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1 August 2019 - 5 minute read

The Ivory Coast and Ghana’s formation of a cocoa price syndicate bucks a trend that has seen the breakdown of all bar one of the big commodity cartels launched in the last several decades.


A notable development in commodities markets since the turn of the millennium has been a weakening in the influence over the oil price wielded by the Organization of the Petroleum Exporting Countries (OPEC) – the sole survivor in a line of seven large commodity cartels launched between 1954 and 1980.

Historically, these cartels constituted a significant component of world supply and introduced both distortions and predictable patterns visible in price and volume data.

But while commodity cartels are no longer the force of old, they can never be entirely written off – as Ghana and the Ivory Coast’s announcement of a cartel in cocoa on July 19 showed. Commodities that have become more important recently, such as the ingredients in electric car batteries, would also appear be potential candidates for cartelisation. But the failures of many erstwhile commodity cartels show that mere survival is a tall order.


Cartel Tale Signs

In the period after World War II, commodity exporters formed various cartels to achieve high, stable prices. Through their use of export controls and buffer stock interventions, they had some success in elevating short-term prices as, for example, OPEC did during the 1970s. Generally, however, they failed meaningfully to reduce price volatility or improve their members’ terms of trade.

Of the seven most prominent cartels to emerge, only OPEC still functions as anything approaching an economic force. The others have either collapsed or no longer seek to control prices and are primarily concerned with monitoring. In the section that follows, we examine five triggers for a cartel’s fall.

Cartel

Creation

Lapse/Collapse

Notes

International Cocoa Organization (ICCO)

1972

1988

1993, 2001, 2010 agreements lacked economic provisions

International Coffee Organization (ICO)

1962

1989

1994, 2001, 2007 agreements lacked economic provisions

International Natural Rubber Organization (INRO)

1980

1999

International Sugar Organization (ISO)

1954

1983

1984, 1987, 1992 agreements lacked economic provisions

International Tin Council (ITC)

1954

1985

Organization of Petroleum Exporting Countries (OPEC)

1960

n/a

Intergovernmental Council of Copper Exporting Countries (CIPEC)

1967

Effective breakdown in 1976

Five Reasons for Failure


1. Insufficient Market Share

For a cartel to control price and output, it helps for production to be concentrated in just a few countries to enable effective coordination. A measure of a commodity’s suitability for cartelisation (and a cartel’s oligopolistic power) is provided by the four-country concentration ratio – the output of the top four producers as a share of world production. In addition to high levels of concentration, high barriers to market entry and a lack of product substitutes can increase a cartel’s staying power.

As shown below, none of the major cartelised commodities possessed all these characteristics during the 1970s heyday of cartels. Only three out of the seven commodities had a greater than 60% concentration ratio in 1974. As for barriers to entry, only tin enjoyed a strong moat in 1974. Oil and sugar, for example, saw a flood of new producers following the price hikes of the early 1970s, with the European Commission turning from the largest importer of sugar to the largest exporter within just a few years.

Market

4-country concentration ratio (%)

Concentrated (4-country CR >60%)

Barriers to Market Entry

Non-substitutability

Petroleum

58.7

No

Weak

Strong

Sugar

40.0

No

Weak

Strong

Coffee

56.4

No

Moderate

Strong

Rubber

85.8

Yes

Moderate

Moderate

Tin

65.4

Yes

Strong

Moderate

Cocoa

70.0

Yes

Moderate

Moderate

Copper

53.5

No

Moderate

Moderate


Source: International Commodity Markets and Role of Cartels (LeClair, 2016)

2. Substitution

High prices also encourage consumers to look for substitutes. When the copper cartel CIPEC attempted to jack up prices in 1975 by restricting exports, manufacturers shifted towards aluminium, leading to the organisation’s eventual demise. A short-term lack of substitutes is not sufficient, however, to guarantee enduring cartel power if consumers can find supply elsewhere or cut down usage. After OPEC hiked oil prices during the 1970s, consumers economised on oil and started importing from countries such as the UK.

3. Lack of discipline

Quota cheating has long plagued cartels since members gain by unilaterally increasing production even if they collectively suffer. During the early 1980s, Saudi Arabia’s fellow OPEC members routinely exceeded their quotas, causing Saudi Arabia to lose market share and revenue as it singlehandedly shouldered OPEC’s price cuts. Eventually Saudi Arabia’s patience wore out and it opened its taps in 1986, halving the world oil price.

OPEC Oil Production has Consistently Outpaced Quotas

Sources: Bloomberg and OPEC.

4. Disputes

Cartel members often have differing agendas, making it difficult for them to pursue concerted action. In the 20th century, many international commodity arrangements included consumer nations, who signed on in a bid to stabilise prices and ensure adequate supply. However, their interests clashed with those of the producer nations, who prioritised high prices. The International Natural Rubber Organisation foundered because its producer members despaired of its inaction and low support ranges during the depressed rubber market of the 1980s and 1990s.

There may also be disputes between producers. Low-cost producers may feel less advantaged by cutbacks than high-cost producers, while dominant producers may seek to impose their interests on smaller producers by threatening unilateral action. For example, when OPEC voted for production cuts in 1992, Saudi Arabia rejected the decision for fear that it would harm its relations with the United States. Similarly, Brazil had historically used the threat of flooding the world coffee market to secure favourable quota allocations through the International Coffee Organisation. But when consumers turned away from Brazilian robusta to mild arabicas during the 1980s, the mild arabica-producer countries refused to accept the Brazil-biased quotas, causing the ICO to unravel.

'Grade Distortion' Seen in Coffee Prices

Arabica producers resented the Brazil/robusta-biased ICO quotas since they artificially inflated the consumer price of Arabica vs Robusta. The extent of this ‘grade distortion’ was seen in the year following the February 1986 suspension of quotas when the arabica-robusta premium fell from 42% to 6%, and was a key contributor to the 1989 breakdown of the ICO. Source: FRED.

5. Buffer stock financial exhaustion

One of the mechanisms by which cartels influence prices is the buffer stock, whereby members commit to buy and sell a commodity at predetermined price levels. Due to long investment lead-times, markets can remain outside the pre-agreed equilibrium for a long time. If prices are persistently below the support range, pursuing buffer stock stabilisation around the supposed long-term price can be financially exhausting. The tin market provides a clear example of this. During the 1970s, the International Tin Council support range chased the market price upwards, committing it to a very high stabilisation range when the market tanked in the early 1980s due to recession. Concurrently, the US pulled out of the ITC, depriving the cartel of the necessary financing to buy up surplus tin and forcing it to undertake a series of complicated forward transactions that left it seriously overexposed. Ultimately, a combination of adverse exchange rates movements and changing fundamentals caused the ITC’s positions to unravel, resulting in the cartel’s dramatic collapse in 1985.

ITC Support Range