Global crude oil markets today are more competitive than at any time since January 1993, as measured by the Herfindahl-Hirschman Index (HHI) of industry concentration. Such competitiveness makes sustaining high prices extremely difficult. Yet, for over two years, Opec-plus has kept prices well above levels that might otherwise prevail. However, its success may be about to face challenges, as a few Opec-plus members, like Kazakhstan, have been consistently overproducing their targets.
Oil producers now confront what looks increasingly like an ultracompetitive agricultural market in which they have little power to move prices without decisive government intervention.
Economic theory predicts that intense competition among producers will create an environment in which prices experience continuous pressure, which benefits consumers. Market regulators such as the US Department of Justice and the US Federal Trade Commission emphasize the negative consumer impact of reduced competition in their merger guidelines, which focus on industry concentration — using HHI to measure concentration.
The HHI score reflects “the size of companies relative to the size of the industry they are in and the amount of competitiveness.” It is calculated as the sum of squared market shares. The sum will be small if a market has many producers but increases as a market becomes more concentrated, that is, has fewer producers. Regulators generally flag markets with HHIs above 1,500 and challenge mergers in industries where the HHI exceeds 1,800.
Measuring Oil Market Competition
In evaluating the market impact of mergers, lawyers and economists first carefully define the relevant market. Those defending the merger try to define it as broadly as possible to lower the HHI, while those attacking it attempt to define it as narrowly as possible. For example, in the grocery store sector, the market may be defined as a small metropolitan area. In contrast, the oil market is global because refiners can choose from among all suppliers.
Competition in oil markets can be measured in several ways. In the past, my analysis focused on Opec and Opec-plus, given that these producers are the primary entities attempting to hold prices high. However, the unexpected increase in US crude oil production, as fracking boomed, and output hikes in Guyana and Brazil have changed the global oil market dynamics.
My new calculation for global oil production HHI works as follows. I treat all nations except the US and Canada as “firms.” For example, in computing the global HHI for oil, I measured Saudi Arabian output as if the country were a single company because a single entity produces its volumes. Such is the case for many nations.
The situation is different in the US and Canada because the many firms operating there make individual decisions regarding output. In the US, the largest producer, Chevron, produces fewer than 1 million barrels per day. All but four companies produce fewer than 500,000 b/d. Using the limited data available, I concluded that the US oil sector comprises at least 20 firms (“countries”) and modified the HHI to reflect this assumption. For Canada, we assumed the nation’s oil sector comprises four firms.
The graph above presents the HHI computed under these assumptions. One can observe from this that the oil market is more competitive now than at any time in a quarter century. I draw this conclusion because the computed HHI is at its lowest point since February 2000. This suggests that prices are highly susceptible to downward pressure.
It also shows how the price rise after 2000 closely followed an increase in concentration until prices peaked in 2008 — with the price rise from 2009-14 again following an increase in concentration.
The relationship broke down after 2014. In this case, the surging US production from frackers and the passage of legislation permitting US crude oil exports broke the linkage. Prices only began to rise along with the HHI after Opec joined forces with Russia and Opec-plus was created.
The Opec-plus alliance has successfully sustained high prices since January 2023. From January 2017 until then, oil prices and the world HHI seemed closely linked. Since then, market concentration has declined, while prices have remained high. The decrease in global HHI driven by US and Canadian output suggests prices should have decreased to around $40 per barrel by early 2025. Obviously, that did not happen.
While the evidence from the last 32 years shows a link between oil producer concentration and oil prices, the relationship appears to have diverged after 2023 as Opec-plus members kept prices perhaps 50% higher than the data implies. The historical data would suggest that there could be downward pressure on prices if Opec-plus continues to accelerate the return of oil to the market.
Consequences and Conclusions
Circumstances now have echoes of conditions in the spring of 1990 when Kuwait thumbed its nose at the other Opec members by boosting oil production. In February of that year, the country’s oil minister called for an end to quotas. That July, Saudi Arabia pressured the United Arab Emirates and Kuwait to cut oil output. As The New York Times reported at the time: “The new resolve of the big producers follows a warning from Iraq a few weeks ago that cheating by the United Arab Emirates and Kuwait has flooded oil markets, weakened prices and severely reduced Iraq’s income, which the country considers a vital interest. With every drop of a dollar in the price of a barrel of oil, Iraq’s annual oil revenues are reduced by $1 billion.” Opec met that month and agreed to a production cut. But within a week, Iraq invaded Kuwait.
Today, thanks in part to Chevron’s Tengiz field expansion, Kazakhstan exceeded its quota by more than 360,000 b/d in March. Opec-plus members don’t need military force to squeeze Kazakhstan if it continues to flaunt production limits. The nation is especially vulnerable because its exported oil must pass through Russia to the terminal in Novorossiysk. Russia ordered a drastic reduction in shipments from that location on Apr. 1. Courts subsequently lifted the ban, but Moscow can easily do it again.
Here, the old saw often wrongly attributed to Mark Twain comes to mind: “History never repeats itself, but it rhymes.”
Philip Verleger is an economist who has written about energy markets for over 40 years. A graduate of MIT, he has served two presidents, taught at Yale, and helped develop energy commodity markets since 1980. Kim Pederson is the editorial director of PKVerleger. The views expressed in this article are those of the author.
