Monday, February 28, 2011

But OPEC Is A Cartel - There's No Free Market in Oil

A commenter to my post on an oil price chain letter pointed out that OPEC is a cartel and able to charge what they want. 

OPEC is, indeed, a cartel; just as DeBeers is with diamonds.  And neither of them is able to charge "whatever they want" for their products.   The more they charge, they more they motivate their customers to find alternatives to their product.  It's a tenet of free market economics that "cartels don't last".  DeBeers is cracking (largely due to Russian and Canadian diamonds).  OPEC has historically been unable to hold production down and prices up.  In both cases, we have an impaired market.  Not a free market, but not a cartel monopoly, either.

I have a lot of admiration for the marketing genius of the diamond cartel.  They have taken a stone that is not particularly rare (they are, after all, produced in whatever quantity is desired, year after year) and created a tremendous aura about it.  One of the problems diamond sellers have is found in their slogan "a diamond is forever"; their product does have an essentially unlimited life, given reasonable care.  If a decent fraction of women who own diamonds were to sell them it would easily outstrip the world's annual supply, collapsing the price.  So they have been able to create such an intense attachment to the little stones that most women will sell almost everything they own before they sell their diamond ring. 

OPEC doesn't have that marketing power, but they have a few things going for them.  First, the world needs their product.  Most importantly, people must destroy their product in order to use it, ensuring a steady parade of buyers (and which is the complete opposite of diamonds).  In turn OPEC members have to deal with buyers who might pressure them in other ways.  Don't like my offer for your oil?  Perhaps we should cut our foreign aid back (yes, I realize we're paying for it either way).  I'm trying to show that OPEC is not really charging whatever they'd like for the oil. 

Let's look up a fun fact or two.  In 1974, right after the price of oil "shot up", a gallon of regular gas averaged 53 cents. An ounce of gold averaged around $155.  That means a gallon of gas cost .0034 ounce of gold.  In today's inflated money, that gallon of gas costs $4.79.  This means that in terms of a gold price, gasoline has gone down. 

I'll be the first to admit this is a crude way to analyze the situation, and it's strictly a snapshot, but OPEC doesn't seem very effective at that whole "charge what they want" thing, do they? 

In the final analysis, what we pay at the pump is the result of a bizarrely complicated mixture of the deal between buyer and seller for the crude, the government's regulations of gasoline mixes a refinery can make, the time of year (they make less gas and more heating oil this time of year) thousands of EPA regulations, but most importantly the pernicious influence of the detestable Ben Bernanke, whose insane monetary policy is being called responsible for the Mideast unrest that catalyzes and inflames all of this. 


  1. I'm glad you responded to that comment. I was trying to formulate a response but it just kept getting longer and longer as I delved into feedback loops and cause-and-effect relationships. I kept getting bogged down in trying to explain first principles - definitely not appropriate for the comment section someone else's blog. You did a much better job of covering it in a compact manner.

    On a related note - especially considering the commenter's admonition to you to "get a clue" - my wife was having a discussion with an otherwise intelligent young person on facebook where he continued to proffer what amounted to talking points without any real understanding of the philosophy behind them. Of course she was easily able to point out the assumptions and erroneous reasoning, but during the course of the exchange a thought occurred to me...

    Intelligence + Arrogance != Wisdom

    And ignorance + arrogance is not only worthless but dangerous (and disgusting). I'm not sure where the commenter yesterday was coming from but my guess is the latter equation.

  2. Not only is intelligence + Arrogance not equal to wisdom, that combination is about as far from wisdom as one can get!

    Unfortunately, it's a common condition.

  3. That got me to thinking... what would a chart of gasoline priced in gold look like? Unless I've screwed up my math, it sure looks like gasoline is pretty cheap, it's just that the dollar is even cheaper.

    Or, put another way, Gold isn't going up, paper money's going down!

    People see gas prices rising, and forget (or are too oblivious to note) that the US Dollar is losing value rapidly, in no small part due to Helicopter Ben Bernanke's recent QE/QE2 activities.

  4. Someone who is truly intelligent couldn't be arrogant. Not necessarily humble (false humility?) either, but understanding how little we actually know, and how difficult it can be to effectively control your path in life, would definitely rule out arrogance.