The Limits of OPEC in the Global Oil Market 603 This ambiguity leads many scholars to continue to believe that OPEC is a cartel, albeit imperfect.Hyndman asserts "OPEC is obviously a cartel that restricts output in order to obtain super-competitive profits,"an assertion shared by other econo- mists.29 This is true also among many political scientists.30 For instance,Blaydes argues that there is an intra-OPEC bargaining game to divide the cartel's profits,in which oil-rich states allow oil-poor states to cheat on their OPEC quotas to a greater extent than the oil-rich ones do.31 Yet Blaydes provides no evidence of cartel profits.Empirically,she studies only the behavior of the OPEC members, and does not compare them with non-OPEC members,so it is not possible to assess how either the oil-rich or oil-poor OPEC states'production behavior differs from other states. Given the extent of scholarly debate,it is perhaps not surprising that many journal- ists and policy-makers continue to view OPEC as a cartel.Yet international relations theory offers important reasons to doubt that view.As Downs and colleagues argue, even states that appear to be cooperating might be acting as they would have done even without the agreement,because states design international agreements to avoid requirements for costly adjustments to their behavior.32 Thus OPEC quotas, even if strictly obeyed,might not actually require states to deviate significantly from their counterfactual behavior in which no quotas existed. Consequently,one needs to have a fresh look at the evidence.None of the existing studies provide any direct evidence that OPEC members produce less oil than they would in the counterfactual world in which OPEC did not exist.They typically focus instead on measuring the degree to which production changes in one OPEC member are correlated with production changes in the rest of OPEC,a correlation that could be explained in a variety of other ways,such as common reactions to market conditions.33 Moreover,many models do not incorporate relevant political variables,such as the regime type and investment risk of a state,creating the potential for omitted variable bias. OPEC As Market Manipulator? Many observers have noted that cheating on OPEC quotas is widespread,but there are additional problems that are probably even more important.I consider four major tests of OPEC's market impact.I focus on the period since 1982,when OPEC first began to assign quotas("market allocations")to its members.The tests focus exclusively on OPEC's impact on oil production,rather than oil prices,for two reasons.The first is practical:the relationship between OPEC quotas and 29.See Hyndman 2008,812;Smith 2005 and 2009;and Simpson 2008. 30.See Ikenberry 1988;Alt,Calvert,and Humes 1988;Lieber 1992;Shaffer 2009;and Sovacool 2011. 31.Blaydes 2004. 32.Downs,Rocke,and Barsoom 1996. 33.See Griffin 1985;Kaufman et al.2008;and Bremond,Hache,and Mignon 2012
This ambiguity leads many scholars to continue to believe that OPEC is a cartel, albeit imperfect. Hyndman asserts “OPEC is obviously a cartel that restricts output in order to obtain super-competitive profits,” an assertion shared by other economists.29 This is true also among many political scientists.30 For instance, Blaydes argues that there is an intra-OPEC bargaining game to divide the cartel’s profits, in which oil-rich states allow oil-poor states to cheat on their OPEC quotas to a greater extent than the oil-rich ones do.31 Yet Blaydes provides no evidence of cartel profits. Empirically, she studies only the behavior of the OPEC members, and does not compare them with non-OPEC members, so it is not possible to assess how either the oil-rich or oil-poor OPEC states’ production behavior differs from other states. Given the extent of scholarly debate, it is perhaps not surprising that many journalists and policy-makers continue to view OPEC as a cartel. Yet international relations theory offers important reasons to doubt that view. As Downs and colleagues argue, even states that appear to be cooperating might be acting as they would have done even without the agreement, because states design international agreements to avoid requirements for costly adjustments to their behavior.32 Thus OPEC quotas, even if strictly obeyed, might not actually require states to deviate significantly from their counterfactual behavior in which no quotas existed. Consequently, one needs to have a fresh look at the evidence. None of the existing studies provide any direct evidence that OPEC members produce less oil than they would in the counterfactual world in which OPEC did not exist. They typically focus instead on measuring the degree to which production changes in one OPEC