Chocolate and Gold Coins

Tuesday, April 26, 2005

Busting Up OPEC

I have read several recent articles at Tech Central Station and elsewhere explaining the folly of trying to create a policy that will rid the U.S. of dependency on foreign oil. You can read these articles here, here, and here. In short, these articles explain why it is a waste of time and money to try to rid ourselves of middle-east oil dependence and to subsidize alternative energy.

I don’t disagree that it would be foolish to try to shift from buying middle east oil and instead buy other oil because oil is oil. And conserving energy is only efficient if people do it voluntarily as a reaction to the high price of energy. However, there is something missing in these articles. Oil is highly priced today largely because of OPEC the oil cartel. Those who love free markets should understand that the efficiency of free trade depends on destroying the cartels. We should explore ways of busting up OPEC.

There are two myths about cartels promoted by those who support laissez-faire economic policy. The first myth is that competitive pressure tends to tear apart the cohesiveness of the cartel over time. If this were so, OPEC would be long gone by now. But there are only a dozen players in OPEC and they are playing a repeated game. Each nation knows that it is very much in its individual interest to cooperate. And they have succeeded in keeping the price of oil about the cost of production by a factor of 5 to 10 for more than 30 years.

The second myth is that the high price set by the cartel will soon encourage the creation of new technologies that will use alternative fuels. This is partly true, but not as true as you might think. Any producer who risks $10 billion in a new technology (like hybrids) assuming that the price of oil will stay high while they go ahead and eat OPEC’s market is delusional. If anyone does produce a technology that seriously erodes the market for oil, OPEC can easily drop the price of oil down low enough to destroy the market for that new technology. Toyota and Honda might yet rue the decision to pour so much money into their hybrid technology.

How do we break up OPEC? The answer is to fight fire with fire. We need cooperation from all of the non-OPEC nations to place economic sanctions on OPEC. Getting cooperation from so many nations will be difficult, so we will probably have to threaten sanctions on any nation that fails to cooperate. Really, this is essentially the way the WTO works; you cooperate or you see your goods taxed to death.

Imagine what would happen if all the non-OPEC nations agreed to place a $10 a barrel tariff on oil from any OPEC nation but no tariff on oil from any non-OPEC nation. The price of oil would soon rise to $60 a barrel and countries such as Canada and the UK would get a windfall profit because they produce oil and do not belong to OPEC. But Venezuela would see their oil drop a bit in price because their oil would be taxed. Now the pressure to quit OPEC becomes very hard to resist.

Here is an interesting question: if Venezuela claims that they have quit OPEC, how would we know that they are not secretly supporting them? The answer is in the method that OPEC uses to set prices. They set quotas for each member of OPEC. We simply insist that each nation exceed its quota by 20% (for example) to be considered a non-OPEC nation.

My prediction is that this kind of economic sanction program would bust up OPEC with five years and the price of oil would drop to $25 a barrel. And all of the people who praised the beauty of the marketplace when the price of oil was $50 a barrel will still praise the beauty of the marketplace when the price is is $25 ─ except other people will then see what they mean.


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