by R. Morris Coats

The OPEC countries have agreed to cut back production in order to lift oil prices out of the $10 - $12 per barrel doldrums. Not only have the OPEC countries agreed to cut production to help boost prices, but the non-PEC country of Norway, the world's second largest oil producer, has agreed to cut production if OPEC does, as have two other non-OPEC countries, Mexico and Oman. Prices for light, sweet crude have risen to about $15 as I write. While this is the kind of news that we in south Louisiana have been waiting for, let's not start counting these chicks.

The OPEC oil cartel has the same problems that most cartels have. It's easy to get the members of the cartel to raise prices or slash production levels, but it's another thing altogether to get them to do what they promise. Not only is there a problem getting cartel members to abide by their promises to raise their prices or cut their production, but producers who don't belong to the cartel often fill up the whole in production left by the cartel's cutback.

Let's look at this last problem. Think about what we hope to see happen with this new, higher price for oil. The reduction we have seen in oil and gas exploration and production in the Gulf this last year would be halted and, perhaps, reversed because the new, higher price for oil beckons us to producer more. If we produce more, we will partially negate the production rollbacks that OPEC and others have promised. To paraphrase an old song--we rush in where OPEC promised not to tread.

It is easy to see why cartel members agree to raise prices or cut back on production--a higher price will give everyone a larger profit. All cartel members will usually agree to the production rollback, because if they don't agree to it, no one else cuts back on production. The reason that cartel members tend to go back on their promises to cut production is a bit more involved, but not much.

Suppose you and your fellow nine cartel members each have ten percent of some market, and suppose that you have each agreed to cut production by ten percent. The total promised cutback in production is as much as any member's total production level. If instead of cutting production by ten percent, one cartel member raises output by ten percent, then production still gets cut by eight percent, which still raises prices.

Why would a cartel member want to raise output instead of cutting output as promised? The reason is the same reason that non-cartel members increase their output: higher prices make it profitable to increase production.

If it were just one cartel member increasing its production when it promised to cut production, it probably wouldn't matter much, because total production would still get cut and prices would still go up. But that's not the case--if its profitable for one to do raise production, its profitable for others to do the same.

It should be easy to see that only some of the producers have to raise production in order to negate the cutbacks of the rest. Not only that, but as soon as some begin to see that others are going back on their word to cut production, they will no longer fill honor-bound to keep their own production low.

OPEC has had such problems in recent agreements to cut production. Iran and Venezuela would not abide by the promised cuts. In fact this agreement had special concessions for Iran, giving Iran a smaller share of the production cutbacks. This agreement might work to boost oil prices, but some other cartel members may turn out to be cheaters this time.

While the recent upturn in oil prices is welcomed news in the oil patch, this new price is no more written in stone than the previous low prices had been. The only thing under these new higher prices that keeps them up are the promises of OPEC members and several others to not expand their production even though they could make more money if they did. That's not the sort of promise to take to the bank.