Question

Why would the petroleum producing countries form a cartel (OPEC) to determine the price of their product?

Answer 1

An instance of an global cartel is the Petroleum Exporting Countries Organization. The organisation was founded on September 10-14, 1960, at a meeting in Baghdad, Iraq. The founding members including Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela agreed to build an organisation that could bring some degree of stability to the oil industry around the globe. OPEC agreed to coordinate energy measures in order to guarantee a fair price for their oil exported and a constant market supply. The OPEC governments agreed to coordinate with petroleum companies (both state-owned and private) to manipulate the global supply of oil and hence the cost of oil.

They develop a cartel when companies agree to collude, that is to say they agree to a certain price and quantity for a good or service. A cartel is an oligopoly form. As cartels are established and function in secret, it is up to the cartel members to maintain in touch with their contract. Companies have to trust each other not to drop their price to undermine others or boost production. This is hard to guarantee as companies may have distinct manufacturing expenses and thus require more profit to satisfy their expenses. Because of this, the market has less power than a monopoly system would have.

For most of the latter part of the 20th century, OPEC governed the oil markets and prices in the years to come. However, the U.S. has re-emerged as a top oil producer with the discovery of shale in the U.S. and developments in drilling methods. The cartel derives its pricing authority from two trends: the lack of energy sources and the lack of feasible energy-industry financial options. It maintains three quarters of conventional oil reserves worldwide and has the smallest cost of barrel manufacturing worldwide. The combination allows the cartel to affect oil prices in a wide range. Thus, OPEC cuts back its manufacturing quotas when there is a glut of oil in the globe.

Oil prices should theoretically be a function of supply and demand. Prices should fall when supply and demand rise, and vice versa. But there's a distinct truth. The status of oil as the preferred energy source has made its pricing more complex. Demand and supply are just component of the complicated equation with generous geopolitical and environmental components.