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Oligopoly

An oligopoly is a market form in which a market or industry


is dominated by a small number of sellers (oligopolists). The
word is derived from the Greek for few (entities with the
right to sell). Because there are few participants in this type
of market, each oligopoly is aware of the actions of the
others. The decisions of one firm influence, and is influenced
by the decisions of other firms. Strategic planning by
oligopolists always involves taking into account the likely
responses of the other market participants. This causes
oligopolistic markets and industries to be at the highest risk
for collusion.

In an oligopoly, firms operate under imperfect competition


and a kinked demand curve which reflects inelasticity below
market price and elasticity above market price, the product
or service firms offer are differentiated and barriers to entry
are strong. Following from the fierce price competitiveness
created by this sticky-upward demand curve, firms utilize
non-price competition in order to accrue greater revenue and
market share.

"Kinked" demand curves are similar to traditional demand


curves, as they are downward-sloping. They are
distinguished by a hypothesized convex bend with a
discontinuity at the bend - the "kink". Therefore, the first
derivative at that point is undefined and leads to a jump
discontinuity in the marginal revenue curve.
Above the kink, demand is relatively elastic because all other
firms' prices remain unchanged. Below the kink, demand is
relatively inelastic because all other firms will introduce a
similar price cut, eventually leading to a price war.
Therefore, the best option for the oligopolist is to produce at
point E, which is the equilibrium point and, incidentally, the
kink point.
Classical economic theory assumes that a profit-maximizing
producer with some market power (either due to oligopoly or
monopolistic competition) will set marginal costs equal to
marginal revenue i.e. MC= MR.

This idea can be envisioned graphically by the intersection of


an upward-sloping marginal cost curve and a downward-
sloping marginal revenue curve (because the more one sells,
the lower the price must be, so the less a producer earns per
unit). In classical theory, any change in the marginal cost
structure or the marginal revenue structure will be
immediately reflected in a new price and quantity sold of the
item. This result does not occur if a "kink" exists. Because of
this, jump discontinuity in the marginal revenue curve,
marginal costs could change without necessarily changing
the price or quantity.

The motivation behind this kink is the idea that in an


oligopolistically competitive market, firms will not raise their
prices because even a small price increase will lose many
customers. However, even a large price decrease will gain
only a few customers, because such an action will begin a
price war with other firms. The curve is, therefore, more
price-elastic for price increases and less so for price
decreases. Firms will often enter the industry in the long run .

Cartels

• Cartels imply direct agreement among competing


oligopolists.

• The aim is reducing uncertainty and maximization of


joint profits.

• The firms appoint a central agency, which decides not


only the total quantity and the price but also the
allocation of production among the members of the
cartel and distribution of profits among them.

Forms of Cartels

There are two forms of cartels -

• Cartels aiming at joint profit maximization.


• Cartels aiming at sharing of the market.

In any cartel, success in the short run sets in motion events


which make maintaining success nearly impossible. A
successful cartel raises prices which encourage consumers to
cut demand and potential producers to enter the market.
OPEC (Organization of Petroleum Exporting
Countries) is a permanent, inter-governmental
organization, established at the Baghdad Conference held in
Iraq, 10-14 September 1960, presently working with 13
nations. Its objective is to coordinate and unify
petroleum policies among Member Countries, in order to
secure a steady income to the producing countries, an
efficient, economic and regular supply of petroleum to
consuming nations; and a fair return on capital to those
investing in the petroleum industry.

In this report, we are going to analyze how the OPEC is


acting as oligopoly in petroleum industry, how OPEC has
impact on oil prices and how it impacts the economy of world
countries.
History of OPEC

Venezuela was the first country to move towards the


establishment of OPEC by approaching Iran, Iraq, Kuwait and
Saudi Arabia in 1949, suggesting that they exchange views
and explore avenues for regular and closer communications
between them.

In September 1960, at the initiative of the Venezuelan


Energy & Mines Ninister, Juan Pablo Pérez Alfonzo, and the
Saudi Arabian Energy & Mines Minister, Abdullah al-Tariki,
the governments of Iraq, Iran, Kuwait, Saudi Arabia and
Venezuela met in Baghdad to discuss the reduction in price
of crude oil produced by their respective countries.

