OPEC Behaviour and World Oil Prices

James M. Griffin, David J. Teece

• Publisher: Routledge
• Year: 2016
• Topic: Economics
• eBook ISBN:
  9781317237778
• Subtopic: Business General
• Index: Economics

This volume, originally published in 1982, brings together economists, political scientists and industry experts to explain OPEC's past achievements and future (in the early 1980s) prospects. The book opens with a clear, concise amd easy to follow treatment of the economics of exhaustible resources under monopoly and competition, the framework frequently used to examine pricing issues. The role of wealth maximisation, wealth satisficing and political factors as OPEC objectives are discussed and implications for world oil prices assessed. The stability of OPEC and the limitations of its pricing policy are examined and OPEC oil pricing and importers' policies analysed.

1
Introduction

JAMES M. GRIFFIN and DAVID J. TEECE

I Introduction

The decade of the 1970s ushered in a new epoch in the history of the world petroleum industry and in the economic power of the oil exporting nations. The price of oil at the end of the decade was about twenty times higher than it was at the beginning, with profound economic, political, and social consequences for consumers and producers.

The principal purpose of this book is not, however, to recount the tumultuous events of the 1970s; rather, we wish to gain insights into the price path for oil over the next two decades. Since this depends significantly on the production decisions of the oil exporting countries, we seek insights into the economic and political factors which will shape future crude oil production and export decisions.

Interest in the Organization of Petroleum Exporting Countries (OPEC), already awakened by the quadrupling of crude prices in 1973–74, surged dramatically in 1979 when oil prices doubled, but despite the enormous flurry of research activity occasioned by these events, OPEC behavior still elicits considerable puzzlement. Debates erupt over very basic matters, such as the degree to which OPEC is a cartel responsible for propping up the world price, or whether OPEC simply ratifies prices determined in an environment which is approximately competitive. It appears to us that OPEC behavior is not well understood, either by politicians, professional analysts, or the OPEC members themselves.

Indeed, professional analysts need little reminder that their understanding of OPEC and the world petroleum market has sometimes been wide of the mark. Professor Adelman reflected the views of many experts when he predicted in the 1960s that the world price of oil would approach the long run cost of extraction, which he estimated at just cents per barrel.¹ The events of 1973–74 took almost everyone by surprise, partially discrediting the earlier projections. However, for the most part, industry economists viewed the quadrupling of prices in 1973–74 as temporary. There were good theoretical and historical reasons to believe that cartels collapse under the weight of cheating,² and economists of no less renown than Nobel Laureate Milton Friedman predicted that prices would fall to competitive levels.³ If these dogma were not sufficient, an army of energy modelers came forth with energy models showing that OPEC had reached or over-stepped the limits of its monopoly power.⁴ Instead of collapsing, prices rose dramatically once again in 1978, and had reached $35–40 a barrel by 1981.

The events of 1978–79 seemed to fundamentally transform the views of many professional economists. The new orthodoxy of the early 1980s is that prices will continue to rise at a rate 3–4 percent faster than the rate of inflation, once the temporary glut evaporates. This view has become embedded in government policy and in the planning assumptions of the major petroleum companies.⁵ The new orthodoxy is set forth in the Stanford Energy Modeling Forum’s 1981 study of ten world oil price models. To summarize the findings of the forum, The unmistakable overall message is that the world price of oil, in real terms, can be expected to rise during the next several decades.’⁶

Admittedly, the above characterizations of the pre- and post-1978 orthodoxies do not do justice to the works of individual researchers who have either rejected or added important caveats in their endorsement of the conventional wisdom. But our purpose is not to berate the profession of which we are members. Rather we wish to emphasize the complexities and uncertainties of the world petroleum market, together with the specialized and often unrecognized assumptions of economic models. It is this last matter which is of critical importance. As Graham Alison demonstrated in his classic study of the Cuban missile crisis, analysts tend to use the conceptual lens of a particular analytic paradigm without being fully cognizant of its specialized characteristics.⁷ The unrecognized assumptions of a particular analytic perspective nevertheless often have important ramifications for the frame of reference which is adopted, the type of evidence which is considered relevant, and the predictions which are advanced.

This monograph enables the reader to compare, contrast, and synthesize various paradigmatic views of OPEC behavior. Too often researchers utilize a conceptual lens of a particular paradigm without recognizing its specialized characteristics. By assembling and integrating the writings of a group of distinguished scholars with backgrounds in economics, operations research, the petroleum industry, and political science, with known differences in views,⁸ we hope to highlight elements of commonality as well as disagreement. While we feel compelled to set forth our own views on the future of OPEC in the concluding chapter, we believe that the analytical process by which one reaches such conclusions are as essential as the conclusion itself.

Before discussing the future of OPEC and the path of oil prices, we must first consider: What is OPEC? Essentially four theories of OPEC are considered by three leading scholars of OPEC. These three include two economists, Professor Morris Adelman and Professor David Teece. The third is Professor Theodore Moran, a prominent political scientist specializing in the Middle East. Each sets forth a different perspective on the question: What is OPEC? Our thesis is that depending on how one characterizes OPEC, the implications for future oil prices are quite different. Thus Chapters 2, 3, and 4 are essential reading.

