate the price of oil.

Also, the tax revenues of these nations are excessively dependent on the price of oil. The incomes of the people in these nations fluctuate with the price of oil and so does the income tax collected. Also, indirect taxation on oil comprises the majority of the state’s budget. When prices are in decline, the state is unable to meet its budget and is forced to borrow money as a result.

Countries with oil reserves have a very nationalistic view of their oil. They believe that only their citizens must benefit from the proceeds of oil sales. Hence, they believe that a cartel is required to ensure that the state’s revenues remain stable.

Thanks to OPEC, the standard of life in most oil producing nations is better than the rest of the world. Countries like UAE have zero income tax and very little other taxation. Yet, the citizens have access to the best facilities in the world!

OPEC and Saudi Arabia

Although, OPEC has 13 members, it is often said that it is run single handedly by Saudi Arabia. The other major countries are either too small to match the clout of Saudi or they are in political unrest and are therefore unable to compete with Saudi.

OPEC has been accused of making decisions that are adverse to the interests of rest of the oil producing nations but are in line with Saudi’s interest. The resulting faction has considerably reduced the bargaining power of OPEC.

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