J.E. Spero and J.A. Hart, The Politics of International Economic Relations (7th ed., 2010), Ch.

9, OIL AND POLITICS, (338-355)

History of the international regime of oil and oil markets: 1. Corporate Oligopoly -Seven Sisters: oligopoly of international oil companies from USA, UK and the Netherlands (political dominion
of oil-producing region) -Vertical integration*: control of supply, transportation, refining, marketing, exploration and refining technology -Origins: late 19th century, control of foreign supplies on goods terms after WWI: seven sisters divide up sources of

supply under explicit agreements -> divide markets, fix world prices, discriminate against outsiders*. -upstream: restrict exploration through concession agreements with oil rich areas -downstream: manage price of crude oil! Such control over the market was possible because of: +inelastic demand for oil* : no substitutes, hard to decrease consumption +political intervention: home countries of seven sisters nationalized their assets abroad -Changes: after WWII 1950s: -Consumer side: increase in consumption (US becomes net importer) and greater reliance on relatively inexpensive oil imports (Western Europe and Japan) -Producer side: nationalism leads to more aggressive policies - revision of concession agreements, increase in royalty payments, income tax on foreign oil companies, etc.

-Decline:

1. Increase in competition 2. 1959-60: international companies forces producers to lower posted price -> catalyst for producergovernment action against the Seven Sisters! 3. Changes in oil producing states: they have greater leverage in bargaining (+greater monetary reserves also increases their bargaining power) 4. Emergence of the OPEC 5. Consumer countries are under threat of supply interruption (decrease in US supply/ dependence on Gulf)

2. OPEC System -OPEC: formed in 1960 (Iran, Iraq, Kuwait, Saudi, Venezuela) -Origins of OPEC System:

-1970s: triggered by Libya (25% of European supply) that demands raise in posted price -agreements are made to raise posted price to $2.48 (BUT: such fixed price is disadvantageous for producers when demand starts to rise) -December 1972 Agreement: between Saudi Arabia, Qatar, Abu Dhabi plan for increase in government ownership from 25% to 52% by 1981. -OPEC Management: was successful thanks to: 1. Role of Saudi Arabia: willing to absorb production reductions to maintain stable prices 2. Recession in OECD: stable demand for oil, while supply is increasing 3. Political factors: -OPEC willing to maintain high production to finance their lavish economic development programs -Friendly US-Saudi relations -the higher posted prices were lower than inflation therefore there was a decline in real price of oil!

-Opposition (?):

1. Seven Sisters: though their power had been reduced, they remain as important service contractors for Arab governments. 2. IEA: Although USA-Western Europe-Japan had wanted to form a counter-cartel, collective action is hard among consumer countries, and it is hard to agree on ways to sanction OPEC due to their high reliance on OPEC oil. -1st Oil Crisis (1973): Fourth Arab-Israeli war leads to unification of Arab states into OAPEC (Organisation of Arab Petroleum Exporting Countries) that raise the price to $5.12. As a result the OPEC raises it to $11.65 -> 1973~ OPEC is in control of oil prices!! -2nd Oil Crisis (1978): with rising demand, the market for oil becomes very unstable and Saudi is no longer willing or able to act as regulator of the market. + political uncertainty (e.g. US-Saudi relations are not so good anymore) -Cause: 1978 Revolution in Iran (stops the 5.4 million barrel/day supply of oil) -Consequence: -panic in spot markets* (alternative to oil sold in long term contracts) -first REAL rise in oil prices -shows that OPEC has lost control over world oil market

Oil Crisis:

Factors for the Success of the OPEC: -Economic factors: 1. High and price inelastic demand for oil imports: importance as source of energy in USA, Western Europe and Japan. 2. Supply: a. Price inelasticity: rise in price doesnt lead to rise in competition. b. Tight supply of oil in international market: high bargaining power of OPEC -Political factors: 1. Relatively small number of oil-exporting countries: common political (collective) action is easier. -This was made even easier with experience! 2. Common political interest of Arab states against Israel reinforced their common economic interest 3. Strong leadership of Saudi Arabia to manage prices and production levels 4. Sellers market*: very little reduction in productivity could influence prices -International companies: helped joint-producer action* - prices could also be managed by taxing companies + governments could order companies to reduce production 5. Absence of consumer power Other cartels? -although cartels in other commodities MAY have been possible, they were unsuccessful. For the success of a cartel, you must take into account two factors: 1. Producers cant make prices TOO high- because this would encourage substitutes (requires sophisticated market knowledge and predictive ability) 2. Supply response of other producers needs to be managed , i.e. no cheating on collective action! Barriers to cartels include: -lack of leadership in managing supply -in the absence of tight markets, buffer stocks or production reductions are politically complex or economically costly -stagnant or declining demand for goods

1980s: OPEC in decline!

-demand for oil fell -non-OPEC oil production grew -prices fell THEREFORE: difficult for OPEC to manage prices !