Last week, I appeared on CNBC’s Morning Call to discuss OPEC’s impact on the world oil market. On the show with me was Raymond Learsy, author of Over a Barrel: Breaking the Middle East Oil Cartel. Learsy argues that the OPEC cartel single-handedly sets the world price for crude oil, thoroughly manipulates petroleum markets and, presumably, fixes the World Series. I spent most of my time on the show qualifying those assertions. (If you want to watch the five-minute exchange for yourself, click here.)
Well, yesterday, Learsy posted over at “The Huffington Post” (where he’s something of a regular) and decided to initiate Round 2. OK, I’m game — not just because I hate letting someone else get the last word, but because the issues in play are quite interesting.
Let’s consider Learsy’s arguments in turn:
First, he contends that OPEC sets price. Well, as I noted on the show last week, that’s not quite right. The cartel does not set price; it imposes production limitations on its members (theoretically, anyway). Price is established in world spot markets, where Mr. Supply and Ms. Demand come together to do the voodoo that they do so well. OPEC has a lot of say over the former (OPEC nations produce about 40 percent of global supply) but little say over the latter. OPEC nations certainly influence price, but they do not set price.
Since Learsy is a former commodities trader, I assume he knows this as well as I do, so it’s a mystery to me why he insists on making this “OPEC sets price” claim. After all, if you believe that OPEC sets world crude oil prices, then you have to come up with some explanation for why OPEC set the price at $10 a barrel back in 1998–1999. Were the oil sheiks simply in a kind and generous mood? Were they so enamored of Bill Clinton that they decided to send him an economic love note? Did they get so thoroughly drunk over the course of several months that they had no idea what was going on in market? Similarly, why did OPEC's ministers cut prices from $70 a barrel to $50 a barrel a few months back? Did they take a collective happy pill?
When I made those points on the show, Learsy shifted gears from “OPEC sets price” to "Big Oil sets price." Well, beyond the fact that it can’t be both, he backed up this contention with the observation that British Petroleum is currently under investigation for manipulating the California oil market. With all the money and influence these big oil producers have, Learsy asked, “who says the exchanges are free of any kind of manipulation?”
Well, one can’t prove a negative, so I’m not going to try. The right question to ask is, “What evidence do we have that oil markets are being systematically manipulated?” After all, by my count, there are 37 major oil futures markets, “over the counter” markets, and physical oil markets across the globe, all of which are quite transparent with thousands of well-informed buyers and sellers. Investigations of “Big Oil” and their market practices have been an around-the-clock phenomenon since the 1970s, so the fact that BP is currently under investigation in the state of California (land of business investigations) does not in itself suggest that there is fire to be found amongst the political smoke.
Question: How many government investigations of “Big Oil” for price manipulation have been undertaken over the past three decades? Answer: At least 30 that I’m aware of, but that’s almost certainly an undercount. Question: How many government investigations of “Big Oil” have found any one of these major companies guilty of price manipulation? Answer: None. Zip. Zero. Nada.
Now, that doesn’t mean it’s not going on. But it does mean that there’s no evidence to suggest that it is. Once you combine that with a functional knowledge of how the oil market actually works, you can’t help but conclude that manipulation is a figment of the imagination. Markets — believe it or not — sometime produce price increases, especially when instability rocks oil producing regions.
In sum, Learsy can believe what he wants. But belief without evidence is called faith, and organized faith is called religion.
The more interesting discussion, however, is whether OPEC even influences (much less “sets”) oil prices. I’m inclined to think that it does. After all, the whole point of the cartel is to collude with regards to production. As long as this collusion reduces production by more than zero, it will affect market prices.
But does it? The best evidence for that proposition comes from economists Robert Kaufmann, Stephane Dees, Pavlos Karadeloglou, and Marcelo Sanchez. In their 2004 paper "Does OPEC Matter? An Econometric Analysis of Oil Prices," published in The Energy Journal, they examine quarterly data from the third quarter of 1986 to the third quarter of 2000 and find a statistically significant relationship between real crude oil prices, OPEC capacity utilization, OPEC quotas, the degree to which OPEC exceeds those production quotas, and OECD oil stocks. According to most laymen, this probably qualifies for a cover story in “Duh!” magazine.
But not so fast! The evidence forwarded by Kaufman et al. does not settle the matter. After all, Learsy’s case is that the cartel delivers less oil to the market than would be the case if the cartel did not exist — which is, after all, the very definition of the claim that “OPEC sets/influences oil prices.” That’s a tricky matter to establish because we can only guess what production levels would be absent the cartel. Economist James Smith noted in 2005, “Despite a strong consensus among experts and laymen alike that OPEC operates as a cartel, very little conclusive statistical evidence of collusive behavior has appeared in the economics literature to date.” His 2005 paper "Inscrutable OPEC? Behavioral Tests of the Cartel Hypothesis," likewise published in The Energy Journal, comes closest to answering the question. His econometric investigation of monthly OPEC production data from January 1973 to December 2001 finds strong evidence that OPEC “acts as a bureaucratic syndicate; i.e., a cartel weighed down by the cost of forging and enforcing consensus among its members, and therefore [is] partially impaired in pursuit of the common good.”
OK, we've now found empirical reason to believe that OPEC is indeed the clumsy economic cartel that oil economists long suspected. But that doesn’t tell us whether this cartel succeeds in its mission or not. As Smith writes:
This paper has examined the conduct of members of an alleged cartel, not the performance of the cartel itself. Any conclusions regarding the effectiveness of OPEC’s cooperative actions, or the organization’s impact on market prices and member profits, is beyond the scope of this research. A cartel’s actions may be in vain if it lacks either the information base to anticipate, or the operating flexibility to respond to market forces. Whether the rewards reaped by OPEC have actually gone beyond what one could expect of a non-cooperative oligopoly is not clear. That part of the question remains.
Like Learsy, I suspect that the cartel produces some net economic benefit for its members. That is, I suspect that the cartel serves to increase prices above where they would be absent the cartel. But I don’t KNOW that. And if you think countries like Saudi Arabia, Venezuela, Kuwait, and the UAE have a significant amount of unilateral power in world crude oil markets given their large reserves and low production costs, then it’s perfectly reasonable to suspect that formalized collusion in the form of a cartel is not the root of the (price) problem.