OPEC: Cartel Breakup?

Last week, talks between member nations of the Organization of Petroleum Exporting Countries (OPEC) were described as the worst ever as the Saudi representative commented. The group could not come together and set a target production for the future. Could a breakup of OPEC be in the future?

OPEC is a cartel no matter how much they hate being called one. They limit the production of crude oil to keep the prices high. It is well known that member countries could produce more than the allotted monthly quota OPEC gives to each member. Recently Saudi Arabia increased its production when Libya ceased production due to the ongoing conflict. The recent talks broke up because some members wanted to increase production to bring prices down while other, mostly countries without excess capacity that do not want to see prices and profits fall.

Many have argued that oil above $100 is not sustainable. I believe Saudi Arabia and other member who want to increase production understand this. Western Europe, China, the United States, and other oil importers will seek other sources of energy with prices this high. For example,  ethanol, a gas substitute costs about $3.50/gallon without government subsidies. When oil prices are higher than $80 is when ethanol becomes economically sustainable. OPEC needs to maintain prices so that the importing countries do not seek new technologies that make oil obsolete. While they may bring in record profits now in the future there may be much less demand for oil.

Take this game theory for example
Assuming what they product now is 28,985/month (April 2011 total production in 1000's of barrels) and a barrel of oil's price remains constant.
 

	Increase Production	Keep Production
Present	35,000 barrels/month @ $70	28,985 barrels/month @ $100
Future	35,000 barrels/month @ $60	28,985 barrels/month @ $40

Their profits will look like this

Profits
Present	$2.45 billion/month	$2.8985 billion/month
Future	$2.1 billion/month	$1.1594 billion/month
Total	$4.55 billion/month	$4.0589 billion/month

This is a very rough explanation of oil markets, there are many other factors but basically you can see it is in OPEC's best interest to keep prices where the importers don't search for alternatives.

So I believe OPEC will begin to either raise production to bring down prices or the countries that understand the game I just explained will leave the oil's allocation and begin to produce on their own. There is another game to explain cheating cartels which I will not get into but ultimately a cartel is only good until someone cheats, that is, produces more than what is agreed upon. For the cheater, record profits will be made as the price remains high due to low supple but soon others will realize the cheat has happened and also begin producing more and the cartel is no more. In this example I look to Saudi Arabia as the cheater, they have the most excess capacity and the best relations with the West. I stand by my $80 barrel by the end of summer, it might even go lower.