OPEC - the Economics of a Cartel - Essay Example

Case Study OPEC-The Economics of a Cartel Oil is considered one of the most valuable possessions by a nation. OPEC has been playing a key role in deciding about the prices of the oil and the production quantities from time to time. Today's era is known for fast developing consumerism patterns. As the consumption grows, so does the use of resources. Consumption of energy, the all important resource for production of goods and services, is therefore on the rise. Oil and Gas form key energy sources and it is because of the fast growing consumerist society that despite a consistent increase in the crude oil prices over the years, its use has not decreased. Instead the use of oil and gas has kept growing over the years. Though the oil price are now on a declining trend, but in the recent past the world was worried by the way oil prices started marching upward, touching a level of about $130. Events following the mortgage crisis have now led to a fall in oil prices, thus making the OPEC nations sit up and take note. Price of any commodity in general is determined by the law of demand and supply. As per this law, 'all other factors remaining constant, the higher the price of a product, the less number of people will demand it. Or in other words, the higher the price, the lower the quantity demanded.' But if we look at the historical perspective, it is found that oil, the source of energy has also defied this law. The demand for oil continued to increase even when the prices kept increasing. With majority of the share going in favor of Middle-East nations, the oil is not only the source of energy, but in today's global scenario, it has become an important source of political power as well. As pointed out in the case study, US is one of the largest consumer of oil from OPEC nations, therefore the recession hit economy of US has certainly led to an economic downturn all over the globe in varying degrees. But if we take a historical perspective we find that till the early 1970s, the prices of crude oil kept hovering around $15-20. But the huge strength of oil was realized by the oil producing nations in 1973, when they all decided to stop exporting oil to US and other western nations, in retaliation to the US assistance to Israel in the Yom Kippur War1. Oil prices started moving upward all around the globe as it became a much desired commodity in the consumerist society in western nations. Since then the OPEC nations have seen many ups and downs. With leadership positions in oil production, many OPEC members have seen tremendous growth and advancement during the last 2-3 decades. OPEC-SWOT analysis Strengths i. About five decade old organization: OPEC came into being in the year 1960, with Iran, Iraq, Kuwait, Saudi Arabia and Venezuela as the founding members. The stated objectives of the intergovernmental group are to co-ordinate and unify petroleum policies amongst member countries, so that a fair and stable price can be extracted for petroleum products. Later on some more countries joined the group, thus providing the group further strength. The fact that, despite many hiccups during all these years, the group has been able to able to sustain its monopolistic standing and continues to define the oil prices, speaks volumes about its clout in world affairs. ii. Well-knit grouping: Though Ecuador and Gabon had to leave the grouping on account of some differences of opinion, but the rest of the group is still intact all through these years, despite having serious differences amongst some nations like Iran and Iraq, Kuwait and Iraq etc. The group seems to have developed good mutual understanding on protecting the economic interests of the member states. iii. Big say in deciding oil prices all over the world: OPEC certainly has a control in deciding about the oil prices and quantity to be produced in such a manner that while fulfilling the demand for fuel, the member states are also able to command a good price for the product. iv. Membership has a Premium Value attached with it: Though many countries have been producing oil from their domestic reserves, but the membership of OPEC makes it mandatory that the country must be a regular exporter of oil, after fulfilling the domestic needs. Therefore, not everybody is allowed to become a member of OPEC. v. Cost of oil production minimum in OPEC nations: The production cost of oil in OPEC nations is less than $5 per barrel, while in other countries this cost is on the higher side. Weaknesses i. Not able to attract more members: Some of the countries like Russia, Mexico, etc. have exported varying quantities of oil in the past, but they did not join the OPEC group. ii. Member countries economy Oil-dependent: Though the rich oil reserves are a big asset for the OPEC nations, but the over-dependence of their economies on the oil prices makes them quite sensitive to global impacts. For example, having seen a substantial gain in economic parameters during the late 1980s, the OPEC nations had to suffer adversely on account of currency crisis in the East Asian nations in 1997. iii. Too much dependence on American Market: As per the factual position stated in the case study, USA is the largest consumer of oil from OPEC nations. USA is stated to consume more than double of the Britons and Germans and 13 times as much as Chinese. But in the challenging times when US economy in under pressure, the OPEC group too feels the pinch. The present times can be categorised as one of the worst for the OPEC economies as