Opec has managed to come to agreement to extend cuts in production quotas among its various members. Those who are not formal members such as Malaysia also joined in the cuts for the next six months which ends in June this year.
This brings us to a statement issued by Economic Affairs Minister Datuk Seri Azmin Ali following the 5th Opec and non-Opec ministerial meeting in Vienna, Austria last December.
The minister said Malaysia via Petronas has agreed to continue its voluntary commitment to reduce its total oil output by 15,000 bpd. The aim, of course, as with any cartel, is to agree to lower production so that prices rise.
If they manage to get the price production level equation right they can gain higher income from less production. This is, again of course, what we expect of monopolists.
A cartel is an attempt to create a monopoly among a number of different producers, or at least gain something close to monopoly power so that monopolists’ trick of lowering production to get higher revenue can be pulled off.
But the problem here is that they don’t have as much market power as they would like. They don’t have the power that they used to have. So, is this something we need to worry about? The answer is, no, not really.
True, Opec still has some market power, but not all that much. They just don’t control enough of the market any more. They can push the oil price up a bit, that’s all. Definitely, not $140 a barrel and keep it there.
Therefore I personally think the whole minister’s agenda in the Opec meeting is not going to work, unless, as Azmin said, Malaysia stands in solidarity with other oil producing countries to achieve global market stability in the interest of all oil producers and consumers. The reason is it doesn’t seem to be the right thing to do.
Certainly, Malaysia can always try to stand in solidarity with other members, but we are usually sceptical of such a move because while it’s agreed that Opec might try it, they’re really not sure that anyone in the organisation ever manages to do it in a meaningful way.
We then have Azmin indicating that he’s going to protect the interest of all oil producers and consumers. We have just got two points contradicting each other here. And we can actually test them.
Oil producers, really? For a minister of economic affairs who should take the pain of cutting production and therefore income? Much of the benefit of doing so is going to flow to the others in Opec, so, why take pain yourself only to benefit others?
Not only that, when Opec tries to get all members and non-members to agree to production quotas, their aim is to restrict supply and thus raise prices.
If done well then the Opec members and non-members can be collectively better off as total income rises and, of course, consumers are collectively worse off! However, it depends on how it is happening.
If it is happening because we’re finally better off, the effects of the increased oil price or being better off could be greater than the effects of the oil price rise. It is very hard to tell.
Anyway we as consumers should hate such behaviour as it makes us poorer; we have less oil to consume and yet must give up more of our incomes to have it. Fortunately, Opec’s move is not always done well. There’s an incentive to cheat built in.
As production restraints push up the price, why not produce a little bit more, you know, just a little bit (without releasing it to the market immediately), to take advantage of the resulting higher prices?
And if only one member does it just a little (just a little bit, remember?) no problem would crop up. But if everyone cheats just a bit then the production restrictions are breached and all members lose.
It’s a nice example of the problem of Opec’s standard collective action. If everyone cheats then the higher prices cannot be reached or maintained. And then Opec’s hold over the prices is broken.
The end result of this is that, always, the price ends up falling below where it would have been in the absence of Opec in the first place. This happened with tin before and it did not work well.
Over time – enough time – competition will come from people figuring out new technological solutions to produce what is good, whatever it is. In the case of petroleum production, the solution is fracking (primarily in the US) which has driven prices down.
Unlike conventional oil producers, the frackers are operating under market rules. Clearly, private companies, undirected by Trump, Bin Salman or Putin, are better at extracting oil than Opec as technology has taken the market power away from politicians.
The oil price is now driven by the dispersed decisions of thousands of frackers. They have different production methods, incentives and economic model. They simply produce all the oil they can to maximize profits.
No, this is not to say that fracking technology is cheaper than what Opec conventionally used oil or anything like that. It’s just that the technology of fracking has entirely changed the elasticity (sensitivity) of supply of oil, which does change the whole market.
Just because certain oilfields spend $70 to produce a barrel there’s no certainty that oil prices will remain above the figure.
Who gets the profits – fracking companies or oil producers? This is an interesting question unless of course you’re a driller or an Opec member, in which case it becomes quite important.
To simplify this, compare it to the supermarket world. There is little complaint that a local supermarket’s price reductions benefit many workers outside of the retail sector. Surely, the savings from the supermarket alone are enormous per household. But, this is not actually what people save when shopping at this particular local supermarket. They save from the existence of market competition that this supermarket brings.
Their focus on low prices driven by their logistical efficiency means that all those involve must offer “better” prices.
That local supermarket mentioned above and its owners profit instead of their competitors is interesting but not important. What is important is that consumers benefit from the competition far more than anyone else in the equation. It is the very competition itself which leads to consumer gains.
As with the competition between the local supermarket and other supermarkets, so it is with Opec and frackers. Opec had a great deal of market power but their very actions have led to the development of the technologies that are undermining them today, which is why I think Azmin should stop wasting his time and taxpayers money to meet with Opec in the future.
The views expressed are those of the author and do not necessarily reflect the official policy or position of the New Sarawak Tribune.
