Saudi Arabia's Strategic Role in Global Energy: Lessons from OPEC Simulation and Real-World Dynamics

Source: DALL·E AI (2024)

Aldy, J. E. Course API 165: Energy and Environmental Economics and Policy. Harvard Kennedy School, Fall 2024. 
​Team Saudi Arabia, Planet Alpha: Aashis Luitel, Lydia Glock, Noura Mansouri, Ruben Figueroa

As part of the course API 165 "Energy and Environmental Economics and Policy" by Joe Aldy at Harvard Kennedy School, we were asked to run a two-week OPEC simulation. This exercise allowed us to step into the shoes of policymakers within the global oil cartel and grapple with the intricate challenges of managing oil supply, pricing, and market stability. The simulation offered a hands-on approach to understanding how OPEC nations collaborate—or defect—within the cartel, and how these decisions have far-reaching consequences for global energy markets. It closely mirrored real-life scenarios, particularly the role of Saudi Arabia as a key stabilizer within OPEC and in global oil markets more broadly.
Participating in the OPEC simulation as part of Saudi Arabia’s delegation on Planet Alpha offered an exceptional learning experience, especially in navigating the complexities of cartel behavior, oil market dynamics, and strategic decision-making. The simulation allowed us to grapple with the challenges of coordinating production quotas among OPEC members and balancing short-term profitability with long-term sustainability. Here, I’ll reflect on the experience and the economic lessons learned along the way.

Saudi Arabia's Role: Leading the Formation of an OPEC Cartel
Saudi Arabia assumed a leadership position right from the beginning. Our strategy was simple yet bold: we proposed the formation of an OPEC cartel, inviting other key oil-producing countries to join forces in controlling production and stabilizing prices. Our objective was clear—to maximize profits for all member countries while safeguarding Saudi Arabia’s interests, given our significant oil reserves.
One of the key dynamics we introduced was the creation of a structured approach for setting production quotas. Each country’s oil reserves and production costs were taken into account to distribute quotas in a way that aligned with their market share. By advocating for a strong cartel, we hoped to control global oil output, prevent market oversupply, and keep prices high enough to secure profitability for all.

A Cooperative Approach, Initially
During the early stages, we prioritized cooperation, closely monitoring other countries’ production levels. By building trust, we aimed to maintain alignment on quotas and communicate openly about any necessary adjustments. Coordination was crucial, and Saudi Arabia facilitated this by creating a WhatsApp group to ensure real-time communication among OPEC members.
Through this group, we could quickly address any concerns and adjust strategies when needed. Our initial strategy included limiting production to maintain a price of at least $80 per barrel, a price guaranteed by the final stages of the simulation. This was inspired by several economic models we discussed during the OPEC meetings, particularly the work of Robert Pindyck, who explored the benefits of cartelization for resource-rich countries (See Appendix 1) .

Shifting Strategies: From Collusion to Retaliation
Despite our efforts to build trust and ensure compliance, some countries deviated from the agreed-upon quotas. Non-compliance among members began undermining the collective effort. To address this, Saudi Arabia issued a warning: if the quotas were violated again, we would retaliate by flooding the market with oil, driving down prices to punish those who overproduced.
This threat proved effective in periods 2 and 3, as it led to an increase in our per-barrel revenue. However, coordination remained imperfect, and by period 4, further defection forced us to follow through on our threat. We flooded the market, contributing to a significant drop in oil prices. Our intention was to make it clear that defection would be costly for everyone involved. However, this strategy only led to greater defections from other countries, forcing us to rethink our approach.

Maximizing Individual Profits Amidst Defection
By period 5, it became clear that long-term cooperation was no longer viable. Saudi Arabia shifted focus to maximizing individual profits, overproducing in order to benefit from our low marginal costs, even if it meant accepting lower prices. Our revised strategy aimed to produce as much as possible while keeping prices above a critical threshold. In periods 5 and 6, this approach worked well, with relatively favorable prices and high production volumes ensuring substantial returns.
However, when prices plummeted in period 7, we cut back production slightly to prevent losses. From there, we maintained a steady output level until the final period, prioritizing profitability despite fluctuating market conditions.

