Wednesday, August 31, 2005

A Practical Method for Creating a Buyer's Cartel

Whereas it can be easily established by economic analysis that a buyer's cartel of oil importing countries could stop the gargantuan wealth transfer from from their citizens to the governments of oil exporting countries; however implementing such a cartel faces an obvious difficulty.

The buyer's cartel (composed of the government's of oil importing countries) is supposed to purchase oil from the oil exporting countries and re-sell it on the international market. However it cannot be expected that oil exporting countries would agree to sell to a buyer's cartel. Such an attempt may lead to an oil embargo.

Instead of a cartel, the governments of oil importing countries can agree to a treaty whereby they agree to tax oil entering their countries. The tax can be gradually increased over the years. For example, the tax could be 20% the first year, and be increased by 20% every year for 9 years, reaching 200%. Again, standard economic analysis suggests that with inelastic supply, this would cause the price of gas to remain unchanged to the consumer and fall by 67% to the supplier. Hence under current conditions, the price per barrel of oil would fall from $70 to $23.

The governments of the oil producing countries could then offer to buy oil from the oil producing countries at $23, and would meet less resistance as that is the price which these countries would be getting for their oil.

Jayanta Sen

PhD Finance, University of Chicago

Gas at $10 a barrel and $0.49 a gallon

The greatest fallacy in economic times in recent times is the idea that gas prices are market determined and hence the government can do nothing to stop the transfer of wealth from American consumers to government of foreign oil producing countries.

In the international oil market, the producers are cartelized, whereas the buyers are fragmented. As standard economic analysis suggests, this results in a greater share of the surplus for the producers. The cost of production for a barrel of oil to the producers is approximately $8, whereas the recent price is $65. A buyer's cartel could be formed by the governments of the major oil importing countries like the U.S., Japan, Germany, China, India etc. All oil sold in these countries would have to pass through the buyer's cartel. The buyer's cartel could negotiate a price with the oil exporting countries, say $10 a barrel (which should be a sufficient markup over production costs). After purchasing oil from the producing countries, the buyer's cartel would release the oil in the market and let demand determine the price. If current demand conditions remain unchanged then the price would still remain at $65. However, this would reduce the effective price to the citizens of the importing countries to $10 a barrel as their governments would earn a profit of $55, which could be used to reduce taxes or pay for programs like Social Security. For the U.S. (which imports 10 million barrels a day) the savings would be $55 x 10 million x 365 = $200.75 billion a year.

Jayanta Sen is a PhD in Finance from the University of Chicago