well. Opportunities i. Growing industrial activities: The process of globalisation has given huge impetus to industrial activities all over the world. This has certainly provided a boost to the oil consumption in the recent past. ii. Peak achieved in most other oil producing nations: It has been pointed out in the case study that 42 nations of the world today produce 98 percent of the oil, 70 other nations produce just about 2 percent of oil and the remaining 70 countries do not produce any oil at all. It has further been pointed out that 14 out of these 42 nations have already achieved their peak in production, which implies that the production will be lesser from these countries in future. On the other hand, Saudi Arabia, a formidable member of OPEC is stated to control 16.3 percent of world's future oil supply. Threats i. The Recessionary Trends: The current recessionary trends around the globe, if keep on stretching for long, then it might prove to be very difficult for OPEC to keep oil prices at profitable levels. Till the early 2008, the world was surprised to see the way oil prices were nearing $130 per barrel, but just within a year the prices have come down to around $40 per barrel, which doesn't augur well for OPEC. ii. Decreasing share of OPEC nations in world oil production: OPEC envisaged to form a cartel, in such a manner that it is able to dictate the oil prices, but the manner in which the share of OPEC nations is falling down doesn't allow OPEC to have a firm control over the oil supply and prices. With fast depleting oil reserves, the situation might become truly worrisome for the group. iii. Increasing emphasis on alternative sources of energy: The world is today expressing concerns over the increasing levels of pollution in the environment and reducing the dependence on carbon producing fuels. Oil and its products are stated to be one of the reasons for leaving carbon footprints on our environment. Environmentalists have now started promoting alternative sources of energy like solar energy, nuclear energy etc. PESTEL Analysis A number of factors influence any company, a sector or the overall business environment. To analyze the macro-environment the industry has been making use of PESTEL analysis. PESTEL includes Political forces, Economic forces, Socio-cultural forces, Technological forces, Economic and Legal aspects affecting the business environment. Political: Oil is a much wanted resource around the world, which has given rise to political leanings depending upon the nation's requirements. During the Yom Kippur War when western nations supported Israel, the oil trade was adversely affected as the OPEC nations brought into effect an oil embargo on oil exports to countries seen in support of Israel. Some analysts also point out that the present crisis in Iraq is also because of the political reasons, besides of course the terror angle. Economic: 'Economics' is the key driver in carrying along the resources, benefits, and people to people exchanges. Today we are in an era when the power of a nation is being assessed not by its military arsenal but by its economic strength instead. Economic factors have forced many traditional rival nations to adopt friendly policies in order to have better economic exchanges. Oil based economies are certainly no exception. With better ties amongst the oil exporting and importing nations, the economies of both nations are bound to improve. On the other hand, if for example, the economy of an importing country suffers, this will lead to lesser import of oil, which in turn would affect the OPEC group. Socio-Cultural: If two nations have similar socio-cultural patterns, mutual understanding and cultural exchanges amongst the citizens, this gives rise to better trade and economic ties as well. Though OPEC is an organization meant to further the business and economic goals of the region, but the socio cultural ties definitely impacts the way business is conducted. The Middle East region for example is the one having similar thinking nations both culturally and socially, but the US and South Asian society on the other hand is different. Technological: Technology is indeed redefining the way we interact, we travel, we do the business, we offer our services etc. The heavy machinery and information technology in particular has made the business world tech-savvy, with advanced techniques helping out the industry as well as the customer in carrying out the business transactions. OPEC has gone a long way since the 1960s, when the task of analysis used to be on the basis of delayed data from different sources, but with the advancements in IT, the organization can access all relevant data instantly and devise strategies accordingly. Controlling the operating capacities more efficiently is also possible with the possible of technological advancements. E-commerce and m-commerce have also helped in shaping the business world of today. Legal: The law of the land the legal framework governing the organization impacts the functioning of the organization. In addition how the legal framework of the customer nations has advanced over the years also affects the business transactions. Often, cases like defaults in payments, monopolistic trade practices etc. gives rise to situations which calls for intervention of law of the land to settle the disputes. Therefore, a legal framework with internationally accepted laws helps in instilling a sense of confidence amongst the investors. Environmental: Today the world appears very much concerned about the impacts