Photo by Ben Wicks on Unsplash
Much of OPEC behavior is fundamentally driven by the strategies price targeting and market sharing or any mix thereof.
OPEC’s capacity utilization critically affects its ability to take new supply online or offline, and thus their ability to respond to changing market dynamics like new players entering the market or a demand shock. Thus, capacity utilization impacts both market sharing and price-targeting strategies and thinking.
Price targeting is the idea that OPEC wants a specific oil price and adjusts production as a price maker to influence price. Empirically, when global oil prices have deviated significantly, OPEC holds meetings to discuss output adjustments, thus signifying their motivation to make price-moving decisions about supply as a result of price deviations.
Price targeting produces a positive correlation between real oil prices and capacity utilization since OPEC members must shut in use spare capacity to stabilize prices, meaning they will not produce much more (compared to the market sharing model) when prices increases to maintain that spare capacity.
Market sharing is the idea that OPEC seeks to maintain and grow its share of the world oil market, and more specifically, for each member country to maintain its share via OPEC-allocated production quotas. Here, preserving market share matters more than price.
Empirically, it may be seen that OPEC often alters the quotas of individual member countries and react to new supply (that of U.S. frackers, for example) by adjusting its own production to maintain market share. Market sharing produces a negative correlation between real oil prices and capacity utilization since producers will scale production as prices increase to maintain market share and earn more revenue.
Furthermore, the idea of market sharing provides some backbone to the notion of quotas, and thus the motivation of OPEC countries to follow them, unless a country disagrees with its quota and would like to significantly expand its market share.
When new production comes online and new players enter the world oil market, OPEC has responded in two principal ways: one, by making space for the new player through decreasing their production, or two, undercutting their prices (in part via supply increases innately leading to price decreases) and driving their production offline as per pure unprofitability.
Ultimately, these two approaches do not explain all of OPECs decision making. Still, the dynamic between market sharing and price targeting is fundamentally one of balancing an ability to influence price and respond to market share threats, which are doubtless critical to OPEC operations and thinking.
Thanks for reading! To learn more, consider reading about PADD Districts, the Why WTI and Brent are Crude Oils, and Why There are Price Differences Among Crude Oils, and my Oil & Gas Terms Guide.