Imperfect Cartelization in OPEC

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1 Imperfect Cartelization in OPEC Samuel J. Okullo Dep. Environmental Economics, IVM Vrije Universteit Amsterdam Jun 2012 Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

2 Outline 1 Motivation 2 Modeling approach 3 Some results 4 Conclusions Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

3 Motivation What is the role of OPEC? OPEC objective: coordinate and unify production policies. production, prices, revenues BUT, does OPEC really influence prices? OPEC power, enormous: Sizable portion of world oil reserves ( 80%) Sizable portion of internationally traded crude oil ( 60%) Sizable portion of crude oil produced ( 40%) Often carries excess capacity ( 2 mn barrels daily) OPEC power, limited: Heterogeneity among members increases costs of coordination No well defined production allocation rule No monitoring and punishment for over production The free-riding non-opec fringe Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

4 Motivation What is the role of OPEC? OPEC objective: coordinate and unify production policies. production, prices, revenues BUT, does OPEC really influence prices? OPEC power, enormous: Sizable portion of world oil reserves ( 80%) Sizable portion of internationally traded crude oil ( 60%) Sizable portion of crude oil produced ( 40%) Often carries excess capacity ( 2 mn barrels daily) OPEC power, limited: Heterogeneity among members increases costs of coordination No well defined production allocation rule No monitoring and punishment for over production The free-riding non-opec fringe Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

5 Motivation What is the role of OPEC? OPEC objective: coordinate and unify production policies. production, prices, revenues BUT, does OPEC really influence prices? OPEC power, enormous: Sizable portion of world oil reserves ( 80%) Sizable portion of internationally traded crude oil ( 60%) Sizable portion of crude oil produced ( 40%) Often carries excess capacity ( 2 mn barrels daily) OPEC power, limited: Heterogeneity among members increases costs of coordination No well defined production allocation rule No monitoring and punishment for over production The free-riding non-opec fringe Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

6 Motivation What is the role of OPEC? Traditional optimization models: OPEC has positive gains from cartelization Pindyck (1978), high, (50%-100%) Berg et al (1997), modest, (18%) Griffin and Xiong (1997), modest, (24%) Empirical tests: Bureaucratic syndicate (e.g Smith 2005, Kaufman et al (2008)) Spenders and Savers (Adelman 1982, Brémond et al 2011) Semi cartel MR i MR j i j (MacFadyen, 1993) Our results 1 Does OPEC still enjoy positive gains from cartelization? YES (25%) 2 Is OPEC behavior consistent with perfect cartelization? NO (heterogeneity, non-opec, elasticity of demand) 3 But, how do we model imperfect cartelization???? Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

7 Motivation What is the role of OPEC? Traditional optimization models: OPEC has positive gains from cartelization Pindyck (1978), high, (50%-100%) Berg et al (1997), modest, (18%) Griffin and Xiong (1997), modest, (24%) Empirical tests: Bureaucratic syndicate (e.g Smith 2005, Kaufman et al (2008)) Spenders and Savers (Adelman 1982, Brémond et al 2011) Semi cartel MR i MR j i j (MacFadyen, 1993) Our results 1 Does OPEC still enjoy positive gains from cartelization? YES (25%) 2 Is OPEC behavior consistent with perfect cartelization? NO (heterogeneity, non-opec, elasticity of demand) 3 But, how do we model imperfect cartelization???? Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

8 Motivation What is the role of OPEC? Traditional optimization models: OPEC has positive gains from cartelization Pindyck (1978), high, (50%-100%) Berg et al (1997), modest, (18%) Griffin and Xiong (1997), modest, (24%) Empirical tests: Bureaucratic syndicate (e.g Smith 2005, Kaufman et al (2008)) Spenders and Savers (Adelman 1982, Brémond et al 2011) Semi cartel MR i MR j i j (MacFadyen, 1993) Our results 1 Does OPEC still enjoy positive gains from cartelization? YES (25%) 2 Is OPEC behavior consistent with perfect cartelization? NO (heterogeneity, non-opec, elasticity of demand) 3 But, how do we model imperfect cartelization???? Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