of imbalances as a result of increasing economic activities on environment. Globalization has also necessitated the need for uniformity in dealing with regulations concerning environment. Now encouragement is given to industries, which favor alternative fuel over coal and oil, as it lessens the possibility of acid rain and ozone layer depletion. Environmental regulations are being accordingly changed with a futuristic view on sustainable development and safeguarding environment. Therefore, this factor has become quite relevant for an organization like OPEC, as such measures need to be put in place which not only minimize the impacts on environment, but OPEC must also be seen as compensating for the damage to the environment. Today we are in an era when 'corporate social responsibility' has become the cornerstone of being seen as responsible. Porter's Five Forces analysis Porter came out with the five forces analysis, which helps in analyzing the attractiveness of an industry by taking into account different aspects of the business. Porter's Five Forces have become a yardstick for assessing industry profitability. This helps the retailer in consistent performance and planning. The five forces are; Buyers'/customers' power Suppliers' power Rivalry among competitors Threat of new entrants Threat of substitute products For the oil industry in general and the OPEC nations in particular the Five forces can be depicted as follows. Suppliers: For the oil industry in general and OPEC in particular, the suppliers include the instrumentation suppliers, the helicopter or aircraft suppliers used in monitoring the operations and ferrying the staff, maintenance companies and transporters for transporting the oil. It is worthwhile here to mention that a grouping like OPEC has some advantage over the suppliers, which helps the oil exploring companies in having an upper hand during price negotiations. With OPEC still commanding a monopolistic share in supply of oil to the world, the organization is a preferred customer for many suppliers as well. As there are not many countries around the world having oil exploration facilities, so the suppliers are not having many options to go around on the lookout for customers. But, it also needs to be emphasized that there are not many suppliers of such specialized equipment and machinery for the oil sector. Competition: OPEC nations still command a more than 60 percent of the export market share. As per the case study findings, only about 38 percent of oil is exported from non-OPEC countries. Therefore, it is amply clear that not much competition exists for OPEC nations in producing oil. Though in all more than 100 countries produce oil, but the fact that only about 42 countries command 98 percent of the market makes things rather easy for OPEC. Moreover, oil reserves happen to be natural to the geography of the region and cannot be produced artificially. Potential Entrants: As per the case study findings, out of the 42 nations commanding 98 percent of the oil export market, more than 14 have already achieved their production peak, thus implying that these countries are on their way out. On the other hand oil being extracted from natural reserves, not many countries can claim to find oil reserves on such scales. The manner in which oil consumption levels are going up, makes oil a scarce commodity for future. With almost nobody to enter the field, the OPEC nations command good leverage in this aspect as well. Buyer/ Customer's Power: If we go by the present circumstances, it is amply clear that OPEC nations are suffering because the industrialized world has lowered it oil consumption on account of recession in the industry. This might give an indication that the customers hold good power in deciding about the oil prices. But, it is equally pertinent here to note that the recession is not here because somebody wants it, instead it has come as a big problem for the industries around the globe. Therefore, the customers do not have much power which they can exercise over the oil producing companies and OPEC nations. In fact, just about a year back when the oil prices were on an upward march, many economies around the world were expressing apprehensions of inflating oil bills and industrial problems of a different kind. Substitutes: Oil sector as such is slightly under pressure for some time now from the NGOs and proponents of the environments. The environment degradation has started raising questions about the continuing usage of oil. Therefore, the industry has started exploring alternative fuels like Biomass, solar power, nuclear energy, tidal power, wind energy etc. Therefore, these alternative fuels can be stated to be the substitutes of oil. But, as per the available indications, OPEC doesn't have to worry too much, because the alternative fuels are still in nascent stages, and it might take long to make use of such fuels on wider scale. For example, Biomass generally comes from organic matter like crops and grasses or from the industrial and agricultural bio-products. This method is not considered as an efficient method as it requires proportionately large amount of biomass to generate electricity. While methods like nuclear energy, tidal power etc considered risky from many angles. The solar energy though is known to be one of the cleanest methods of electricity generation. But, it might take time to make it user friendly and cost-effective. Reference: Case Study: 'OPEC-The Economics of a Cartel (A)'. ICFAI Business School. Reference no-208-066-1 Read More