member are correlated with production changes in the rest of OPEC, a correlation that could be explained in a variety of other ways, such as common reactions to market conditions.33 Moreover, many models do not incorporate relevant political variables, such as the regime type and investment risk of a state, creating the potential for omitted variable bias. OPEC As Market Manipulator? Many observers have noted that cheating on OPEC quotas is widespread, but there are additional problems that are probably even more important. I consider four major tests of OPEC’s market impact. I focus on the period since 1982, when OPEC first began to assign quotas (“market allocations”) to its members. The tests focus exclusively on OPEC’s impact on oil production, rather than oil prices, for two reasons. The first is practical: the relationship between OPEC quotas and 29. See Hyndman 2008, 812; Smith 2005 and 2009; and Simpson 2008. 30. See Ikenberry 1988; Alt, Calvert, and Humes 1988; Lieber 1992; Shaffer 2009; and Sovacool 2011. 31. Blaydes 2004. 32. Downs, Rocke, and Barsoom 1996. 33. See Griffin 1985; Kaufman et al. 2008; and Brémond, Hache, and Mignon 2012. The Limits of OPEC in the Global Oil Market 603
604 Interational Organization world oil prices is fraught with potential endogeneity.34 Low oil prices might cause OPEC to lower its production quotas,but if OPEC actually has market power,lower OPEC quotas would cause high oil prices.Thus on its own the (lack of)correlation between OPEC quotas and oil prices does not give one enough information to make valid inferences about its status as a cartel.35 Some sophisticated statistical techniques might be used to try to overcome this problem,but they are not satisfying.36 The second reason is perhaps even more important:production constraints are a necessary element of cartel behavior.If OPEC is not constraining its members'production,then it is not a cartel,by definition.37 Focusing on production allows one to directly inves- tigate the extent of collusion between OPEC members,rather than looking at its indir- ect effect on prices.Indeed,even if OPEC was somehow affecting market prices without constraining its members'production,it would not be doing so as a cartel. What evidence should one expect if OPEC is a cartel?Mankiw defines a cartel as a group of firms (or states,in this case)that creates agreements about quantities to produce or prices to charge,and further it"must not only agree on the total level of production but also on the amount produced by each member."38 This definition implies that a gap between market price and marginal cost of production is not by itself evidence of a cartel.39 Instead,one should see signs that the organization is cooperating to restrict production (to drive prices up).One should see the following kinds of evidence:new members of the cartel have a decreasing or decelerating pro- duction rate(first test);members should generally produce quantities at or below their assigned quota (second test);changes in quotas should lead to changes in production, creating a correlation(third test);and members of the cartel should generally produce lower quantities(that is,deplete their oil at a lower rate)on average than nonmembers of the cartel (fourth test).Failure to observe any of these phenomena would cast doubt about OPEC's status as a cartel,although none is totally determinative.The fourth test is perhaps the strongest because it is difficult to imagine how an organization that does not restrict output compared with nonmembers could be called a cartel how else could it increase average prices?40 To preview the results,OPEC fails all four of the tests. 34.Subsequent sections further discuss the link between oil prices and inferences about OPEC as a cartel. 35.A simple bivariate ordinary least squares (OLS)regression between world oil prices and OPEC's aggregate production target from 1982 through 2009 yields an R2 value of just 0.15. 36.To date,no one has identified a plausible instrumental variable or natural experiment.Other approaches exist but have not produced a widely accepted conclusion on the cartel question.See Dahl and Yuicel 1991;Gulen 1996;Alhajji and Huettner 2000:Reynolds and Pippenger 2010;and Bremond etal.2012. 37.ankiw2011,351. 38.bid.351. 39.Producers who stop producing before marginal costs equal market price (like some OPEC producers. possibly)are not behaving perfectly competitively,but that does not necessarily imply cartelization. 40.One of OPEC's stated goals is to stabilize prices.It is possible that an organization could seek to stabil- ize prices without affecting the long-run average price or production levels of its members.Yet such an organization could not be considered a classic cartel because it would not be profit maximizing.It
