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Opinion

OPEC – not as powerful as you might think

Brazil's oil may destabilize OPEC, but not the US.

By Peter Z. Grossman / March 5, 2008



Indianapolis

Brazil's recent announcement that it might join OPEC reportedly produced a lot of hand-wringing among the experts. According to CNN, "analysts" feared that putting Brazil's big new oil finds under the Organization of Petroleum Exporting Countries' banner would mean higher oil prices.

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Just who are these "analysts?" Either they need remedial economics training, or they are grossly misinformed about how OPEC works.

First, in a petroleum-thirsty world, Brazil's oil discoveries are good news. Any Econ 101 student knows that when you increase the supply of something, the price goes down – not up. Not even OPEC can reverse the laws of supply and demand. Second, the possibility of Brazil's reserves falling under OPEC's rules aren't cause for alarm. If anything, a Brazilian seat at the OPEC table could mean greater stress for the cartel than it will for the rest of us.

But the analysts' fears seem to fit with the belief that OPEC has great and special power over us. This fear is irrational; I believe it's based on a misunderstanding of the causes and consequences of the gas lines of the 1970s. That episode made people think: If oil exporters can disrupt our lives once, then what's to stop them from doing it again? Surely not the normal rules of economics, maybe not even the laws of physics.

If they get a new member, or make any other significant change, the analysts seem to want to remind us: Be very afraid.

Actually, there is a way for OPEC to raise prices if Brazil, which right now exports no oil, joins the cartel. In fact, there's only one way: Everyone else in OPEC can cut production by more than the amount Brazil adds to it.

That is, to put it mildly, unlikely.

The OPEC countries are notable for the one-dimensional nature of their economies. Their wealth and well-being depend almost entirely on oil revenues. Even Saudi Arabia, which could cut its production, is unlikely to cut much or for long. It would be just too expensive.

Say Brazil eventually adds 1 million barrels per day to the world market. Just to keep prices from falling (much less rising), the Saudis would have to sacrifice about $35 billion a year in revenues. Even for Saudi oil sheikhs that's a lot of money.

And surely no one else would dream of making cuts. Does anyone seriously imagine Hugo Chávez of Venezuela taking a big hit for his brothers in Brazil? Even with all of his country's oil money, Venezuela's economy is in shambles.

If Brazil joins, it is more likely to destabilize OPEC than enhance the oil cartel's power. If the "analysts" had taken a few more economics courses, they'd have learned that cartels, are notoriously fragile. And one of the main sources of fragility is the entry of new players into the market.

In 1880s America, the railroad companies kept trying to form cartels but they'd fall apart whenever new railroads would ask to join. Why? Because there was only so much demand to go around, and so any time a new company would join, older members were ordered to give up some of their market share, just as OPEC countries would have to do if Brazil joined.

The railroad companies didn't appreciate that idea and it usually led to temporary price wars that sent prices not just falling but plummeting.

The belief that OPEC will avoid this end shows an ignorance not only of economics but of history – recent history as well as the history of 19th-century America.

OPEC gained its status as the oil bogeyman back in the 1970s, and surely, the US suffered through some bleak times that decade. But by the 1980s, US consumers were doing fine, and the nation did even better in the 1990s.

Not so the oil producers. The collapse of oil prices in the 1980s, which occurred mainly because the cartel became too greedy, was so devastating to OPEC producers that some of them didn't recover for 20 years.

They have, in fact, much more at stake in this game than we do, and the last thing they want to do is make the same mistake again.

"Analysts" may believe that there is an evil oil cartel out there that can defy logic, history, economics, and common sense. But OPEC is not omnipotent, and is much less of a threat to the US than those analysts seem to believe.

Peter Z. Grossman is a professor of economics at Butler University in Indianapolis, and the author of three books on energy issues.

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