After the reader has formed an opinion on this fundamental question, he is then prepared to examine the market environment within which OPEC is likely to be confronted in future years. In Chapter 5, Mr John Lichtblau, a leading petroleum industry consultant, offers his characterization of the market OPEC will face in the years ahead. In Chapter 6, Professors George Daly, James Griffin, and Henry Steele apply modeling techniques to simulate oil demand, and OPEC and non-OPEC production for the period 1980 to 2000 under a variety of assumptions regarding economic growth and the price elasticity of oil demand.

In Chapter 7, Professor Robert Pindyck offers his own assessment of the future price path of oil as well as the importance of treating explicitly the large uncertainty that must be attached to any forecasted price path. Chapter 8, by Professor William Hogan, emphasizes that irrespective of the economic power attributes of OPEC, the consuming nations will continue to face serious security problems. Chapter 9, by Professors Griffin and Teece, summarizes the diversity of views on the important questions of the future of OPEC and the long run price path of oil. Particular attention is given to the policy implications arising from this analysis.

But before embarking on a demanding and, we hope, rewarding trip through the remaining eight chapters, the reader will need certain background information on the historical origin and development of OPEC, the economic theory of the pricing of nonrenewable resources, and a summary statement of four competing theories of OPEC. We now turn to each of these.

II OPEC: An Historical Overview of the Period 1960 to 1980

In 1960, when five major oil exporters – Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela – joined together to form the Organization for Petroleum Exporting Countries, certain observations were no doubt fresh on the founders’ minds. First, they were aware that there were substantial economic rents in the world oil market. The gap between the marginal production cost of oil of $.10 to $.20 per barrel and the price consumers paid for refined petroleum products was indeed large and only a small portion could be explained by transportation, refining, and marketing costs.⁹ In 1960, retail gasoline prices exceeded $30 per barrel in numerous European countries, owing to the large gasoline excise taxes collected by the consuming countries. The hefty taxes on petroleum products were rather revealing, at least to OPEC. Thus, rents were spread quite unevenly between the consuming country’s treasury, the international oil companies, and the oil producing countries.¹⁰ The existence of these rents, with a large portion accruing to the consuming countries and the international oil companies, no doubt created considerable resentment in the producing countries. Thus, an initial goal of OPEC was to wrest some of these economic rents from the international oil companies and the treasuries of the consuming nations.

Second, OPEC founders were quite disturbed that producing-country taxes per barrel had been declining systematically since 1957. The decline in these revenues could be traced to the declining world price of oil, which in turn resulted from the increasingly competitive nature of the world oil market due to the entry of many new firms. Table 1.1 shows the market shares of the largest four, the largest seven, and other companies. In 1950, the ‘Seven Sisters’ consisting of Esso (now Exxon), British Petroleum, Shell, Standard Oil of California, Mobil, Texaco, and Gulf accounted for virtually all of the oil production involved in international trade. As Figure 1.2 (later on) reveals, the difference in 1950 between the market price of $1.80 per barrel and the payment to the host country of $.60 per barrel left a margin of about $1.20 per barrel, reflecting production costs and profits. With such large profits, entrants explored for oil in areas not controlled by the original concessions. The effect of this new entry was evident by 1957 when the market shares of the seven largest producers had declined from 98 percent to 89 percent. As this trend continued, prices gradually declined until 1970, when the companies’ margins had fallen to a level consistent with long run competition. The demise of the ‘Seven Sisters’ would not have been a serious concern to OPEC except for the fact that in the mid-1950s exporter government taxes were based on 50 percent of the profits of the concessionaire. Thus, declining world oil prices posed as serious a threat to OPEC as it did to the international oil companies. Moreover, the declining per barrel taxes only exacerbated pressures for still lower prices. Host governments recognized that the only way to increase total tax revenues was to increase production. Thus during the 1950s, history is replete with examples of host countries pushing their concessionaires to increase production. This, of course, only put further downward pressure on prices.

Table 1.1 Percentage Market Shares of International Oil Companies in World Oil Market

	1950	1957	1969^a
Exxon	30.4	22.8	16.6
British Petroleum	26.3	14.4	16.1
Shell	13.8	17.5	13.3
Gulf	12.1	14.8	9.8
Largest four	82.6	69.5	55.8
Standard Oil of California	6.1	7.6	7.5
Texaco	5.7	6.9	8.0
Mobil	3.9	5.0	4.8
Largest seven	98.3	89.0	76.1
All others	1.8	11.1	23.9
TOTAL	100.	100.	100.

aFirst half of 1969.

Source: M. A. Adelman, The World Petroleum Market (Baltimore: Johns Hopkins University Press, 1972) pp. 80-1. Note this excludes production from North America and communist countries.

A third reality facing the OPEC founders was that 1960 world supply/demand cond...

Table of contents

• Cover Page
• Half Title page
• Title Page
• Copyright Page
• Title Page
• Copyright Page
• Contents
• Preface
• List of Contributors
• 1 Introduction
• 2 OPEC as a Cartel
• 3 OPEC Behavior: An Alternative View
• 4 Modeling OPEC Behavior: Economic and Political Alternatives
• 5 The Limitation to OPEC’s Pricing Policy
• 6 Recent Oil Price Escalations: Implications for OPEC Stability
• 7 OPEC Oil Pricing, and the Implications for Consumers and Producers
• 8 Policies for Oil Importers
• 9 Conclusions
• Bibliography
• Conference Participants on ‘The Future of Opec and the Long Run Price of Oil’ Sponsored by: Center for Public Policy University of Houston May 8, 1981
• Index