world oil prices is fraught with potential endogeneity.34 Low oil prices might cause OPEC to lower its production quotas, but if OPEC actually has market power, lower OPEC quotas would cause high oil prices. Thus on its own the (lack of) correlation between OPEC quotas and oil prices does not give one enough information to make valid inferences about its status as a cartel.35 Some sophisticated statistical techniques might be used to try to overcome this problem, but they are not satisfying.36 The second reason is perhaps even more important: production constraints are a necessary element of cartel behavior. If OPEC is not constraining its members’ production, then it is not a cartel, by definition.37 Focusing on production allows one to directly investigate the extent of collusion between OPEC members, rather than looking at its indirect effect on prices. Indeed, even if OPEC was somehow affecting market prices without constraining its members’ production, it would not be doing so as a cartel. What evidence should one expect if OPEC is a cartel? Mankiw defines a cartel as a group of firms (or states, in this case) that creates agreements about quantities to produce or prices to charge, and further it “must not only agree on the total level of production but also on the amount produced by each member.”38 This definition implies that a gap between market price and marginal cost of production is not by itself evidence of a cartel.39 Instead, one should see signs that the organization is cooperating to restrict production (to drive prices up). One should see the following kinds of evidence: new members of the cartel have a decreasing or decelerating production rate (first test); members should generally produce quantities at or below their assigned quota (second test); changes in quotas should lead to changes in production, creating a correlation (third test); and members of the cartel should generally produce lower quantities (that is, deplete their oil at a lower rate) on average than nonmembers of the cartel (fourth test). Failure to observe any of these phenomena would cast doubt about OPEC’s status as a cartel, although none is totally determinative. The fourth test is perhaps the strongest because it is difficult to imagine how an organization that does not restrict output compared with nonmembers could be called a cartel— how else could it increase average prices?40 To preview the results, OPEC fails all four of the tests. 34. Subsequent sections further discuss the link between oil prices and inferences about OPEC as a cartel. 35. A simple bivariate ordinary least squares (OLS) regression between world oil prices and OPEC’s aggregate production target from 1982 through 2009 yields an R2 value of just 0.15. 36. To date, no one has identified a plausible instrumental variable or natural experiment. Other approaches exist but have not produced a widely accepted conclusion on the cartel question. See Dahl and Yücel 1991; Gülen 1996; Alhajji and Huettner 2000; Reynolds and Pippenger 2010; and Brémond et al. 2012. 37. Mankiw 2011, 351. 38. Ibid., 351. 39. Producers who stop producing before marginal costs equal market price (like some OPEC producers, possibly) are not behaving perfectly competitively, but that does not necessarily imply cartelization. 40. One of OPEC’s stated goals is to stabilize prices. It is possible that an organization could seek to stabilize prices without affecting the long-run average price or production levels of its members. Yet such an organization could not be considered a classic cartel because it would not be profit maximizing. It 604 International Organization
The Limits of OPEC in the Global Oil Market 605 First Test:Does Joining OPEC Affect Oil Production? The first test of OPEC as a cartel is the impact that the organization has on the oil production rates of new members.I adopt a before-and-after methodology,following the event history approach used by Rose in his evaluation of the WTO on its members'trade levels.41 If OPEC has a constraining influence on oil production, states that join OPEC should have a decreasing or decelerating oil production rate. Conversely,states that leave OPEC should have an increasing oil production rate. There is scant evidence that OPEC has such an effect.Figure 1 shows the average oil production rate of all states in the five years before they join OPEC and the five years after they join OPEC.Each state's oil production is standardized to a value of 100 in the year that it joined OPEC so that the relative increase or decrease can be compared.As the graph shows,the average production rate increased at almost an identical rate before and after the state joins OPEC-thereby providing no indication that OPEC has constrained oil production. 