Economic Models and Strategic Decision-Making
Throughout the simulation, several economic models and theories guided our strategic decisions. Inspired by Pindyck’s work on the cartelization of exhaustible resources, we recognized that controlling production and ensuring compliance were key to maximizing long-term profits. Pindyck’s insights into the benefits of cartel behavior—such as controlling supply to maintain high prices—were evident in our initial strategy of quota enforcement (See Appendix 1).

However, the simulation also highlighted the difficulty of sustaining long-term cooperation in the face of individual incentives to defect. This tension between collective action and individual profit-seeking became a central challenge, forcing us to continuously adapt our strategy in response to other countries’ behavior (See Appendix 2).

Key Lessons Learned

1. The Fragility of Cartel Agreements: Despite the clear benefits of working together, maintaining long-term compliance within the cartel proved to be extremely difficult. Trust among members eroded quickly, and defection was inevitable when countries felt their interests were better served by maximizing short-term gains.
2. The Importance of Flexibility: As market conditions changed and countries deviated from agreed-upon quotas, we learned the importance of flexibility. Our shift from a cooperative strategy to a more self-serving approach demonstrated that rigid adherence to a plan can be detrimental if others are not playing by the same rules.
3. The Role of Retaliation: Threatening to flood the market was an effective short-term strategy, increasing our revenue in the initial rounds. However, it also revealed the limits of using retaliation as a tool to enforce compliance, as it ultimately led to greater defection and a collapse of cooperation.
4. Maximizing Individual Profits: In the later stages of the simulation, our focus on maximizing individual profits through overproduction paid off, particularly when prices were still relatively high. This showed that when collective action breaks down, prioritizing self-interest can be the best way to preserve profitability.

Insights on OPEC Dynamics and Saudi Arabia's Role in Global Energy Stability
In the simulation, the role of Saudi Arabia stood out as pivotal, echoing its real-world significance in stabilizing global oil supply, particularly in times of crisis. Saudi Arabia’s ability to quickly increase or cut oil production gives it considerable leverage to influence global oil prices. This aspect became even more pronounced during moments of defection, when member countries chose short-term gains over collective stability. Saudi Arabia, with the lowest marginal cost of production at $6 per barrel, responded by threatening to flood the market with oil—a tactic it has employed historically, as seen during the 2014-2016 oil price war. The 70% drop in oil prices from their 2014 highs to an average of $47 per barrel has heavily impacted oil producers. The price slump is due to factors such as an oil glut, lower demand, and the rise of U.S. shale extraction. 

The simulation also highlighted the tension between short-term energy security and long-term sustainability, although the climate and environment goals were not factored into the simulation, in the real-world, such a challenge exists and adds complexity to energy geopolitics. The Russia-Ukraine conflict has highlighted the growing priority of energy security, particularly in Europe, where countries are relying more on coal to replace Russian oil and gas, contradicting COP26 commitments (Mansouri, 2022). Saudi Arabia plays a dual role in this dynamic: on one hand, acting as a “safety valve” during energy crises by increasing oil production and continuing investments in oil, while on the other hand, reallocating its oil wealth to advance Vision 2030, which aims to diversify energy sources and reduce dependence on fossil fuels.

Further, geopolitical dynamics continue shaping the global energy landscape. As alliances in the Middle East shift—partly due to the waning influence of the United States and the growing presence of Russia and China—Saudi Arabia has strategically positioned itself through multi-vector partnerships. The alliance between Saudi Arabia and Russia has significantly strengthened their influence over global oil markets, ensuring that they can collectively stabilize prices and mitigate volatility, even during periods of geopolitical upheaval like the Ukraine conflict.