OPEC was founded in Baghdad, triggered by a 1960 law


instituted by American President, Dwight Eisenhower, that
forced quotas on Venezuelan oil imports in favor of the
Canadian and Mexican oil industries. Eisenhower cited
national security, land access to energy supplies at times of
war.

Venezuela's President, Romulo Betancourt, reacted seeking


an alliance with oil producing Arab nations as a preemptive
strategy to protect the continuous autonomy and profitability
of Venezuela's natural resource, oil.

As a result, OPEC was founded to unify and coordinate


members' petroleum policies. Original OPEC members include
Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Between
1960 and 1975, the organization expanded to include Qatar
(1961), Indonesia (1962), Libya (1962), the United Arab
Emirates (1967), Algeria (1969), and Nigeria (1971). Ecuador
and Gabon were members of OPEC, but Ecuador withdrew on
December 31, 1992 because they were unwilling or unable to
pay a $ 2 million membership fee and felt that they needed
to produce more oil than they were allowed to under the
OPEC quota.
Similar concerns prompted Gabon to follow suit in January
1995. Angola joined on the first day of 2007. Indonesia re-
considered its membership having become a net importer
and being unable to meet its production quota.

The United States was a member during its formal occupation


of Iraq via the Coalition Provisional Authority. Indicating that
OPEC is not averse to further expansion, Mohammed
Barkindo, OPEC's Secretary General, recently asked Sudan to
join. Iraq remains a member of OPEC, though Iraqi production
has not been a part of any OPEC quota agreements since
March 1998.

In May 2008, Indonesia left the OPEC group because of the


soaring prices and the rising oil demand in East Asia.
Economists think that the withdrawal of Indonesia will have
little effect on OPEC and on the oil prices even though it has
a high percentage in world oil production.

OPEC has stood the test of time, and since its creation, has
proven to be one of the most prosperous and effective
industrial monopoly alliances the world has known.
Notwithstanding OPEC's success as a market controlling
power, noncompliance and cheating by members have
caused some problems along the way. In order for a cartel to
successfully control a market, there must be complete
cooperation and trust among members.

OPEC's history exemplifies and supports this statement. In


1973 and 1974, all of OPEC's member nations worked
together under the parameters established by the
organization, and in turn, were able to raise the price of oil
four-fold. Contrarily, in 1995, OPEC set a price target of
twenty-one dollars, but as a result of deception and a lack of
trust among member states, some members exceeded their
quotas and the over-production and consequent flooding of
the market caused the price to fall well below the twenty-one
dollar goal. Still, despite devious actions by some members
taking advantage of the organization, OPEC continues to hold
sway over the trading of petroleum globally. OPEC became
oligopolist, because of its competitors.

The success of OPEC in the 1970s triggered conservation,


substitution, and new production in the 1980s. While oil
prices are currently stable, it is clear that in the history of
OPEC and demand for oil will continue to rise. Moreover, the
lack of major oil finds in the last twenty years implies (but
obviously does not guarantee) that supply will grow only
slowly. Unless a cheap alternative source of energy is
discovered in the meantime, this combination of effects will
create an environment conducive to cartelization.

Impact of OPEC on Oil Prices

This table shows us how much the OPEC countries are


depending on oil exporting compared to total exports of
country.

Value of
Total Value Percent of Total
OPEC Petroleum
of Exports Exports Made
Member Exports
(Million US Up of Petroleum
Country (Million US
Dollars) Exports
Dollars)

18543 13737 74%


Venezuela
Nigeria 12087 11724 97%
Algeria 11046 7008 63%
Libya 7960 7763 98%
Saudi
50183 42502 85%
Arabia
Iraq 567 461 81%
Iran 18346 14944 81%

45417 6441 14%


Indonesia
Kuwait 13036 12217 94%
Qatar 3610 2987 83%
United
Arab 24028 12349 51%
Emirates

Data collected from official website of OPEC


(www.opec.org)

The table shows how much oil is being exported by OPEC


countries which are compared to the total exports of the
particular OPEC country. This total export is almost 41% of
total production oil worldwide and 15% of total production of
natural gas.

In the table, Libya, Saudi Arabia, Iraq, Nigeria, Iran, Kuwait,


Qatar are the countries which are exporting 80% of oil in
their total exports. These are the countries named as oil
ores of world. These 7 countries are exporting above 50%
of share of OPEC exports and 30% in total exports of oil
worldwide.