160 140 0m001 120 100 40 20 0 Pre5 Pre4 Pre3 Pre2 Prel. jPostI Post2 Pos Pos4 Posis Years before/after the state joined OPEC FIGURE 1.Impact of joining OPEC on oil production Two Tests on the Impact of OPEC Quotas The second test focuses on cheating.A strong cartel would have little cheating,but in OPEC cheating is endemic.During the period 1982-2009,the organization as a whole overproduced a staggering 96 percent of the time.I use monthly production seems unlikely that OPEC is simply trying to stabilize prices without increasing their own profits-even its members do not make that claim. 41.See Rose 2004 and 2007:and Goldstein.Rivers.and Tomz 2007
First Test: Does Joining OPEC Affect Oil Production? The first test of OPEC as a cartel is the impact that the organization has on the oil production rates of new members. I adopt a before-and-after methodology, following the event history approach used by Rose in his evaluation of the WTO on its members’ trade levels.41 If OPEC has a constraining influence on oil production, states that join OPEC should have a decreasing or decelerating oil production rate. Conversely, states that leave OPEC should have an increasing oil production rate. There is scant evidence that OPEC has such an effect. Figure 1 shows the average oil production rate of all states in the five years before they join OPEC and the five years after they join OPEC. Each state’s oil production is standardized to a value of 100 in the year that it joined OPEC so that the relative increase or decrease can be compared. As the graph shows, the average production rate increased at almost an identical rate before and after the state joins OPEC—thereby providing no indication that OPEC has constrained oil production. Two Tests on the Impact of OPEC Quotas The second test focuses on cheating. A strong cartel would have little cheating, but in OPEC cheating is endemic. During the period 1982–2009, the organization as a whole overproduced a staggering 96 percent of the time. I use monthly production FIGURE 1. Impact of joining OPEC on oil production seems unlikely that OPEC is simply trying to stabilize prices without increasing their own profits—even its members do not make that claim. 41. See Rose 2004 and 2007; and Goldstein, Rivers, and Tomz 2007. The Limits of OPEC in the Global Oil Market 605
606 Intemational Organization data,drawing on data from the US Energy Information Agency.42 Table I shows the variation among OPEC members.All but two members overproduced more than 80 percent of the time.Moreover,some OPEC countries manage to avoid having quotas for significant periods of time.43 The magnitude of overproduction varies over time and across states,but it is not trivial:on average,the nine principal members of OPEC produced 10 percent more oil than their quotas allowed.44 This is equivalent to 1.8 million barrels per day,on average,which is more than the total daily output of Libya in 2009.Even on the relatively rare occasions when member countries are not overproducing,the root cause is often involuntary production constraints such as a strike or accident,rather than a conscious decision by the government to obey its OPEC quota. TABLE 1.Relationship between OPEC quotas and production,1982-2009 Correlation between production and quota' OPEC member months production exceeds quota Beta coefficient P-value R-squared Algeria 100% 0.105 0.035 0.014 Iran 72% 0.002 0.981 0.000 Irag 82% 0.065 0.819 0.000 Kuwait 90% 0.106 0.450 0.002 Libya 83% 0.183 0.038 0.014 Nigeria 88% 0.138 0.383 0.002 Oatar 909% 0.118 0.245 0.004 Saudi Arabia 82% 0.138 0.130 0.007 UA.E. 96% -0.140 0.170 0.006 Venezuela 77毫 0.095 0.472 0.002 OPEC-9 (excludes Iraq) 96% 0.153 0.017 0.018 1.Values displayed are from bivariate OLS regression of first-differences,where DV=changes in production. 2.Up to March 1998 only.Iraq was not assigned an OPEC quota after March 1998. One might wonder how much this level of cheating actually undermines the cartel's operation.One possibility is that the OPEC anticipates a certain amount of cheating and sets the quotas accordingly.The real questions are whether OPEC pro- duction rates are affected by quotas,and whether they are lower than the counterfac- tual in which no quotas were set.The remaining tests investigate those questions. 42.EIA estimates can differ from OPEC's reported production data.OPEC's data are not fully credible because they are self-reported by member countries that have an incentive to dissimulate when they are overproducing. 43.Iraq has not had a quota since 1998.Iran,Angola,and Ecuador have also had periods without a quota. OPEC production allocations available at <http:/www.opec.org/opec_web/static_files_project/media/ downloads/data_graphs/ProductionLevels.pdf>,accessed 10 November 2013. 44.The nine members are Algeria,Iran,Kuwait,Libya,Nigeria,Qatar,Saudi Arabia,UAE,and Venezuela.Calculated using data from the United States,EIA for actual production,and from OPEC for market allocations,1982-2009.Note that Smith estimates that overproduction averages just 4 percent using ostensibly the same data(though for a different time period).Smith 2008
