Against OPEC: Why OPEC is so detrimental to international commerce.

In my last post, I touched on the act of state doctrine, and OPEC. In a previous post, I discussed the court's rationale for affording OPEC the benefit of the act of state doctrine.

In 1981, OPEC was afforded the benefit of the act of state doctrine. The court's reasoning for applying the doctrine was sound, but the doctrine should not have applied. It is time for a change in the applicability of the act of state doctrine. I have no issue with applying the doctrine to conduct of a single country when it has minimal or minor effects on international commerce. But the doctrine causes substantial problems and consumer harm when individual countries cartelize to affect international commerce.

Now, it is not likely that the Vitamin C litigation will be OPEC's undoing. But OPEC's time is limited, because its constituent countries will be unlikely to adapt to compete with and invent alternate methods of energy. So as alternative energy becomes more economical to produce and use, the more difficult it will be for OPEC to compete.

To get an idea of how detrimental OPEC is to international commerce, consider an alternate scenario: The U.S. and other Western nations cartelize and form an Organization for Technology Exporting Countries (OTEC). OTEC fixes and strives to stabilize prices for technology-based products like computers, smartphones and tablets. Companies in OTEC countries must conspire to fix prices for technology-based products, despite the fact that consumers throughout the world are harmed by having to pay higher prices.

Simply because a foreign government chooses to act in a certain way does not mean that it should be afforded any exemption when it affects the global market in such a detrimental way. OTEC would have that effect. There are two reasons that OPEC is tolerated. First, it has been historically accepted. Organizations that have existed for a long time become accepted no matter how detrimental they are to society or commerce. Second, the U.S. does not want to cause any more international friction in the Middle East and North Africa than there is already. Six of the 12 OPEC members are in the Middle East. Two of the 12 OPEC members are located in North Africa, and another two are located elsewhere in Africa.

Some may argue that my opinion on OPEC is myopic and typical of an American. But there are about 200 countries in the world, and only about six percent of those are members of OPEC. The other 94 percent or so use oil, and only a small number of them can handle increased oil prices and maintain a high standard of living. OPEC affects all countries, but the really detrimental effects are felt in second and third-world nations that either cannot afford oil due to OPEC's cartelization of the oil market, or only a small number of people in those countries can afford oil. So my opinion is not just an American one.

On Cartels and OPEC.

Cartels are illegal in the United States. They are occasionally in the news, most notably when reference is made to the Organization for the Petroleum Exporting Countries ("OPEC"). OPEC is a classic cartel, which is a formal arrangement of competitors intending to limit competition and/or effect that limitation. Cartelization can occur on an informal basis, such as with the Mexican drug trade. The tamest form of informal cartelization is "oligopolistic pricing," which is when a market only has a few competitors who never intend to cartelize, but essentially do so based on market conditions.

The gasoline industry in the United States is an example of an oligopoly. There are only a few competitors, and their pricing is almost always in concert. The price of gasoline fluctuates rather widely, based on the price of crude oil. Irrespective of the price of crude oil, the formula for the price at which gasoline is sold to consumers remains constant. So, the price fluctuation in gasoline in the United States is affected by the price of crude oil and OPEC's restriction of output.

There is debate whether oligopolistic pricing should be legal or illegal, because not much competition exists in markets with oligopolies. Any lowering of the price by one competitor causes others to meet that price. Any temporary advantage gained by the company who lowered its price is negated when its competitors lower their prices. For instance, if two gasoline stations are across the street from each other, and they both start with a price of $4.00 per gallon for unleaded gasoline, one cannot lower its price to $3.90 per gallon because the other station would clearly do so, putting both stations in a worse position than keeping their prices at $4.00 per gallon.

Hence, profits of the oligopoly are diminished when one company tries to lower its price. The difference between oligopolies and informal cartels is basically academic. Consumers are harmed by both, and oligopolies engage in tacit cartelization. They just do not split profits like classic cartels.

So why is OPEC allowed to operate as a cartel when its effects are felt in the price of gasoline in the United States? In 1981, the Court of Appeals for the Ninth Circuit heard this issue. In district court, the Central District of California concluded that it lacked subject matter jurisdiction over OPEC and could not hear the case. The Ninth Circuit decided the case on different grounds on appeal. The Ninth Circuit concluded that The Act of State Doctrine precluded the court from declaring OPEC's activities illegal.

The Act of State Doctrine provides that a U.S. court will not adjudicate a politically sensitive dispute which would require the court to judge the legality of the sovereign act of a foreign state. International Association of Machinists and Aerospace Workers v. The Organization of Petroleum Exporting Countries, 649 F. 2d 1354 (1981), cert. denied, 454 U.S. 1163 (1982). OPEC is made up of 12 member countries, so the court reasoned that it was not going to infringe on their decision to cartelize. Id.

OPEC's members are primarily in the Middle East and North Africa. They restrict the output of crude oil in order to stabilize prices and keep them higher than they would be in a free market. OPEC's days are numbered however, because two essential characteristics of a cartel are an ability to control output and a lack of alternatives (called "inelasticity of demand").

If OPEC did not restrict output and control prices, then its member countries would compete with each other, making less than they do in OPEC. Clearly, consumers are harmed, because higher pricing finds its way to them at fuel pumps.

OPEC will either adapt or die when alternative energy becomes readily available, or enough oil reserves are opened in non-OPEC countries that allow for free market competition between OPEC and the new entrant into the market. Current inelasticity of demand and the ability to control output allow OPEC to operate in such a way as to harm consumers across the globe. Within 20-40 years that will not be the case. I think it is extraordinarily unlikely that OPEC will find a way to adapt to a competitive market.