CASE STUDY

OPEC AND THE WORLD OIL MARKET

Our story about the town’s market for water is fictional, but if we change water to crude oil, and Jack and Jill to Iran and Iraq, the story is close to being true. Much of the world’s oil is produced by a few countries, mostly in the MIddle East. These countries together make up an oligopoly, Their decisions about how much oil to pump are much the same as Jack’s and Jill’s decisions about how much water to pump.

The problem that OPEC faces is much the same as the problem that Jack and Jill face in our story. The OPEC countries would like to maintain a high price of oil. But each member of the cartel is tempted to increase its production to get a larger share of the total profit. OPEC members frequently agree to reduce production but then cheat on their agreements.

OPEC was most successful at maintaining cooperation and high prices from 1973 to 1985. The price of crude oil rose from $3 a barrel in 1972 to $11 in 1974 and then to $35 in 1981. But in the earlv 1~80s, member countries began arguing about production levels, and OPEC became ineffective at maintainingcooperation. By 1986, the price of crude oil had fallen back to $13 a barrel.

In recent years, the members of OPEC have continued to meet regularly, but the cartel has been less successful at reaching and enforcing agreements. Although the price of oil rose significantly in 2005, the primary cause was increased demand in the world oil market, largely from a booming Chinese economy, rather than restricted supply. Moreover, the price of crude oil, adjusted for overall inflation, has never again
reached the peak levels of 1981 (which, in today’s dollars, is about $90 a barrel). While this lack of cooperation among OPEC nations has hurt the profits of the oil-producing nations, it has benefited consumers around the world.

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