Imperfect Cartelization in OPEC

Samuel Okullo, F. Reynes

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Abstract

A model of global oil production is applied to study cartelization by OPEC countries. Writing out the shadow price on quota allocations so as to draw correspondence to coefficients of cooperation (Cyert et al. 1973), we examine the incentives that different OPEC members to collude. We find that heterogeneity in OPEC and the supplies of the non-OPEC fringe create strong incentives against OPEC cooperation. OPEC’s optimal supply strategy although observed to be substantially more restrictive than that of a Cournot-Nash oligopoly, is found to still be more accommodative than that of a perfect cartel. The strategy involves allocating larger than proportionate quotas to smaller and relatively costlier producers as if to bribe their participation in the cartel. This is contrary to predictions of the standard cartel model that such producers should be allocated relatively more stringent quotas. Furthermore, we find that cartel collusion is likely to be sustained for elastic than inelastic demand. Since global
oil demand is well known to be inelastic, this observation provides another structural explanation for why OPEC behavior is inconsistent with that of a perfect cartel. Our study points to multiple headwinds that limit OPECs ability to raise long-run global oil prices.
Original languageEnglish
Place of PublicationTilburg
PublisherCentER, Center for Economic Research
Number of pages30
Volume2016-011
Publication statusPublished - 21 Mar 2016

Publication series

NameCentER Discussion Paper
Volume2016-011

Fingerprint

Cartel
Incentives
Coefficients
Oil prices
Shadow price
Prediction
Participation
Supply strategy
Oil production
Bribes
Cournot-Nash
Collusion
Oligopoly

Keywords

  • imperfect cartels
  • oil
  • OPEC
  • Nash bargaining
  • cullusion strategies

Cite this

Okullo, S., & Reynes, F. (2016). Imperfect Cartelization in OPEC. (CentER Discussion Paper; Vol. 2016-011). Tilburg: CentER, Center for Economic Research.
Okullo, Samuel ; Reynes, F. / Imperfect Cartelization in OPEC. Tilburg : CentER, Center for Economic Research, 2016. (CentER Discussion Paper).
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Okullo, S & Reynes, F 2016 'Imperfect Cartelization in OPEC' CentER Discussion Paper, vol. 2016-011, CentER, Center for Economic Research, Tilburg.

Imperfect Cartelization in OPEC. / Okullo, Samuel; Reynes, F.

Tilburg : CentER, Center for Economic Research, 2016. (CentER Discussion Paper; Vol. 2016-011).

Research output: Working paperDiscussion paperOther research output

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AB - A model of global oil production is applied to study cartelization by OPEC countries. Writing out the shadow price on quota allocations so as to draw correspondence to coefficients of cooperation (Cyert et al. 1973), we examine the incentives that different OPEC members to collude. We find that heterogeneity in OPEC and the supplies of the non-OPEC fringe create strong incentives against OPEC cooperation. OPEC’s optimal supply strategy although observed to be substantially more restrictive than that of a Cournot-Nash oligopoly, is found to still be more accommodative than that of a perfect cartel. The strategy involves allocating larger than proportionate quotas to smaller and relatively costlier producers as if to bribe their participation in the cartel. This is contrary to predictions of the standard cartel model that such producers should be allocated relatively more stringent quotas. Furthermore, we find that cartel collusion is likely to be sustained for elastic than inelastic demand. Since globaloil demand is well known to be inelastic, this observation provides another structural explanation for why OPEC behavior is inconsistent with that of a perfect cartel. Our study points to multiple headwinds that limit OPECs ability to raise long-run global oil prices.

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Okullo S, Reynes F. Imperfect Cartelization in OPEC. Tilburg: CentER, Center for Economic Research. 2016 Mar 21. (CentER Discussion Paper).