April 18th 2020


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Articles from this issue:

COVER STORY Justice at last: Cardinal Pell set free

EDITORIAL Australia needs an economic reset after covid19 crisis

CANBERRA OBSERVED The very young can still be 'taken care of' during the covid19 outbreak

RURAL AFFAIRS A national disgrace: Our great land sale

NATIONAL AFFAIRS Use detention centres to help deal with covid19

GENDER POLITICS Do we really need to ask, what is a woman?

REFLECTION A chance for a change of heart: Covid19 as Memento mori

FAMILY Who let the kids out? The stay-at-home parent and covid19

ECONOMICS The oil cartel: The lesson for other industries from OEC

HEALTH Lessons from the 1918 Spanish flu epidemic

CULTURE AND SOCIETY There is a war: The battle in and for hearts

ASIAN AFFAIRS What makes China different is not the Chinese but the CCP

HUMOUR Locked down in Covi Town

MUSIC Great, er, swan songs

CINEMA+TV Staying in; staying sane

BOOK REVIEW Not our Robin Hood

BOOK REVIEW At home among others

POETRY

LETTERS

AS THE WORLD TURNS

CARDINAL GEORGE PELL FREE: The commentary file

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ECONOMICS
The oil cartel: The lesson for other industries from OEC


by Colin Teese

News Weekly, April 18, 2020

Readers of these pages, whether or not they follow national or international events, will know about the price of petrol. Because every time they fill up their car, it touches their hip pocket nerve.

If the price of petrol rises, buyers have less to spend on other things or to boost their savings.

OPEC has had control of the valves
that regulate the world oil supply.

Petrol, like many other base commodities, is an undifferentiated product – one brand of petrol is basically the same as all others. As a consequence, its consumption is not importantly sensitive to price. In economic jargon, petrol is price inelastic. We don’t rush to buy more because the price falls, or less because the price rises. We buy what we need.

This has important implications for how oil (from which petrol is produced) is priced. Unlike many other basic commodities, such as, say, coal and iron ore (also undifferentiated and price insensitive), the price of oil is not determined by market operations, but by a producer cartel called OPEC (Organisation of Petroleum Exporting Countries). OPEC, created in 1960 and based in Vienna, comprises most of the world’s oil producers, large and small, except for the United States and Russia.

Essentially, OPEC oil-price fixing is determined by Saudi Arabia, in consultation with Russia. Though the latter is not a member of OPEC, no pricing arrangement concluded by OPEC could work without Russia’s cooperation.

Russia and the Saudis are the world’s largest and most economic producers. Collectively, they set the oil price, which typically will be at a level that will enable the less efficient OPEC members to survive. Of course, that same level of price happens to be highly profitable for the Saudis and Russia.

When it’s working, and that is most of the time, OPEC is a great deal for all – all oil producers, that is. First, and most importantly, because the buyers of oil, the powerful oil refiners, are denied the opportunity to play one oil producer off against another, and thereby drive down the price of oil.

OPEC keeps its membership in the driver’s seat when it comes to price negotiations. Admittedly, this higher price comes at a cost to the efficient producers. They sell smaller quantities than would otherwise be the case, but at a much better price.

So, should we applaud them as protectors of consumer interests?

Yes and no. While it is true that oil would be cheaper in the absence of OPEC, rest assured that this would not necessarily be reflected in the price we all paid for petrol. The refiners would see to that.

There is no evidence of a formal cartel of oil refiners in the manner of OPEC. But what we do know is that the price of petrol at the pump does not usually match the movement in oil prices. Various brands of petrol studiously avoid competing on price.

What we can assume from all this is that the big oil refiners are not stupid. They might sell their output under different brand names, and even use advertising to pretend that each one of them is supplying a differentiated product.

But the purpose of their full-on advertising/marketing is not to underwrite inter-refinery competition on price. Quite the opposite. The aim is to consolidate the domination of the market by existing refiners. What they most want to discourage are new entrants breaking into the refining business, since this means a reduction in market share for all refineries.

Curiously enough, although refiners publicly deplore the presence of OPEC, the oil cartel actually helps the refiners to keep control over the price of petrol. Neither side has the interests of the consumer at heart.

