OPEC and Adam Smith: Part II

Abstract OPEC's failure to discipline itself clearly suggests that that organization refuses to acknowledge that Adam Smith is alive and well. Thus, the pain of Economics 101 is making itself felt through lower crude prices and a competitive fight for market share. The current fight by OPEC for increased market share is a direct result of its two quantum jumps in energy prices during the decade of the 1970s. The ten to twenty fold increase in oil prices set in motion irreversible forces that have changed the structural demand for energy which reduced by about 50% the historic growth relationship of energy to economic activity. In addition, the quantum jump in energy prices has encouraged the incremental supply of non-OPEC oil and non-petroleum energy at an annual rate of 1.0–2.0 million BD per year. Since the beginning of 1986, OPEC in general, and Saudi Arabia and the Gulf States in particular, have made a decision to flood the market with oil and thereby reduce prices (rather than prorate production and increase prices) in an attempt to regain their historic market share of 54%, up from the current 31%. The degree to which they are successful at this game will depend almost entirely on the following factors: (1) the rapidity with which existing non-OPEC oil production declines; (2) the degree to which non-OPEC oil reserves are replaced; and (3) the degree to which the structural changes in demand will be re-altered at current prices of some 50% less than those experienced in late 1985. This paper will discuss these issues by focusing on the forces of supply, demand and pricing and how they are changing the characteristics of the industry.