Why are oil prices increasing? Politicians and media focus on the lack of sufficient OPEC production. But a quick glance at the data suggests that U.S. production (October 2021 Table 3.1 p.59) is down 10.6% in 2021 from its 2019 peak while world production is down only 6.5% from its 2018 peak and Saudi production is down only 8.5% from its 2018 peak. But a focus on U.S. production would require unpleasant discussions about shutdowns in February from the deep freeze in the South and in September from Hurricane Ida in the Gulf of Mexico. Much more palatable to change the subject to OPEC.

Beyond a simple look at recent production data, the academic literature is not very supportive of the claim that OPEC is a cartel in the usual sense of the term. OPEC does not restrict output once the capacity to produce exists. Instead, OPEC diverts revenues from production for other purposes (pacifying their populations) instead of increasing production capacity. The capacity of OPEC has not changed since 1973 although known deposits doubled over that time. OPEC does not restrict output, but it does not invest in capacity expansion.

OPEC also fails four empirical tests for cartel activity. First, crude oil production of OPEC countries did not really change after OPEC formation. Second, OPEC cheating on quotas is rampant. In 96 percent of the country-months since OPEC’s creation, countries exceed their quotas. Third, no statistical relationship exists between actual OPEC production and changes in OPEC quotas. And finally, OPEC oil reservoir depletion rates do not differ systematically from the rates of countries that are not members.

So, if OPEC does not vary output to squeeze consumer countries what does it do? OPEC exists for political purposes in both producing and consuming countries. It allows consuming countries to blame someone and allows producing countries to look good to their people by taking the West to the cleaners.

OPECs lack of investment has resulted in a world oil supply that historically has not been very responsive to price. But the fracking revolution in the U.S. has produced a vastly improved relationship between higher prices and more supply: up 13-fold from 2006 to 2017. In 2017 a $10 a barrel price increase results in 1.5 million barrel per day increase in output by the end of a multi-year ramp-up period whereas in 2006 only 110,000 incremental barrels per day would result from the same $10 increase. And the current price of oil (about $81 per barrel) is well above recent estimates of both the average ($40) and marginal ($20) costs of oil production using fracking technology.

Thus, the good news is that currently high oil prices will not persist as long as they would have during past supply demand imbalances. How soon will production increase and prices stabilize? Futures market data (November 10, 2021) suggest the price of oil will be $10 lower per barrel a year from now.