Question

The opening statement on the website of the Organization of Petroleum Exporting Countries (OPEC) says its members seek “ to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry.” To achieve this goal, OPEC attempts to coordinate and unify petroleum policies by raising or lowering its members’ collective oil production. However, increased production by Russia, Oman, Mexico, Norway, and other non-OPEC countries has placed downward pressure on the price of crude oil. To achieve its goal of stable and fair oil prices, what must OPEC do to maintain the price of oil at its desired level? Do you think this will be easy for OPEC to do? Explain.

Short answer

There are great barriers to the entry of new oil producers. There are very few countries that serve many consumers. Thus OPEC countries produce a homogeneous good, and the agreements between the largest producers seeks to establish that the rival countries will hold their oil output constant if it changes its output.

Step-by-step solution

The role of the OPEC

The role of the OPEC in the world oil market is fundamental and indisputable. The members that make up this cartel comprise approximately of the world's crude oil production and own of crude oil reserves.

However, on numerous occasions, countries that are not members of this cartel that have a significant level of production such as Russia, Oman, Mexico, Norway, among others, may make decisions contrary to those established by OPEC to try to change the oil supply and capture a greater market share.

For example, between Russia decided that it was not going to cut its production, which caused prices to decrease by .Faced with this decision, Saudi Arabia decided not to follow the OPEC agreements to cut production and increased its crude production to start an oil war prices with Russia, which caused prices to decrease even more and will affect the balance of payments of the middle and small oil-producing countries.

Finding it will be easy for OPEC 

An alternative and solution that has been developed and has been gaining ground is OPEC+, which consists of a group of members (the members of OPEC plus members), in which agreements can be established together with all large producers inside and outside OPEC to decide production levels according to the supply and demand of the oil market.

This OPEC+ measure is related to the Cournot oligopoly which meets all the conditions:

• There are great barriers to the entry of new oil producers,
• There are very few countries that serve many consumers,
• They produce a homogeneous good,