The Oil Cartel and Misallocation of Production

The oil cartel’s activity causes distortions of the oil industry structure resulting from the spatial misallocation of production. In the long term, production shifting from the low-cost cartel to the high-cost competitive fringe brings about a misallocation of global oil resources. In this chapter we consider a two-region model of resource extraction with investment in reserves development, in which the global allocation of oil resources is determined endogenously. We show that if the cartel’s advantage in production costs over the competitive fringe is considerable, the distorting effects of the cartel are substantial, and the efficiency losses on the industry level may be significant. The cartel captures a part of consumer benefits at the cost of significant losses from resource misallocation and deadweight losses. These losses, however, can be reduced due to technological changes improving the competitiveness of the fringe.