Having shown at least to my own satisfaction that the reason for this war -- even the oil reasons for this war -- have nothing to do with intelligent economics, I'd like to return to the discussion some of us we were having about the economics of Opec. It may not explain the war, but it's still inherently interesting.
My first suggestion is that we should give up the sterile opposition of Opec as a monopoly vs. the oil market as purely competitive. I think it's clear both are too crude to be useful.
I think instead the dynamics of Opec turn around two questions:
1. Under what conditions is Opec able to exercise a corner? And how much does it make out of it? (My model of a corner just because it is ready to hand is what the electricity producing companies were able to do in California in the summer of 2001, even though the underlying conditions before and after were those of electricity glut.)
BTW, does anyone know if there are any mathematical models of cornering?
2. How much power does Saudi Arabia have over its fellow Opec members (and non-Opec countries) to force them fall into line when such moments present themselves?
I think those are the two key questions when it comes to Opec and that if we settle them, we can move onto other more subtle ones.
The main other question I would like to ask is -- If Saudi Arabia does have considerable power over other producers, is it exercising that power in a way that benefits it? Or is it costing it more to discipline others than it makes in cornered rents?
My cursory study of the last 20 years of oil history makes me think that Saudi Arabia's position in Opec might be kind of like a Keiratsu that fights for market share at the expense of profits. It's gone from a $140 billion cash surplus in 1982 to a $130 billion national debt today. And during that period most of its effort seems to have been directed towards keeping prices low. This seems like a power that's benefited consumers more than producers. To take another indicator of the basic long term lowness of real oil prices: when the oil crisis hit in the 1970s, the US was filled with huge Buicks and Cadillacs, all of which disappeared fairly quickly to be replaced by energy efficient small cars. In the 90s the country filled back up with SUVs that make the old Cadillacs look downright modest.
BTW, I turned up a couple of statistics apropos Shane's question of whether Opec has ever affected the market in the last two decades. I had answered at the time that Opec affected things in 1998. But the extent of its action, and its effect, was more enormous than I gave it credit for. Benchmark oil in 1998 was going for close to $8 a barrel, the lowest recorded price in 1973. Then Opec initiated production cuts that totaled 5 million barrels a day total -- an enormous restriction of output. And oil prices have remained above $22 bbl ever since. Accidents like the Venezuela lockout have helped of course. But on the other hand Russia has done everything it could to hurt. Overall, it seems like a damned effective bit of action. And a large part of why other countries went along with it seems to be that Saudi Arabia flooded the market during the 90s to bring them all to their knees -- and succeeded. Although whether it was worth the price is something I haven't worked out yet.
This also raises another interesting question, namely Russia. Most of us have long forgotten that the Soviet in the last year of its existence pumped 12.5 million barrels of oil a day -- 2 million more than Saudi Arabia's maximum. Today that production is spread out among several countries, but Russia's production alone might soon rival Saudi Arabia's if current investment and pipeline schemes pan out fully. It's an interesting thing to think about for the future of Saudi Arabia's (or anyone else's) market power position. And for Russia's interest in events that might impinge on the oil market.
Anyway, having looked around, I've come to the conclusion that that WSJ article that Christian posted last week about the history of the oil market was wrong more than it was right.
It was right about oil prices being low most of that time, and it brought back to memory that hilarious bit of cognitive dissonance when Bush Senior made his trip to Saudi Arabia in 1986 to get them to raise the oil price to help US domestic producers.
It left out, however, the main political justification for that trip, which was that Texas was in a devasting depression at the time while most of the rest of the country was enjoying the height of the Reagan boom. And more importantly and weirdly, the reporters seemed to think that Saudi Arabia was attacking *us* with low prices. Which makes no sense to me at all. To discipline fellow Opec members, or non members, in order to overcome the free rider problem, that makes perfect sense. But there's was no point is lowering prices on America. We not only weren't going to ever join in restricting output, we were going to use high prices to increase our output. And while I wouldn't be surprised to hear that the Saudis sold it as a concession to America, I don't think that's actually why they reversed policy. (See below.) I think they finessed it to get diplomatic credit for something they did for other reasons.
Secondly it left out the Iran/Iraq war (seen as a matter of life and death by SA and Gulf States, for which cash was needed and losses could be rationally borne); the "tanker war" of 1986 (where the US quite patently took Iraq's side in the war by sending warships and attacking Iran directly, in order to keep it from attacking Kuwait. (Remember when we shot down their jetliner? Neither does anyone else outside the Middle East)); and the post-war dispute between Kuwait and UAE and Iraq.
At any rate, below is an alternate account of the same historical period. I think it fails to account for just how long oil prices were relatively low. It seems to concentrate only on when prices were absolutely crashed, i.e, close to $10 in today's dollars, and ignores the longer periods when they were under $20 in today's dollars. And like the WSJ account, it leaves out a lot of episodes that sure seem like they should have mattered. But I think it presents a more plausible account of the basic dynamics. It's from an article in last years March/April issue of Foreign Affairs by Edward Morse and James Richard:
<quote>
In 1985, Saudi Arabia successfully waged a price war designed to force other oil producers to stop "free riding" on Saudi oil policy. That policy meant that those states had to cooperate with the kingdom by reining in production enough to allow Saudi Arabia to produce the minimum level that it targeted. Oil prices fell by more than half within a few months, and Saudi Arabia immediately regained the market share it had lost in the preceding four years, mainly to non-Opec countries.
Then, in the 1990s, Opec member Venezuela challenged Saudi Arabia by deciding to maximize its production. Although Venezuela had an Opec quota of 2.3 mbd, Caracas embarked on an ambitious policy designed to eventually triple its production capacity. Caracas knew it could not do this on its own, so it reopened its nationalized resource sector to foreign investment. By the winter of 1996-97, Caracas was producing 3 mbd, knocking Saudi Arabia from its position as number one supplier to the United States. In response, Riyadh first tried reasoning with Caracas. When diplomacy failed, Saudi Arabia raised its production by close to 1 mbd and induced the oil price collapse of 1998. Riyadh's actions were tough but effective. By engineering a price drop, it had to withstand a painful drop in income -- but it achieved its main goals. Saudi Arabia reasserted its Opec leadership, reestablished itself as the prime supplier of oil to the United States, and induced non-Opec producers Mexico and Norway to support Opec's revenue-maximizing goals.
<end quote>
Not to mention that induced a new government in Caracas that whole heartedly supported Opec policy. Although I have to admit, as fascinating as this emphasis on Venuzeula is, I think it's an overemphasis. Still, it's an interesting picture in simplified form, no?
Michael