The political economy of OPEC

Building on the political economy literature, we develop a conceptual model and apply it to explain the OPEC pricing behavior. We model OPEC as a cartel-of-nations where politician use two instruments: production quotas and domestic fuel consumption subsidies. Our model explains the wedge between domestic fuel prices in OPEC countries and in the rest of the world. The empirical estimates show that when OPEC sets the production quotas it places similar weights on consumers and producers welfare. But when OPEC countries set the subsidies some countries place extra weight on consumer benefits from domestic fuel consumption. Our analysis suggests OPEC pricing behavior employs domestic cheap oil policies.