Why cartels collapse – by Jack M. Mintz (National Post – August 16, 2013)

The National Post is Canada’s second largest national paper.

The potash cartel collapsed, at least for now, and the oil cartel could be next

Cartels are tough to maintain as we have recently seen with the demise of the Russian-Belarusian duopoly that accounts for over 35% of world potash production. The North American Canpotex cartel accounting for another a third of global output faces a sharp reduction in profits.

The stock and bond markets have responded in kind. Potash Corporation, the leading global producer, has seen its credit rating downgraded by Standard and Poor’s from stable to negative following a steep drop in its stock price from $38 to $30.

Yet, not all cartels fall apart. OPEC has been in operation since 1960, first successfully manipulating global oil prices by reducing supply after the Yom Kippur war in 1973. Today, it is the swing producer, producing 32.4 million barrels per day (roughly 45% of world crude production in 2012). OPEC itself is dominated by Saudi Arabia, which accounts for almost one-third of OPEC production.

If a potash cartel can fall apart, could it happen to OPEC?

Cartels operate well if the members can keep prices well above production costs by agreeing to jointly hold back production, allocating quotas to each member. Three conditions are particularly important for a cartel to successfully gouge its customers.

First, the product must have few substitutes; otherwise consumers can switch away, giving the cartel a smaller share of the market.

Second, cartel members must be prevented from cheating on agreements by expanding production beyond agreed-upon quotas. If dominant cartel members employ, for example, a “tit-for-tat” strategy that punishes cheaters by expanding their own production, causing prices to fall, each individual cartel member will be less willing to break the agreement.

Third, cartels must be able to maintain themselves if new suppliers cannot enter the market with relatively low production costs. Otherwise, new supply can enter a market by offering low prices to bid away customers from the cartel.

These three conditions explain why the potash cartel broke up. Potash markets were softening with Chinese and Indian customers moving towards alternatives such as nitrogen-based fertilizers.

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