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| Fig. 1: Map of 2017 OPEC Member Countries. [1] (Source: Wikimedia Commons) |
Founded by five countries (Iran, Iraq, Kuwait, Saudi Arabia and Venezuela) in 1960, the Organisation of the Petroleum Exporting Countries (OPEC) is now the worlds largest oil cartel, controlling roughly three quarters of the world's "proven" oil reserves. [1] (See Fig. 1) The cartel is made up of fourteen nations, who together account for nearly half of global oil production, giving them huge influence over its price. [1] In 2016, they were bringing 39 million barrels of oil to market a day, out of the 92 million produced around the world. [2] The oil market, once dominated by American multinationals, now hums to the tune of OPEC. And, with the immense power that arises from being able to shift the price of oil, comes an even greater challenge. This is because the members of OPEC face a prisoner's dilemma.
The prisoner's dilemma is a classic example within game theory that shows why two entirely "rational" individuals may not cooperate even if it is in their best interest to do so. The dilemma describes a game, formalised by William Poundstone in 1992 as follows:
Two members of a criminal gang are arrested and imprisoned. Each prisoner is in solitary confinement with no means of communicating with the other. The prosecutors lack sufficient evidence to convict the pair on the principal charge. They hope to get both sentenced to a year in prison on a lesser charge. Simultaneously, the prosecutors offer each prisoner a bargain. Each prisoner is given the opportunity either to: betray the other by testifying that the other committed the crime, or to cooperate with the other by remaining silent. The offer is:
If A and B each betray the other, each of them serves 2 years in prison
If A betrays B but B remains silent, A will be set free and B will serve 3 years in prison (and vice versa)
If A and B both remain silent, both of them will only serve 1 year in prison (on the lesser charge) [3]
The game is most easily understood by means of a payoff matrix (See Fig. 2).
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| Fig. 2: Prisoner's Dilemma Payoff Matrix. (Source: Misha Wilcockson) |
The members of OPEC face a similar dilemma to that of the prisoners. It is in all of their best interests to restrict supply (to an extent) to drive prices higher, increasing returns for all parties involved. But, much like the prisoners, even though this would be best for them as a collective, it makes more sense on an individual level for them to increase supply. If everyone else in the cartel is cutting supply, prices are driven higher, so each member has an incentive to sell as much of their oil stockpiles as possible. Therein lies the dilemma. Betrayal always seems like the better option, even though it ultimately makes everyone worse off.
The simple dilemma described above is made a hundred times worse by the geopolitics and messiness of the real world. Cooperation is never simple. The Saudis and the Iranians often refuse to take action that would benefit the other, even if it would benefit themselves. Betraying (i.e. increasing supply beyond a specified quota) is virtually impossible to stop, so many countries do it. Most importantly, there are many energy alternatives available. The rise of hydraulic fracturing has helped keep prices low and the prevalence of shale and natural gas has kept the price setting power of OPEC in check. However, if all the members of OPEC decided to cooperate, perhaps we would see the price of oil rise above $100 a barrel once more.
© Misha Wilcockson. The author warrants that the work is the author's own and that Stanford University provided no input other than typesetting and referencing guidelines. The author grants permission to copy, distribute and display this work in unaltered form, with attribution to the author, for noncommercial purposes only. All other rights, including commercial rights, are reserved to the author.
[1] "Profile: Opec, Club of Oil Producing States," BBC News, 26 Nov 14.
[2] "BP Statistical Review of World Energy 2017," British Petroleum, June 2017.
[3] W. Poundstone, Prisoner's Dilemma (Doubleday, 1992).