9 Modeling approach IPROSE basic, model structure IPROSE (the Integrated model for PRice and Oil SuppliEs) Dynamic optimization model to 2100: crude oil, tar sands, and NGL OPEC producers price leaders in the oil market Reserves are augmented through resource development Production is constrained by geological constraints and by capacity constraints Extraction costs rise over time with increasing depletion Improvements in fuel efficiency with economic growth Isoelastic demand for oil, BUT price elasticity declines ( 0) with increasing demand from developing countries Open-loop information structure for OPEC Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

10 Modeling approach OPEC as an imperfect cartel Output setting condition: ( Price( ) 1 + q i (1 ε o q c + dqc i dq i Modified output setting condition: ( 1 Price( ) 1 + ϕ i ε o + (1 ϕ q i i) ε o q c q i q c i )) = Full MC ) = Full MC ϕ i dqc i dq i ϕ i = 0 Cournot; ϕ i = 1 Cartel; 0 < ϕ i < 1 Imperfect cartelization Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

11 Modeling approach OPEC as an imperfect cartel Output setting condition: ( Price( ) 1 + q i (1 ε o q c + dqc i dq i Modified output setting condition: ( 1 Price( ) 1 + ϕ i ε o + (1 ϕ q i i) ε o q c q i q c i )) = Full MC ) = Full MC ϕ i dqc i dq i ϕ i = 0 Cournot; ϕ i = 1 Cartel; 0 < ϕ i < 1 Imperfect cartelization Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

12 Modeling approach Imperfect cartelization: some results Percentage gain relative to COM (ϕ i = 0.2) (ϕ i = 0.8) (ϕ i = 1) Algeria 23% 45% 44% Angola 23% 47% 45% Iran 19% 26% 22%.... Qatar 23% 31% 25% Saudi Arabia 10% 20% 23% United Arab Emirates 21% 27% 22% Total OPEC 17% 27% 25% Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

13 Modeling approach Endogenizing ϕ i Producers bargain over ϕ i so as to maximize the cartels Nash product st. max {ϕi }z = (π i (ϕ i ) π i (ϕ i = 0)) i c π i (ϕ i ) Ω, ϕ i [0,1] Ω constitutes equilibrium conditions of the quantity setting game In the paper we employ two methods for selecting ϕ i. (i) assuming identical ϕ i, then (ii) individual ϕ i Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

14 Modeling approach Endogenizing ϕ i Producers bargain over ϕ i so as to maximize the cartels Nash product st. max {ϕi }z = (π i (ϕ i ) π i (ϕ i = 0)) i c π i (ϕ i ) Ω, ϕ i [0,1] Ω constitutes equilibrium conditions of the quantity setting game In the paper we employ two methods for selecting ϕ i. (i) assuming identical ϕ i, then (ii) individual ϕ i Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

15 Some results Time path for prices O L I IC P C P ric e (U S $ ) Imperfect cartelization implies prices that are between the two extremes of oligopoly and perfect cartelization Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

16 Some results Time path and level of cooperation in OPEC C o o p e ra tio n c o e ffic ie n t C o o p e ra tio n c o e ffic ie n t OPEC producers collude imperfectly The optimal level of cooperation in OPEC changes overtime Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

17 Some results Optimal cooperation for each member (individual ϕ i ) Qatar Algeria Iran Venezuela (Includes Ecuador) Saudi Arabia Production weighted average Simple weighted average Bargaining power is biased towards smaller producers Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13...

18 Conclusions Conclusions Their are positive incentives to collusion; this enough to keep OPEC trying to raise prices. Heterogeneity among members, however, leads to a weaker cartel. Imperfect cartelization is an attempt at redistributing benefits more fairly among members; this increases benefits from cartelization, more especially to smaller members OPECs ability to cartelize is influenced by the elasticity of demand; low (absolute) demand elasticities are seen to lower the incentive for cooperation OPEC is an imperfect cartel, we propose a means to tractably model this structure Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13

19 Conclusions Q&A Thank you Okullo S. J & Reynès F (IVM) OPECs gains to cartelization revisited Jun / 13