Question

Over the last 30 years the Organization of Petroleum Exporting Countries (OPEC) has had varied success in forming and maintaining its cartel agreements. Explain how the following factors may contribute to the difficulty of forming and/or maintaining its price and output agreements.

a. New oil fields are discovered and increased drilling is undertaken in the Gulf of Mexico and the North Sea by nonmembers of OPEC.

b. Crude oil is a product that is differentiated by sulfur content: it costs less to refine low-sulfur crude oil into gasoline. Different OPEC countries possess oil reserves of different sulfur content.

c. Cars powered by hydrogen are developed.

Answer 1

Answer.)

a.) With  the discovery of new oil by nonmembers of OPEC, there is increased competition. This will lead to a fall in market price and make the cartel agreement harder to maintain.

b.) The OPEC countries sell a differentiated and complex product. This complicates the decision about what prices to set for what types of oil and makes enforcement of a cartel agreement more difficult. Much of the conflict within OPEC rests on the price differential that is set between high- and low-quality oils.

c.)  The development of a hydrogen-powered car would make it more difficult to form or maintain an agreement. Remember that a cartel essentially acts like a monopoly. A cartel’s (or a monopoly’s) market power is eroded if there is entry of new firms or the development of substitute products.