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Does OPEC Matter? Jeff Colgan Responds

by Michael Levi
May 30, 2013

Last week, I blogged about a forthcoming paper in IO that argues that OPEC doesn’t have a significant impact on oil prices. In this post, Jeff Colgan, the author, offers a thoughtful response. A few further notes of my own are at the bottom.

Last week, Michael Levi posted a critique of my forthcoming article in International Organization called “The Emperor Has No Clothes”.  My article claims that there is no good evidence to believe that OPEC is a cartel, using evidence from four quantitative tests.  The paper then explains why OPEC members have good reason to perpetuate this “rational myth” – being seen as a powerful cartel brings them international prestige and political benefits (which we can see in the data on diplomatic representation).  Levi offers a balanced review of my argument but ultimately criticizes it for going too far.

He raises some important questions. First, my article offers evidence that OPEC members generally produce as much oil as a non-OPEC state once we statistically control for things like size of reserves and a country’s investment and business climate, but Levi wonders whether the country’s investment and business climate isn’t itself shaped by a state’s OPEC membership.  He suggests that an OPEC country, “having decided to underinvest in oil production”, makes little effort to improve its investment climate.  His hypothesis about how OPEC influences investment is therefore premised on the idea that its members are intentionally underinvesting in their oil sector.  He doesn’t offer any evidence to support that premise, and I’m skeptical.  Leaders in OPEC states like Nigeria, Ecuador, Venezuela, Iraq, and elsewhere have repeatedly expressed their desire to increase oil production, not restrain it.  They might be lying, of course, but the same countries have big incentives for higher oil production to balance their deteriorating fiscal situations.  (The Gulf monarchies with huge reserves are different: they might actually be trying to under-invest, but the model accounts for that.) Still, intentions are hard to discern: do you think most OPEC states are trying to under-invest?

Second, the statistical evidence shows that we cannot reject the null hypothesis that OPEC is having no effect, which is not the same as proving that OPEC is having no effect.  We should be cautious.  Levi criticizes the article for dealing with this issue only “indirectly.” That’s a bit unfair: I consider it quite explicitly, by exploring what happens if we ignore the statistical insignificance of the OPEC coefficient in the regression model and instead treat it as a real effect.  Doing so suggests that OPEC produces 1.6 million barrels per day (mbpd) less than it would if it was acting competitively.  Levi says this is “not a trivial amount of oil” and argues that it might, in fact, indicate OPEC’s cartel behavior.  A lot of policymakers would agree, but I think that’s a mistake.  1.6 mbpd is less than 2 percent of the world oil market.  In the long-run, that amount is small: it would mean a price increase of a few percentage points at most.  Still, Levi then raises an even more interesting question: what if the coefficient is not only statistically significant but also underestimates the true effect of OPEC (within the span of the error bars)?  That is unlikely but possible, and Levi is wise to raise it as a cautionary point.

Third, Levi concludes that it would be “awfully unwise for policymakers or market participants to quickly flip to an equally over-confident belief that OPEC doesn’t matter.”  He is right to urge prudence, but not if the alternative is for policymakers to continue wasting valuable time, resources, and political capital in the belief that OPEC controls world oil markets when there is no good evidence to support that belief.  Economists have been casting doubt on the OPEC-cartel idea for thirty years.  My work adds more fuel to that fire, and shows why OPEC members have reason to perpetuate the myth – it gives them prestige and political benefits.  When US policymakers want the price of oil to change, they waste political capital by kowtowing to OPEC (not just Saudi Arabia).  Until someone produces some real evidence of cartel collusion, US leaders should stop doing that.

More broadly, journalists and pundits should stop using the assumption that OPEC’s actions are key drivers of world energy markets.  They are not.  Most of the credit or blame for rising oil prices in the last decade rests with the energy demands of new Asian customers, not diabolic moves by OPEC.  Legislation such as the various “NOPEC” bills in the US Congress may be useful for scoring political points, but they have little bearing on the reality of the global oil markets.  With the world price of oil set by market forces almost entirely outside of its control, OPEC seems to be along for the ride like everyone else.

Some further notes from Michael Levi: Colgan makes several important points. In particular, he and I agree that unquestioning claims about massive OPEC influence are unwise. But let me emphasize a few matters of continued disagreement. First, the fact that several “peripheral” members of OPEC appear to produce as much as they can doesn’t provide evidence against the widely held belief that the OPEC “core” restrains investment. Second, regarding whether 1.6 mb/d is a trivial amount of oil underproduction: Colgan is right to say that this isn’t a big amount in the long run. But remember that this figure is obtained by averaging over a period of several decades; to really establish that OPEC under- (or over-) production isn’t important one would need to look at the pattern on shorter timescales (including with a focus only on the shorter period where observers have actually claimed that under-investment was a major OPEC tool). Third, I emphasized in my post that Colgan’s statistics do in fact suggest (though far from prove) OPEC has influence on oil production even after controlling for investment environments, just not at the 90-percent confidence level that political scientists typically require; Colgan appears to accept parts of this. It’s hard to go from that to unequivocal claims that OPEC isn’t a “key” player and that “most of the credit” for rising oil prices lies beyond the group.

Post a Comment 2 Comments

  • Posted by Jim Sanders

    This is an interesting debate, but perhaps the fortunes of individual OPEC members are now even more important than the so-called cartel itself. Ajay Makan quoted Nigeria’s oil minister in yesterday’s Financial Times, (see, “US shale oil boom underscores Opec financial divide”), as saying that African oil revenues risk declines of up to 25 per cent because of US shale oil coming on the market, “crippling the economies of several Opec members.” Nigeria and Angola are at greatest risk. For Nigeria this is scary news. Abuja needs to fund its military operations against insurgent Boko Haram in its north. A tectonic shift is occurring both in global oil markets and in some oil-producing countries. As a petrol state built on free-flowing oil revenues, Nigeria’s adaptation to changing times is by no means certain.

  • Posted by David B. Benson

    I gather there are two hypotheses. There are Bayesian tests which demonstrate which of the two (or more) is best supported by the weight of the evidence [assuming that is quantitative]. Furthermore, there are standard information criteria to determine how much better one hypothesis is. If not much, there isn’t enough evidence to differentiate.

    Given the relative inelasticity of transportation fuel demand, 2% withheld seems quite a bit to me.

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