data, drawing on data from the US Energy Information Agency.42 Table 1 shows the variation among OPEC members. All but two members overproduced more than 80 percent of the time. Moreover, some OPEC countries manage to avoid having quotas for significant periods of time.43 The magnitude of overproduction varies over time and across states, but it is not trivial: on average, the nine principal members of OPEC produced 10 percent more oil than their quotas allowed.44 This is equivalent to 1.8 million barrels per day, on average, which is more than the total daily output of Libya in 2009. Even on the relatively rare occasions when member countries are not overproducing, the root cause is often involuntary production constraints such as a strike or accident, rather than a conscious decision by the government to obey its OPEC quota. One might wonder how much this level of cheating actually undermines the cartel’s operation. One possibility is that the OPEC anticipates a certain amount of cheating and sets the quotas accordingly. The real questions are whether OPEC production rates are affected by quotas, and whether they are lower than the counterfactual in which no quotas were set. The remaining tests investigate those questions. TABLE 1. Relationship between OPEC quotas and production, 1982–2009 Correlation between production and quota1 OPEC member % months production exceeds quota Beta coefficient P-value R-squared Algeria 100% 0.105 0.035 0.014 Iran 72% 0.002 0.981 0.000 Iraq2 82% 0.065 0.819 0.000 Kuwait 90% 0.106 0.450 0.002 Libya 83% 0.183 0.038 0.014 Nigeria 88% 0.138 0.383 0.002 Qatar 90% 0.118 0.245 0.004 Saudi Arabia 82% 0.138 0.130 0.007 U.A.E. 96% −0.140 0.170 0.006 Venezuela 77% 0.095 0.472 0.002 OPEC-9 (excludes Iraq) 96% 0.153 0.017 0.018 1. Values displayed are from bivariate OLS regression of first-differences, where DV = changes in production. 2. Up to March 1998 only. Iraq was not assigned an OPEC quota after March 1998. 42. EIA estimates can differ from OPEC’s reported production data. OPEC’s data are not fully credible because they are self-reported by member countries that have an incentive to dissimulate when they are overproducing. 43. Iraq has not had a quota since 1998. Iran, Angola, and Ecuador have also had periods without a quota. OPEC production allocations available at <http://www.opec.org/opec_web/static_files_project/media/ downloads/data_graphs/ProductionLevels.pdf>, accessed 10 November 2013. 44. The nine members are Algeria, Iran, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE, and Venezuela. Calculated using data from the United States, EIA for actual production, and from OPEC for market allocations, 1982–2009. Note that Smith estimates that overproduction averages just 4 percent using ostensibly the same data (though for a different time period). Smith 2008. 606 International Organization
The Limits of OPEC in the Global Oil Market 607 The third test reveals that OPEC quotas do a poor job of accounting for variation in production levels.Table 1 also shows the R-squared value of a linear bivariate time- series regression between changes in an OPEC member's production and changes in its quota.45 For all but two of the states (Libya and Algeria),changes in the OPEC quota are not correlated with production at standard thresholds of statistical signifi- cance.The R-squared for the nine major OPEC producers as a group was just 0.018,meaning that at most 1.8 percent of the variation in the month-to-month changes in this group's oil production can be explained by changes in their OPEC quotas.In other words,at least 98 percent of the variation is explained by factors other than changes in their OPEC quotas. Even in the face of this evidence,one could still argue that OPEC acts as a cartel in one of two ways.First,one could argue that anticipation by various actors in the oil market obscure OPEC's constraining effect.For instance,perhaps OPEC members change production levels between OPEC meetings because they anticipate forthcom- ing changes in the quotas.46 Second,one could argue that even if OPEC's quota system is entirely meaningless,OPEC still affects oil production over the long term because it encourages the adoption of a slow depletion policy and underinvest- ment in production capacity.47 Both of these propositions have a clear empirical implication:the oil production or depletion rate of OPEC member states ought to be significantly less than the production/depletion rate of comparable non-OPEC members.This leads to my fourth test. Final Test:Do OPEC Members Have Slow Depletion Rates? Depletion rates vary widely around the world.