Another Bad Beltway Idea: Suing OPEC on Antitrust Grounds
The 'NOPEC' legislation circulating in Congress does not address any of the real problems in oil markets.
The “Do Something!” imperative so common in the Beltway as a response to the headlines of the day yields economic or policy improvement only rarely if at all. This cannot be surprising in that this imperative by its very nature does not lend itself to thoughtfulness, even by the standards of federal policy-making. One of the latest manifestations of this is the current effort to enact “NOPEC” legislation — No Oil Producing and Exporting Cartels Act — that would empower the Department of Justice to sue the Organization of the Petroleum Exporting Countries on antitrust grounds, as a purported response to high fuel prices.
Notwithstanding long-term conventional wisdom among many observers, OPEC is not a cartel in the classic sense and never has behaved as one in practice. A “cartel” acting collectively would determine the profit-maximizing price and output for the group as a whole in negotiations both scheduled and ad hoc in the context of whatever time horizon is deemed appropriate, again as a result of internal negotiations. It then would allocate production quotas so that marginal costs are equated across producers, with adjustments for the differences in the qualities of oil produced.
Instead, OPEC in reality is one dominant producer — Saudi Arabia, with output and production capacity of more than one-third of the OPEC totals — and a group of smaller producers who must accept market conditions as they encounter them, driven by global energy demands, OPEC negotiations, production by non-OPEC producers, unanticipated supply disruptions, and other relevant parameters.
Enforcement of the negotiated production levels for each member is difficult, in a way hard to reconcile with claims that it is a cartel. Each producer has an incentive to cheat on its agreed production quota because the price obtainable for an additional barrel is greater than the (marginal) cost of producing it. This means that the agreed price always faces a threat of being undercut, and even for a relatively homogeneous good such as crude oil, the methods available for such cheating are numerous. Various forms of side payments among members might be used to discourage such behavior, or to ameliorate perceived “equity” problems within the overall production agreement.
A threat to use military power to enforce the production quotas is one possible response, but that obviously is problematic for numerous reasons, only one of which is the resulting incentive to expand military forces within the relevant geographical region, in this case primarily the Persian Gulf. The more likely enforcement mechanism is a threat that the Saudis will react to cheating on the agreed production levels by flooding the market — that is what happened in 1986 — reducing revenues for each and all. But that dynamic merely reinforces the central point here, to wit, that the OPEC “cartel” is the Saudis exercising some measure of market power, and a group of smaller producers who hang on for the ride.
On balance, however, it is no surprise that for most of its history, OPEC production has exceeded the sum of the official quotas, by almost 7 percent on average. Total OPEC production more recently has fallen below the sum of the official quotas by, say, about 1.1 million barrels per day in February 2021. But that has been due largely to production-capacity constraints as global demand grew after the Covid downturn.
Some argue that long-run capacity has been depressed artificially by the “cartel,” because incentives to invest in expanded capacity are suppressed by the system of production quotas (limits). Not so fast: The quotas must be negotiated, and an expansion of capacity by a given producer creates a claim for a larger quota. So it is far from clear that aggregate long-run OPEC production capacity is lower as a result of the production agreements.
What is clear is that the Biden administration and the proponents of the NOPEC legislation are in no position to back up their argument, as, regardless of any short-term Russian effect, the administration’s policies are largely responsible for the increase in prices for crude oil and refined products. Those policies have reduced investment incentives, thus increasing expected future prices, and therefore current prices as well. (Because the production of crude oil is substitutable over time — a barrel can be produced now or in the future — an increase in the expected future price creates an incentive to produce less in the current time period, so that over time the expected price path rises at the market rate of interest.)
There is little evidence that the proponents of NOPEC have thought through the implications of their proposal. That there would be a reaction from the Saudis and others is a given: Control of their oil production policies is an overwhelming component of their political power. They can enact their own laws, regulations, and less-formal constraints, jeopardizing the investments of American firms on their territories. They could cut production (or production growth) as a retaliatory measure and negotiating tool, with consequences that are unlikely to benefit the U.S. economy in the aggregate.
And can anyone be surprised that yet another Beltway proposal will yield an outcome diametrically opposed to the one ostensibly sought? Gary Hufbauer of the Peterson Institute makes the additional point that U.S. litigation against OPEC generally or the Saudis in particular would strengthen a Saudi–Russian oil alliance, thus creating a real cartel to replace one that currently does not exist.
The U.S. government is hardly innocent in terms of policies raising prices in important markets. The renewable-fuel standard — the ethanol mandate — has raised food prices globally, not a welcome outcome for most nations, and for many developing economies in particular. Various tariffs, quotas, and other such interference with international trade — quite apart from any national-security imperatives — have bestowed benefits on some domestic producers (and adverse effects on others) while disadvantaging foreign competitors. Subsidies and other artificial favoritism for unconventional energy arguably reduce the aggregate demand for crude oil, thus imposing losses upon the OPEC producers, with environmental or climate benefits effectively nonexistent. The gander/goose principle remains relevant: The U.S. will not be immune to equivalent policies pursued by others, and a system in which national and international bureaucracies and judges must adjudicate such disputes is likely to prove troublesome.
The NOPEC proposal is an attack on the sovereign immunity of national governments, and the consequences of an attempt to erode it in the fashion contained in the NOPEC proposal will engender a large number of problems complex and difficult to predict in advance. But many adverse effects are obvious even if shunted aside by the proponents; NOPEC is a “Do Something!” policy path replete with dangers and perverse outcomes. It should be rejected.
No comments