Recently, the decline in oil prices is not only due to


economical crisis around the world but due to impact of
U.S.A. on Kuwait, which is one of OPEC country. Due to sub-
prime crisis, U.S.A. faced lack of liquidity cash, and then it
forced Kuwait to increase the crude oil production, which is
against the rules of OPEC, then the price of one barrel
reduced almost to $ 75 from $ 147.
Factors Affecting Oil Prices

There are so many factors which influence oil prices.


Industrialization, globalization, scarcity of crude oil
resources are some factors.

Now we are going to analyze the availability of (capacity)


crude oil resources and the demand for oil worldwide.

Source: Outlook Profit, Sep. 2008, Supplementary on OIL &


GAS Reckoner

The graph explains the capacity of crude oil from oil


exporting countries (including non-OPEC). In the graph, the
blue line indicates what the demand of oil from 2001 to 2008
is and the bars indicate the capacity of OPEC and non-OPEC
countries. From the graph, we can say that the demand for
oil is going on increasing but the capacity of production of
crude oil is comparatively less, which will cause increase in
the oil prices.

But in recent times, the crude oil price is reducing because


of stagflation worldwide, so the availability of liquid cash is
less, and the purchase capability of industries is reduced due
to the fluctuating economic conditions around the world.

Impact of Oil Prices on Countries' Economies

Oil price has its own impact on global economy and


individual countries' economy.

Changes in oil prices have been associated with major


developments in the world economy, and are often seen as a
trigger for inflation and recession. The increase in oil prices
in 1974 and then again in 1979 were important factors in
producing a slowdown in the world economy at a time when
inflation was rising. Recent increases in oil prices have
caused concern.

The Effects of a $ 10 Permanent Oil Price Increase on


Long Rates (Percent Points Different from Baseline)

Source: Outlook Profit, Sep. 2008, Supplementary on OIL &


GAS Reckoner

The above graph shows how the higher oil prices affect
output. In the long run, output falls in the US, Europe and the
Euro Area. The short run output effects are largest in the US
in part because of its higher oil intensity, and also because
the inflation effect is larger, and hence, the monetary
response is more immediate. As a result, real long rates rise
rather more than in the Euro Area.

Impact of Oil Prices on Pakistan Economy

Energy demand in Pakistan grew by 9.2 percent during 2004-

05. Supplies from nuclear and LPG also showed slight

increase. The share of natural gas in primary energy during

2004-05 reached upto 50.4% followed by oil 29.4%and LPG

0.4%.

Petroleum products and gas consumption accounts for

approximately 70 percent of modern energy supply in

Pakistan. Electricity (15 percent), LPG and coal account for

the balance. The transport sector is the largest user of

petroleum products (61.5 percent), followed by power (23.5

percent); industry accounts for about 10.5 percent, and the

balance is used in other sectors – including the residential

sector. In the case of natural gas, the power sector is the

largest consumer (43.7 percent), followed by industry,

fertilizer and residential sectors (about 52 percent);

commercial and transport sectors account for the balance.

The large dependence of the power sector on petroleum

products results due to fuel oil-based Independent Power

Plants (IPP).
Nuclear LPG
Coal 1.2% 0.4%
7.6%

Hydel Natural Gas


11.0% 50.4%

Oil
29.4%

Petroleum Products Supply and Demand

The petroleum products account for approximately 40

percent of modern energy consumption in Pakistan.

Consumption of petroleum products grew sharply during the

1980s at about 7 percent per annum, but slowed to about 2.5

percent during late 1990s and has gained a momentum in

2004-05 of 9.31%. Oil products consumption is highly

skewed, with nearly 83 percent in the form of high speed

diesel (HSD) and fuel oil (FO). Only 18 percent of the liquid

fuel supplies are met from local sources, and the balance is

imported in the form of either crude oil or finished products.

Over the past three years, gross imports of liquid fuels have

averaged 23.1million tons (MMT) per annum, generating an

import bill of some US$5.8 billion.


The consumption of petroleum products in the country during

2003-2004 was 14.3 million tones. The drop in consumption

compared to previous year is mainly due to lower demand of

Furnace Oil because of conversion of thermal power plants

on gas and availability of additional Hydel power. The

demand is expected to increase around 17 million tones per

annum by the year 2010-11. Thereafter, it is expected to

further increase to around 19 million tones by the year 2017-

18. The production of refined products by the local refineries

during the year 2003-04 was 10.27 million tons. The deficit

products import were 5 million tons in 2003-04 while it will

remain around 5-6 million tons per annum up to year 2010-

11. Thereafter, it is expected to increase to a level of around

8.0 million tons per annum by the year 2017-18.