(A country's depletion rate is equal to its oil production divided by its proven oil reserves.)Broadly speaking,depletion rates will vary according to three supply-side factors (in addition to global demand for oil):the business climate of the producing country (for example,companies'tech- nical skills,investment climate,the incidence of war or sanctions,etc.);the "lift costs"of oil production (costs of getting oil to the ground,including exploration); and the government's depletion policy.OPEC membership could affect depletion policy,but so could other factors,such as the state's fiscal needs,the incentives gen- erated by its position in the global market (or example,as a"dominant firm"),and the time horizons of the political leadership. I investigate the cross-national variation in depletion rates over a thirty-year period,1980-2010.48 The analysis includes all forty-two oil-producing states 45.Formally,the dependent variable is the first difference in oil production,and the independent variable is the first difference in oil quota.The observations are monthly,although the values are measured in barrels per day. 46.Para2004,321-22. 47.Smith2009. 48.BP Statistical Review of World Energy provides data on proven reserves starting only in 1980
The third test reveals that OPEC quotas do a poor job of accounting for variation in production levels. Table 1 also shows the R-squared value of a linear bivariate timeseries regression between changes in an OPEC member’s production and changes in its quota.45 For all but two of the states (Libya and Algeria), changes in the OPEC quota are not correlated with production at standard thresholds of statistical signifi- cance. The R-squared for the nine major OPEC producers as a group was just 0.018, meaning that at most 1.8 percent of the variation in the month-to-month changes in this group’s oil production can be explained by changes in their OPEC quotas. In other words, at least 98 percent of the variation is explained by factors other than changes in their OPEC quotas. Even in the face of this evidence, one could still argue that OPEC acts as a cartel in one of two ways. First, one could argue that anticipation by various actors in the oil market obscure OPEC’s constraining effect. For instance, perhaps OPEC members change production levels between OPEC meetings because they anticipate forthcoming changes in the quotas.46 Second, one could argue that even if OPEC’s quota system is entirely meaningless, OPEC still affects oil production over the long term because it encourages the adoption of a slow depletion policy and underinvestment in production capacity.47 Both of these propositions have a clear empirical implication: the oil production or depletion rate of OPEC member states ought to be significantly less than the production/depletion rate of comparable non-OPEC members. This leads to my fourth test. Final Test: Do OPEC Members Have Slow Depletion Rates? Depletion rates vary widely around the world. (A country’s depletion rate is equal to its oil production divided by its proven oil reserves.) Broadly speaking, depletion rates will vary according to three supply-side factors (in addition to global demand for oil): the business climate of the producing country (for example, companies’ technical skills, investment climate, the incidence of war or sanctions, etc.); the “lift costs” of oil production (costs of getting oil to the ground, including exploration); and the government’s depletion policy. OPEC membership could affect depletion policy, but so could other factors, such as the state’s fiscal needs, the incentives generated by its position in the global market ( or example, as a “dominant firm”), and the time horizons of the political leadership. I investigate the cross-national variation in depletion rates over a thirty-year period, 1980–2010.48 The analysis includes all forty-two oil-producing states 45. Formally, the dependent variable is the first difference in oil production, and the independent variable is the first difference in oil quota. The observations are monthly, although the values are measured in barrels per day. 46. Parra 2004, 321–22. 47. Smith 2009. 48. BP Statistical Review of World Energy provides data on proven reserves starting only in 1980. The Limits of OPEC in the Global Oil Market 607