Cartels: Myths and realities…

by Dr Mohamed A. Ramady

For a moment, the "C" word seemed to dominate news, following the announcement that Qatar was hosting a meeting of gas producing countries to explore pricing coordination and future strategy. Qatar quickly denied that the meeting was to establish another energy cartel, but the issue of energy cartels, their power and effect on consumers, set feverish minds working.
In the end, Russia which is the world's largest gas producer, will head a new committee to study "gas pricing, infrastructure and consumer-related issues."

But it is not only in the Gulf that the issue of a new energy cartel that was making the news, but in Washington too, as the US House of Representatives approved on May 22, and by a large majority, legislation making oil producing and exporting cartels illegal under the Sherman Antitrust Act. The stage is set for a troublesome, legalistic battle of what constitutes a true cartel.
In the meantime, it would seem that even the gas-producing countriesare not in one mind on the need for setting up such a gas cartel. While Qatar and Egypt opposed the idea, Iran and Venezuela were in favour, which seemed somewhat odd, as both these countries did not export gas while Qatar and Egypt do.

Gas producers however, share one disadvantage compared to oil producers -- gas contracts are based on long term bilateral, and other government agreements. Oil producers have more flexibility with both long term and spot contracts.
However, the fact that even such a group of energy producers were meeting arose some concern, particularly from gas importing European nations who depended on Russian gas supplies. In Qatar, the Russian delegation took great pain to ease such concerns from Europe, and the Russian energy minister was reputed to have said that the story of the emergence of a gas version of OPEC was the product of "a sick mind."

Meeting of gas producers to discuss areas of mutual interest and concern is one thing, while meeting to establish a cartel is another. Gas producers are facing both legitimate concerns and challenges, especially due to rising construction costs. It was recently announced that ExxonMobil cancelled a multi-billion dollar construction project in Qatar, after concerns about high costs. Unlike the oil market, where 70 % of supplies are shipped, most gas is distributed using liquefaction plants and networks of pipelines which are costly.
What the Qatar gas producers meeting could benefit from the long run, is the emergence of a permanent gas producer's secretariat to exchange technology information and trends for environmentally-friendly energy demand patterns. Even this step is significant, as it took OPEC five years to have a secretariat and another ten years for it to become influential. It could take longer for gas producers, as gas pricing formulas are more complicated.

One benefit for gas producers arising from the Qatar meeting is that they could avoid "harmful" competition from each other in terms of differential gas contract pricing. The advent of liquefied natural gas (LNG) has transformed the pricing landscape, although gas, unlike oil, is still far from being a global commodity.
LNG gas is cooled to liquid form, so it can be shipped and is more flexible than pipeline gas which is often supplied to long term customers and contracts. As such, gas markets tend to be regional, reflecting differential pricing, rather than global, as is the case of oil, although there are variations of oil crude sold in the market. What gas producers are most likely to do in the short term, is to try and examine how gas pricing can be "de-coupled" from oil prices, as currently gas price is linked to oil.

Why do cartels arouse such strong emotions from consumers, and is OPEC or the proposed gas cartel, if it ever materializes, a cause for concern?
For a cartel to truly operate and control prices, a number of essential conditions must be met, as any elementary economics textbook tells us. These include that there must be a small number of producers in the cartel, that secret price cuts by members are observable, that entry barriers to the industry exist, that market demand and cost conditions are stable, and that offending cartel members are subject to some form of financial or quota punishment.

The history of OPEC is replete with examples of non-compliance of most of the above conditions. Members of OPEC range from producer giants to small players, discounts are difficult to monitor, although OPEC has been more successful over the past few years in trying to instil more quota discipline. Membership of OPEC is voluntary, and other major oil producers such as Russia are outside OPEC, while cost and demand conditions are not totally in the control of OPEC.
Technological advances have brought marginal fields in non-OPEC countries into production, while "higher" cartel prices have encouraged consumers to reduce demand, by being more energy efficient, or switching to alternative energy such as nuclear and bio-fuel. The same holds true for gas, and the Qatar gas producer nations meeting was fully aware of this consumer choice in the long run.

Given the above mixed bag of results, is the US House of Representatives "NOPEC" legislation justified? The legislation would, in effect, make it a violation of the Sherman Antitrust Act, for any foreign state or an agent of a foreign state to limit the production or distribution of oil or natural gas in order to set or maintain the price. A foreign state engaged in such a conduct would be stripped of immunity from the jurisdiction of US courts.
This is all heady stuff, and it is not certain that the full US Senate will take up the measure or that the US administration will support it, as it might cause problems with key Middle East energy allies. Continuing high oil prices might make it attractive however, for some Senators to play to grassroots American electorate politics. This is where cool heads are needed, before more serious confrontation between energy producers and consuming countries looms once again.

In the final analysis, maybe some good will come out from the Qatar meeting if the world's collective attention is focused on the issue of depleting global energy resources, as well as the mutual interdependency of consumers and producers to strike long term, fairer price and supply relationships, that generates some form of equitable stability for both.
In practical terms, there is no true energy cartels in the world today, whether oil or gas, given the multitude of non-cartel operators and alternative energy sources.

Dr Mohamed A. Ramady is visiting associate professor, finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.