Tacit collusion between oil producers and consumers?

Are crude oil prices set to rise above $100 a barrel and stay there as we head into 2011? As our chart shows, there has been a steady increase in world oil prices over the last two years and a barrel of oil is now comfortably above $90. World economic growth is picking up - the main driver is strong activity in fast-growing emerging nations - and the oil producer cartel OPEC has announced that it sees no need to increase their output quotas in a way to stabilise the price below $90.

OPEC supplies around 35% of world oil supply. It is widely regarded as the swing producer in the international market - in other words, changes in agreed production quotas can tilt the balance between oil demand and supply and swing changes in prices. But the reality is that there is little that OPEC can do to fundamentally change prices - a far stronger determinant is global oil demand which itself is shaped by the strength of global industrial production. Short term demand factors can also move the price - for example the exceedingly cold winter in the Northern hemisphere!

OPEC seeks to control its own supply through the use of production quotas. The last revision these production limits took place in December 2008, when oil ministers agreed to pump a total of 24.85 million barrels per day. As things stand, current production is ahead of this - some OPEC nations are taking advantage of higher prices to boost production - and if you were a hard pressed finance minister in an oil producing oil exporting country, you would be sorely tempted to do the same?

Is this a classic example of a producer cartel unable to stick to agreed production limits? Not really - for all of the cracks that people traditionally see in cartel agreements, OPEC is more resilient than the textbooks suggest. Indeed some economists argue that there is now tacit collusion between oil producers AND consumers to keep crude prices in a relatively stable range between $75 - $90 over the economic cycle. That is high enough for most oil producers to make money; a stable price gives some certainty to oil users. And the price is sufficiently high to encourage innovation to improve fuel efficiency and promote oil subsitututes.

It is the spikes in oil prices that cause the biggest difficulties.