Oligopoly

Discussion on “OPEC Production Cut Surprises the Market” by Stanley Reed (Business Week, September 2008)

 Summary & Relevance

The article discusses OPEC action during 2008. OPEC, the Organization of Petroleum Exporting Countries, experienced a fall in oil prices during the year, and through cutting oil production, hopes to stabilize the price around $100 per barrel. The organization’s plan could take 520,000 barrels a day off the market. Price hawks, such as Iran, Venezuela and Algeria, are enthused by the potential maneuver, while Saudi Arabia, the largest producer of oil within OPEC, would suffer a loss. Saudi Arabia has been working to lower oil prices in the recent months due to the weakening of demand they had observed from consumers, particularly in the West and Japan. A deliberate decrease in supply would undo the progress they had made thus far. Saudi Arabia and a few other OPEC countries are also afraid high prices on gas will drive the innovation of alternative energy sources by alienating key customers. Finally, there is speculation that Saudi Arabia’s recent increase in production and resistance to OPEC’s plan to cut oil production was due to an under-the-table deal with the United States.

The OPEC article is relevant to class because OPEC is an example of an oligopoly. The major oil exporting countries of the world formed the organization for the benefit of the countries involved. Such an alliance allows for substantial control over supply, and consequently, equilibrium prices. The article provides a direct example of how oligopolies can manipulate the supply of goods within a market to benefit from a subsequent increase in consumer prices.

Commentary

While many argue OPEC’s dominant control over the oil market is unethical, there is another side to the story that needs to be explored. OPEC operates as a cartel and achieves its dominance over the market through the process of collusion. These oil-producing nations were blessed with the incredible fortune to sit on bountiful reserves of oil, giving them the opportunity to control one of the world’s most desired resources. However, it can be argued there is no ethical mandate for these countries to provide oil and share it. If this is the view taken by an individual, that person can hardly argue what OPEC has done to develop a stake in the oil market is unethical. Historically, it is evident that the formation of OPEC owed greatly to the previous dominance of Western companies like Shell Oil.  The dominance of OPEC and the subsequent effect of monopolistic price control has had unintended positive effects for non-OPEC countries, as high oil prices has spurred investment in cleaner alternative energy sources. Finally, it is important to consider the effect OPEC has on citizens of OPEC nation; it is reasonable to expect that the price controls implemented by OPEC in external markets benefit the consumers in the home countries. In short, demonizing OPEC may be easy to do, but readers should at least consider an alternative viewpoint.

Real-World Application

 A great example of another oligopoly is the wireless industry. Together four wireless providers in the U.S., AT&T, Verizon Wireless, T-Mobile, and Sprint Nextel, comprise 89 percent of the market. These carriers have control over the industry and are interdependent, reacting to the decisions of the other firms. Within this market, there are substantial barriers to entry. Setting up wireless networks around the country is costly and difficult, thus new firms will not likely enter. The oligopoly structure allows these companies to control their services, thus they do not offer much freedom to consumers. They only allow you to choose one phone approved by them, you must pay to upgrade or wait until your contract expires, and if you attempt to install your own software to the phone, your warranty will be terminated. Additionally, this type of market structure does not necessarily allow for great innovation. The companies are permitted to do things their way and are not necessarily incentivized to invent anything new. However, it is important in these high investment industries that governments allow such market structures, because without guaranteed success or market share, there would be no reason for any company to invest in establishing wireless networks. The wireless industry is a great example here of the good and bad of oligopolies.

Posted by Chris, Barbara and Alex (Section 1)

Resources:

http://www.wired.com/epicenter/2010/06/wireless-oligopoly-is-smother-of-invention/

http://www.tech-faq.com/wireless-oligopoly-was-created-by-government-regulation.html

http://en.wikipedia.org/wiki/Oligopoly

http://en.wikipedia.org/wiki/Opec

http://www.petroleum-economist.com/Article/2730961/Ethical-oil-and-Opec.html

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