Game Theory And How It Applies To The OPEC Nations

Brief Introduction:

In Game theory, we deal with cooperative games, competitive and perverse games.

Cooperative game is a situation where-in both parties benefit from cooperating with each other.

Contradictory is the case with OPEC nations. According to Outsource Financial Research firm, situation of OPEC nations would remind you of what we call in Game Theory as The Prisoner’s Dilemma.

The Prisoner’s Dilemma:

Prisoner’s Dilemma is a situation where both parties would benefit by co-operating with each other. However, due to imperfect knowledge they often take decisions that make them worse off.

Let us highlight this dilemma:

There are two individuals A and B who have been convicted on a lesser charge. They are kept separately in confinement and questioned separately. The prosecutors have enough evidence to get them at least a one year term in jail.

The following situations are put before the two prisoners:

If A and B both confess to each other’s crimes, both will serve 4 years in prison.
If A confesses to the crime of B and B does not confess to the crime of A, B serves 10 years in prison while A goes scot-free.
If B confesses to the crime of A and A does not confess to the crime of B, A serves 10 years in prison while B goes scot-free.
If neither betrays the other, both will serve a 1 year prison term.

Since both A and B are rational individuals they would both try to maximize their profits (i.e. each one would like to go scot-free). Ultimately both of them would betray the other and serve four years in prison. This makes them worse off. It would have been best had they co-operated.

The OPEC Case:

According to findings by Outsource Financial Research firm Market Quotient, similar is the case with OPEC nations. Since member nations are unsure about what other member countries are up to, they often take decisions that are self defeating in nature. This involves over-production, price-cutting, etc.

The problems with OPEC nations at present involve the following:

The inability to reach a decision –

The Saudi Arabians and the Iranians stay constantly wary of each other. Neither would like to reach a decision that would be beneficial to the other even if it’s in their own best self interest.

The inability of maintaining standards and norms –

Member nations often do not stick to norms and end up producing more. There is always a predisposition to cheat.

Furthermore, since there are a number of independent oil producers outside of the OPEC, the OPEC does not stand to gain much by cutting oil production. And even if they venture on cutting oil production, they do not stand to gain by much. This is because the Saudis and the Iranians are wary of each other. Each thinks that the other has a tendency to cheat by producing more. If Iranians cheat, they would be much better off. Consequently, the Saudis won’t be that much better off.

Concluding Remarks:

The economic theory teaches us that human beings are rational individuals who strive to maximize their own profits. However, the real world case study is a different story in itself. People and nations are often jealous of each other. They would often reduce their profits if it means making their competitors worse off. Keeping this scenario in mind, I’d say that crude oil prices (Hint: OPEC Nations) may stay low for a much larger time period.

On the other hand, barrels of crude oil are being extracted from North America and other parts of the world. Therefore a piece of advice to investors who wish to invest in energy would be to stick to strong companies having low production costs and a clear-cut strategy. Recommended also are those companies who have businesses away from energy because they have bought into the low energy price story.

In other words, Market Quotient advices you to play it safe when investing, while the OPEC countries continue to get entangled in the trap they designed for themselves.

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