Strategies for OPEC's Pricing and Output Decisions

This paper examines OPEC pricing and output strategies, both to provide an understanding of OPECs unwise price doubling in 1979-80 and also to analyze what strategy might serve it best for the future. We focus on the unavoidable uncertainty regarding the underlying parameters that characterize the world oil market (price elasticities, income growth rates), and the sensitivity of discounted OPEC revenue to changes in these parameters, for various pricing strategies. In 1979-80, OPEC chose a high-price strategy, which could have yielded good results (like many other price-paths) if the market's underlying parameters had been more favorable. But the price elasticities of demand and non-OPEC supply were much higher than anticipated, so that OPEC did very poorly-not only in absolute terms, but also relative to what it could have achieved if it had set its price more cautiously. We search for a robustly optimal strategy for OPEC in the future, which will serve it well relative to other strategies, regardless of the true parameter values underlying the market (within some plausible range). We conclude that OPEC's interests will be served best by a policy of moderate output growth, at a rate no faster than that of world income growth. This will require that OPEC slow its rate of output growth since 1985, cutting it at least in half. Slowing its output growth will allow OPEC gradually to regain the market share lost after its disastrous 1979-80 price doubling, but without jeopardizing its revenue, as might a policy of more rapid increases in output. This will yield a consistently good result for OPEC, relative to alternative strategies, over a fairly wide range of demand and supply conditions.