OPEC The Organization of the Petroleum Exporting Countries (OPEC) was founded by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela in 1960. Headquartered in Vienna, Austria, since 1965, OPEC currently has 13 member countries— Algeria, Angola, Equatorial Guinea, Gabon, Libya, Nigeria, Republic of the Congo, and the United Arab Emirates, in addition to the five founding members.2 OPEC members control approximately 44% of the world’s oil output. In 2016, a larger group—OPEC+—was formed, incorporating ten loosely allied members (not full members): Azerbaijan, Bahrain, Brunei, Kazakhstan, Malaysia, Mexico, Oman, Russia, South Sudan, and Sudan. The combined group of 23 countries account for half of the world’s output.

OPEC’s official mission is to “coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets, in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers, and a fair return on capital for those investing in the petroleum industry.” OPEC is a textbook example of a cartel—defined as an output-fixing and price-fixing entity involving multiple competitors that seek to increase joint profits. OPEC members engage in explicit collusion, by directly negotiating output and pricing in order to divide markets. The injured parties are customers—oil-importing countries. During the two Oil Shocks in the 1970s (1973–1974 and 1979–1980), OPEC reduced output, drove up prices, and caused worldwide oil shortages and economic recessions. However, as a cartel OPEC is different from cartels formed by companies, which are often illegal and—if caught—prosecuted by governments.

As an intergovernmental organization, OPEC is formed by sovereign countries and their collusion (hereafter coordination, which is a term used by OPEC itself) is protected by the doctrine of state immunity under international law.
In other words, there is no higher authority in the world that can punish such cartel behavior—the United Nations is toothless in this regard. Because most cartels are secretive, OPEC whose functioning is relatively transparent and widely reported by the world media can serve as a great case study to enhance our understanding of cartel behavior.

Saudi Arabia in the 1980s Of particular interest is the behavior of Saudi Arabia, which, as the largest player, has served as a price leader—a leading cartel member that has a dominant market share and sets acceptable prices and margins in order to help maintain order and stability needed for collusion in the industry.
In theory, Saudi Arabia is “the first among equals” within OPEC. In practice, Saudi Arabia has served as OPEC’s undisputed price leader, dictating terms and enforcing compliance of cartel agreements. A key weapon possessed by a price leader is the capacity to punish—sufficient resources to deter and combat defection.
Most cartels have a hard time reaching agreements and—having reached such agreements—enforcing such agreements. Thanks to the “prisoner’s dilemma,” members have an incentive in undercutting each other in order to maximize individual market share. OPEC was originally formed for the common interest of enhancing member countries’ bargaining power when dealing with the “Seven Sisters”—another cartel formed by the seven major oil-producing multinationals that dominated the industry from the 1940s to the 1970s.3 The diverse, expanded membership, now with 13 countries as full members and with ten more as OPEC+, has made OPEC diplomacy more Byzantine and agreements more difficult to reach.
According to Bloomberg Businessweek, the only common interest that unifies OPEC members is “their addiction to petrodollars”—virtually all members significantly rely on oil revenues to fund government spending. Furthermore, after reaching agreements, members have tremendous incentive to defect from such agreements.
In the 1980s, OPEC began setting production quotas for its members. However, a number of members soon defected by “secretly” increasing production to grab more market share. To combat such defection, Saudi Arabia in 1982 pressed OPEC for audited national production quotas in order to limit output and boost prices. When other OPEC members failed to comply, Saudi Arabia in 1985 first slashed its own production from 10 million barrels per day typical during the period of 1979–1981 to just one-third of that. When that action proved ineffective, Saudi Arabia reversed course and flooded the market with cheap oil, causing prices to fall below $10 per barrel—from a thenpeak of $40 per barrel during 1979–1981. While Saudi Arabia lost money, its losses as the lowest cost producer were manageable. However, its action to flood the market made the economic losses for high-cost members unbearable.
Facing increasing economic hardship, the “free-riding” members that had previously failed to comply with OPEC agreements eventually followed Saudi Arabia’s wishes by reducing production and thus jointly jacking up prices in 1986. Overall, the effectiveness of Saudi Arabia’s capacity to punish depended on both its willingness and capability to carry out punishments. Saudi Arabia was willing to unleash such costly punishment, because it realized that if smallscale cheating was not dealt with, defection might become endemic, and the cartel might collapse.
Saudi Arabia in 2020 The biggest threat to OPEC in the 2010s was the shale revolution, which made the United States the top oilproducing country ahead of Saudi Arabia as number two and Russia as number three. Such a rise of US production not only reduced US reliance on Middle East oil, but also threatened OPEC’s 40-year dominance in international energy pricing. After Russia led the other nine countries to join the OPEC+ group in 2016, Saudi Arabia and Russia as well as the rest of the OPEC+ group collaborated and engaged in voluntary production cuts in order to promote higher prices between 2017 and 2019. OPEC+ committed to cutting oil production by 1.2 million barrels per day—
about 3% of members’ output—from a benchmark level in October 2018. While Saudi Arabia and Russia agreed to bear the brunt of the cuts, Saudi Arabia actually cut production by more than 850,000 barrels per day—covering more than two-thirds of the entire OPEC+ target single-handedly.
However, defecting from the production cut agreement, Russia had been overproducing by 250,000 barrels per day.
In March 2020, the tension-filled negotiations between the Saudi and Russian oil ministers in Vienna broke down. Saudi Arabia issued an ultimatum: accept a deal for OPEC+ to have additional cuts of 1.5 million barrels per day (about 1.5% of world output) beyond what was implemented during 2017–2019 or no deal at all. Russia called what many thought was a bluff, and rejected the deal. As a result, as of April 1, 2020, every OPEC+ member country would be free to pump at will.
On March 8, 2020, the first day of oil trading after the OPEC+ negotiations broke down, the price of Brent crude, a global oil benchmark based on European production, dropped by more than 30% within seconds after opening. It was the largest single-day drop since the 1991 Gulf War. In January 2020, Brent crude hovered around $70 per barrel. 