The long term petroleum products demand/supply scenario is

indicated in the following table:-

PROJECTED DEMAND OF PETROLEUM PRODUCTS


(In million tones)

2003-
2004-05 2010-11 2017-18
2004
Demand of
Petroleum 14.3 15.0 17.0 19.0
Products

Production from
10.3 12.0 11.3 11.8
Local Refineries

Surplus Naphtha /
Motor gasoline
1.3 1.3 0.8 0.8
available for
exports
Deficit of HSD
5.0 5.0 6.5 8.2
and FO

Source: Ministry of Petroleum & Natural


Resources

PETROLEUM PRODUCTS CONSUMPTION BY SECTOR


(In tones)
Growth
Sector 2005-06 2006-07 2007-08 2008-09
Rate
Domestic 334,501 282,521 231,459 192,750 -16.1%
Industrial 1,611,995 1,604,068 1,493,080 1,542,398 -6.1%
Agriculture 225,742 196,747 183,506 142,062 -13.5%
Transport 8,018,777 8,082,273 8,464,042 9,024,783 1.7%
Power 6,305,419 6,019,958 2,739,763 3,452,581 -11.1%
Other Govt. 463,654 266,387 309,263 316,686 -1.8%
Total 16,960,08 16,451,95 13,421,11 14,671,26
-3.8%
Consumption 8 4 3 0
Source: Energy Book 2009, Hydrocarbon Development Institute
of Pakistan.
IMPORT OF CRUDE OIL & PETROLEUM PRODUCTS
(In million tones)
2003- 2004- 2005- 2006- 2007- 2008-
04 05 06 07 08 09

Import of
Crude Oil 4.45 7.03 7.07 7.14 7.84 8.28

Import of
Petroleum
Products 11.87 10.03 9.02 8.43 5.17 5.62

Total Imports 16.3 17.06 16.09 15.57 13.01 13.90

Value in
million US $ 2,783 3,326 2,655 3,096 3,119 4,534

Source: Energy Book 2009, Hydrocarbon Development


Institute of Pakistan.

100%

90%

80% 5.17 5.62


9.02 8.43
70% 10.03
11.87
60%

50%

40%

30% 7.84 8.28


20% 7.03 7.07 7.14
10% 4.45

0%

2003-04 2004-05 2005-06 2006-07 2007-08 2008-09


Import of Crude Oil Import of Petroleum Products
EXPORT OF CRUDE OIL & PETROLEUM PRODUCTS
(In
tones)
2005- 2006- 2007-
2008-09
06 07 08
238,60 240,44 110,00
Export of Crude Oil 40,599
6 4 0
Export of 339,84 394,73 755,96
955,754
Petroleum Product 6 1 9
578,45 635,17 865,96
Total Exports 996,353
2 5 9
Value in million
114.95 160.55 203.78 354.92
US$
Source: Energy Book 2009, Hydrocarbon Development
Institute of Pakistan.

100%
126,485

80% 353,469

578,452 635,175
60% 865,969
1,011,995

40% 355,881
433,425

20% 238,606 240,444


110,000
40,350
0% Energy Book 2005, Hydrocarbon Development
Source:
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
Institute of Pakistan.
Export of Crude Oil Export of Petroleum Products
Conclusion

From all the above discussions and data analysis, we


conclude that OPEC is an inter-governmental organization
which controls the major oil producing countries. Even
though the non-OPEC countries are also present but these
are not working under one umbrella which is causing
competition with each other, and there is no scope for other
countries to enter into the market because the crude oil
resources are limited.

Even the experts say that OPEC is monopoly, but due to the
presence of non-OPEC countries which will also affect the oil
prices and cause competition to affect fixing prices of crude
oil, which will shows us that OPEC is probably the best
example of oligopoly.

References

 www.opec.org
 Outlook Profit Supplementary September 2008 Edition,
which is published on OIL & GAS
 The Economist
 Organization of the Petroleum Exporting Countries
Monthly Oil Market Report, July 2008
 www.google.co m
 www.wikipedia.com
 www.worldbank.org
 www.hdip.com.pk
 www.dawn.com