Zycher (2002) defines a cartel as an explicit agreement between two or more firms. It is a group of producers, jointly and formally developed to regulate production and the price of commodities or services. They mainly involve oligopolistic firms that have few sellers and normally deal with identical products. Members of a cartel may agree on the following issues (Economic Outlook, 2003):
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- The amount of total production in every firm.
- Price fixation.
- Contribution of firms to the product and service market.
- The allocation of customers among the firms.
- A description of the territories to engage in.
- Establishment of joint marketing agencies and the means by which profits will be shared.
According to Lane (1989), the major aim of forming cartels is to reduce competition and increase profits for each of the member firms. There are private and public cartels, where the public cartel are mainly regulated by the government and the private cartels are controlled by the members themselves and they mutually agree on how to regulate their policies. Private cartels are normally considered illegal and are hardly supported.
The Organization of the Petroleum Exporting Countries (OPEC)
This is a cartel made up of twelve oil-producing countries, with its headquarters in Vienna. It normally holds meetings with the member countries’ oil ministers to discuss issues relating to producing and marketing oil to the global communities. The key objective of OPEC is to establish and implement the best techniques that will protect and enhance the interest of the members through price stabilization and securing steady incomes for the member countries. It also aims at ensuring a constant supply of oil to the consumers and a good return of capital for the countries investing in the oil and petroleum industry (Adelman 1995).
How does OPEC operate?
OPEC normally uses a model referred to as the World Energy Model to determine the trends in the market demand and supply of oil products. It notes that the world demand for petroleum can be categorized into five sectors, namely (Adelman 1995):
- Industrial demand.
- Transportation demand.
- Agricultural demand.
- Marine demand.
- Total world demand.
OPEC relates these types of demand to the various sectors to come up with a specialized class of sectoral demand. In each type of demand, there are other sub-classes of demand and these are what represent the prevailing market situation. For instance, the location or geographical demand can be used to group regions into developing countries, transition countries, and those countries that fall under Organization for Economic Co-operation and Development (OECD countries). These are then separated into other sub-classes to show specialization of demand (World Economic Outlook 2007).
By identifying the demand in the various regions and sectors, the cartel is able to establish those areas where the market structure needs modification and also areas to increase or lower its production. The supply factors are determined by the demand sectors that are brought up to ensure sufficient but effective supply (Zycher 2002).
OPEC’s activities in the oil market over the year 2008
The global oil market has experienced a downfall for the last one year and OPEC has not been spared the situation either. There have been reports that some member countries are going through a recession, and this has resulted in low demand in the majority of the sectors. In November 2008, the firm’s sales averaged 28% only of the total expected amount of sales in form of exports. With most of the OECD countries experiencing a recession, the oil production went down between July and December 2008 and this, in turn, resulted in low exports and low returns (World Economic Outlook 2007).
On several occasions, OPEC has announced a reduction in the supply of oil, in 2004, 2005, and recently in 2007. In respect to these reductions and other past reductions, there is a trend showing a positive correlation between them as announced by OPEC and a rise in the price of oil within a span of one month. Price increment after these announcements went up to an average of 6.24%. When this trend is applied, the oil prices in the year 2008 are likely to go up to between the US $70 and the US $80 within one month from the date the announcement was made in October 2008 (World Economic Outlook 2007).
According to the report by the World Economic Outlook (2007), the demand and supply of oil have shown a disparity over the second and third quarters of 2008, and OPEC is likely to make efforts to overcome this disparity. There is expected to be a reduction in supply to approximately one million barrels per day and by applying the 6.24% historic price increase rate, the cartel will likely deliver oil at a price of US$ 79.50 with a 25% premium or at a price of US$77.20 with 25% discount. The cartel is however coming up with targets to meet the world demand and lower the high prices that are resulting in market distortions.
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