By March 30, it fell to $22. Enjoying the world’s lowest production cost of $3 per barrel, Saudi Arabia would boost its daily production from 12 million to 13 million starting on April 1, thus unleashing a massive gamble with global ramifications. This gamble would not only punish Russia but also threaten the stability of most OPEC member countries, and disrupt plans for oil companies ranging from giants such as ExxonMobil to small shale producers.
It seemed possible that Saudi Arabia had been preparing to unleash such a massive capacity to punish for some time.

First, organizationally, the kingdom during 2018–2019 pushed its sole state-owned enterprise in the oil industry, Saudi Aramco, to raise public funds by going through an initial public offering (IPO) in order to reduce the funding cost for the government. In December 2019, although only offering 1.5% of its equity on the Saudi Stock Exchange, Saudi Aramco raised $26 billion, making it the world’s largest IPO to date (on top of Alibaba’s IPO in 2014). Its $1.88 trillion market capitalization made it the world’s most valuable listed company.
Second, competitively, Saudi Arabia—as well as Russia— was interested in driving down the oil prices to bankrupt their common number-one threat: US shale producers, which needed $48 a barrel to break even. In response, US shale producers, already having mounting debts, had to quickly cut their production. If Saudi Arabia and Russia drove a large number of US shale producers out of business, it would be possible that they might sit down to negotiate again. This is how cartel members typically behave after driving out nonmembers.

Third, externally, Saudi Arabia might have changed its policy to maximize pricing for the long run. This is because in the long run, its huge oil assets may become rapidly depreciating, as green (non-fossil-fuel-based) energy sources rise. In fact, Aramco’s prospectus for its 2019 IPO predicted that oil demand might peak in the next two decades. Therefore, pumping out as much as oil as possible, even at a lower price, seemed better than being stuck with increasingly unpopular fossil-fuel assets whose demand might eventually plummet. This has become known as a fast monetization policy. A nontrivial benefit is that low oil prices can reduce the incentive for utilities, companies, governments, and households to switch to green energy sources.

However, the timing of Saudi Arabia’s specific action— in the middle of the coronavirus-induced global recession— could not have been worse. The devastation of the coronavirus shut down one economy after another. As people worked at home, they did not need to burn fuel to commute to work. As passengers quit flying and airlines cancelled flights, the demand for fuel collapsed. Therefore, pushing the oil price to rock-bottom levels in order to incentivize more consumption by the end of March 2020 seemed a desperate measure for Saudi Arabia to defend its market share in the world.
Saudi Arabia’s action came at a great cost to itself.
This was typical of a price leader’s endeavors to flood the market with cheap products. Different media sources suggested that Saudi Arabia needed $50–$80 per barrel to balance its budget. But by April 9, 2020, OPEC daily basket price—the average price of the 13 crudes from all member countries—went down to $21 per barrel. Fighting the price war at such low oil prices would certainly result in balance of- payments deficits. Although it could sustain losses for quite some time, there would be severe economic pains for Saudi Arabia to live in a world of low oil prices. For a while, neither the price leader nor the leading rebel (Russia) in the cartel was blinking. Every member was pumping at will.
The lose-lose price war did not last very long. On April 12, 2020, barely 12 days after the commencement of “hostilities,” Saudi Arabia, Russia, and the rest of OPEC+ came to an agreement brokered by US President Donald Trump. OPEC+ agreed to cut 9.7 million barrels per day.
To provide better incentives for the cuts, the United States, Canada, and Brazil would contribute another 3.7 million barrels to cut on paper as their production declined, and other G20 countries would contribute 1.3 million. The G20 numbers did not represent real deliberate, voluntary cuts, but rather reflected the impact of low prices on output.
As recently as in earlier April, Trump told reporters that “I hated OPEC” for its price fixing. However, in the larger context of protecting jobs in the American oil industry (especially shale-production jobs), Trump became the first American president to push for higher oil prices in more than 30 years, reversing his personal opposition to the cartel. April 12 was a Sunday. On Monday, April 13, the price of Brent crude jumped 8% in the first few seconds of trading on Monday in Asia, where markets opened first. At the end of the day, price went up to $31 per barrel.
However, on April 20, the future contracts for May delivery of West Texas Intermediate—the US benchmark price and one of the two global benchmarks (the other is Brent crude)—dropped to minus $37.63 a barrel. The jaw-dropping development meant producers were paying buyers to take the oil away. Clearly, the deal brokered by Trump about a week ago was too little, too late. The industry’s chronic oversupply—magnified by the Saudi Arabia-led price war and the rapidly shrinking demand due to the coronavirus—
simply overwhelmed the world’s storage capacity. The Brent crude ended April 20 down sharply—above $25 a barrel.
For Saudi Arabia as the price leader of the world’s largest cartel, the new agreement was a truce, but not peace. It would not take effect until May 1. Everybody was still free to pump at will for the three remaining weeks of April, thus contributing to the tumultuous price collapse in late April.
In the long run, uncertainties associated with how to verify cuts and how to punish defections—given the well-known incentive to cheat in any cartel—will continue to loom large on the horizon.

Case Discussion Questions

1. ON ETHICS: What are the characteristics of a cartel?

2. What are the benefits and burdens of being a price leader in a cartel?

3. What are the benefits and burdens of being an OPEC+ member?

4. ON ETHICS: As CEO of a US shale producer, you have a chance to meet the president. In addition to lobbying for bailout funds from the US government, how would you advise the president what his administration can do diplomatically to help your firm when dealing with Saudi Arabia?