Fortunately, understanding all of this affords us a good insight into how business prefers to operate – especially in the production, marketing and distribution of differentiated products, which includes most manufactured products such as cars, washing machines, computers and mobile phones. With such goods, it is possible, by means of marketing and advertising, to persuade most consumers of the relative merits of one otherwise identical product over another.

This confers an important advantage to the producers of differentiated products. It enables them to set the price. Consider cars. The manufacturer sets the price, though dealers may be afforded a small measure of price flexibility on the showroom floor.

It will be immediately apparent that the same does not apply to producers of undifferentiated products such as farm output and minerals products such as coal and iron ore. And, of course, oil.

Now the question arises. Why do the producers of farm output not create cartels like OPEC? The answer is, that except for iron ore and coal, we once did, both domestically and through international cooperation.

Australia has in the past been party to international agreements for, among other things, sugar and wheat. The purpose of these agreements was, by one means or another, to have the world’s producers of these products avoid competing with each other for market share, which would invariably lead to overproduction and downward price pressure, to the disadvantage of all.

Today, all those international agreements, except OPEC, have disappeared. Over the last 40 years or so, the rest of us have been persuaded by advocates of free markets and “competition” to surrender control overproduction and price in favour of “market- based solutions”.

It is at last becoming clear that the competition approach leads to a race to the bottom on price, which happens to benefit neither producers nor consumers of commodities. Contrary to everything we have been told, consumers have suffered as much as producers, as middlemen siphon off profits.

OPEC has prevented this happening in the case of oil.

WHAT WE ONCE HAD

More or less unique to Australia, we once maintained domestic marketing agreements for most of the agricultural commodities we produced. We were also party to a number of international agreements; these too, conferred benefits, but the world has given up on them.

The same was not true of domestic marketing boards. These our government gave up as a matter of conscious choice. That this was a tragic mistake is now becoming ever more obvious every day.

But before we move on to discuss what should be done to recreate marketing disciplines on undifferentiated commodities, a final word or two about OPEC and oil.

As we all know, the price of oil has dropped dramatically and is likely to continue its downward path. The reason for this is that the Saudis and Russia, who between them set the OPEC price, have been unable to agree.

Accordingly, OPEC is not functioning to hold up prices by limiting supply. The reason that Russia and the Saudis are allowing the price to fall is not entirely clear but we can speculate.

The U.S. is a big producer of oil extracted from shale – its own reserves of ordinary oil having been largely exhausted. Shale oil is much more expensive to produce than the natural alternative. If the price of natural oil is high enough, then shale becomes a genuine competitor to the natural oil producers. If allowed, it is a new entrant into the market. If the two most efficient oil producers can cut their price for long enough, they may be able to keep shale out of the market.

Additionally, at least for Russia, this might also have a strategic purpose, given its hostile relationship with the U.S.

Whatever else might be said, OPEC makes the case for producers of individual commodities to cooperate on price and output to their own benefit. That having been said, and given the state of our farm sector, then surely the time has come for Australian policymakers to take a fresh look at their attitude to marketing boards and to international agreements.

We can’t do much about international cooperation, but the government can, and should, look at ways of helping our farm sector survive, both domestically and in international markets. First, and quite possibly most important, is to make certain our farmers are allowed to maintain whatever competitive advantages they have over import competition.

Especially, we must not impose, as is currently happening in the case of some farm products, stringent production disciplines on domestically produced goods for health purposes, and yet not require the same standards to be met by competing imports.

Second we must not permit imports from sources that risk introducing into Australia diseases we do not have here. Over many years we have become increasingly lax in the administration of quarantine regulations.

There is an inherent problem for production and distribution of farm products – overproduction. The individual producer of, say, wheat sees the answer to his personal problem of falling prices being solved by producing more. Across the sector, this can’t work. More production overall further drives down prices.

Marketing boards can solve this problem by helping farmers manage the price and production to the benefit of all – rather as OPEC does for oil producers. These same marketing boards can, as they once did, also help farmers meet international competition and penetrate export markets.

Any Coalition government interested in individual farm security and in solving the associated social problems of our rural areas should be prepared to accept that the present policies of cutthroat competition have failed.

It is time to consider alternatives.

Colin Teese is a former deputy secretary of the Department of Trade.




























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