The economic impact of these decisions was also a crucial learning point. Saudi Arabia’s ability to capitalize on high oil prices, as it did during the price surge to over $130 per barrel in early 2022, strengthened its GDP growth and reinforced its economic dominance. The simulation emphasized how oil revenues remain critical for countries like Saudi Arabia, but also pointed to the importance of forward-looking strategies, especially in a world gradually shifting toward sustainable energy. The introduction of a new technology at $80 per barrel in the later stages of the simulation prompted difficult decisions about maintaining short-term oil revenues versus the sustainability of its oil reserves. In real life, this informs a nuanced strategy to delicately balance between carbon management technologies that would become readily accessible in the future and the rising marginal cost of depleting reserves. 

The simulation also touched upon the complexities of cartel behavior. Each member country weighed its self-interest against collective outcomes, leading to cycles of cooperation and defection. As highlighted by Pindyck's (1978) analysis on producer gains from cartelization, cartel members often find short-term temptations difficult to resist. However, Saudi Arabia's capacity to reestablish discipline within OPEC highlighted the country's central role as a stabilizer in global oil markets. By threatening to unleash its full production capacity, Saudi Arabia could realign defection-prone members, ultimately preserving the group's collective interests.

In the article Almutairi et al. (2021) the significant role that OPEC’s management of spare capacity was analyzed, emphasizing its role in stabilizing oil prices and supporting the global economy. The authors examine how OPEC's reserve capacity has historically helped reduce oil price volatility, particularly during market events from 2001 to 2020. OPEC’s ability to maintain spare capacity as a buffer against supply and demand shocks creates substantial economic benefits, lowering the monthly volatility of oil prices from 17% to 11% over the period studied. The paper estimates that OPEC’s spare capacity adds an annual global economic value of $193.1 billion, largely by preventing severe supply disruptions and minimizing GDP losses.

The paper examines three distinct subperiods—commodity boom (2001-2014), market-share campaign (2014-2016), and OPEC+ (2017-2020)—and shows that OPEC's spare capacity was particularly effective during the commodity boom and OPEC+ periods in reducing price fluctuations. However, during the market-share campaign, OPEC focused on protecting market share rather than stabilizing prices, which made the use of spare capacity less impactful.
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The rise of U.S. shale oil, known for being more price-responsive, is also discussed as a factor that might reduce OPEC's influence on global oil prices. However, the study concludes that, while shale oil helps stabilize prices, its smaller share of global supply limits its overall impact on diminishing the significance of OPEC's spare capacity.

Ultimately, the OPEC simulation provided an invaluable lens through which to analyze Saudi Arabia's role as a stabilizer in global oil markets. Saudi Arabia’s geopolitical and energy strategies have evolved in response to the shifting global order, at the intersection of multipolarity and energy security concerns. The simulation brought insights into these tensions to life, showing how delicate the balance is between cooperation and defection, short-term and long-term goals, and geopolitical influences. It became clear how Saudi Arabia continues to play a critical role in global energy markets. Its leadership within OPEC and its ability to navigate both the current fossil fuel-dominated energy landscape and the transition to sustainability have positioned it as a key player in shaping global energy policy. As the world faces ongoing geopolitical and environmental challenges, Saudi Arabia’s decisions within OPEC will likely remain pivotal to global energy security as it continues to lead in managing global oil supply stability while advancing its Vision 2030 goals, its role in both the present energy landscape and the transition to a more sustainable future remains critical.

References
Aldy, J. E. Course API 165: Energy and Environmental Economics and Policy. Harvard Kennedy School, Fall 2024. 
​Team Saudi Arabia, Planet Alpha: Aashis Luitel, Lydia Glock, Noura Mansouri, Ruben Figueroa
Almutairi, H., Pierru, A., & Smith, J. L. (2021). The value of OPEC’s spare capacity to the oil market and global economy. OPEC Energy Review, 45(1), 29-43. https://doi.org/10.1111/opec.12199
DALL·E AI (2024). Image representing Saudi Arabia's strategic role in global energy: Lessons from OPEC simulation and real-world dynamics. Image generated using OpenAI's DALL·E model.
Mansouri, N. Y. (2022). The Emerging Saudi Power Momentum: How the Conflict in Ukraine Shapes Saudi Energy Policy. In Energy Politics in the MENA Region: From Hydrocarbons to Renewables? (pp. 75-92). ISPI Report. Available at: https://www.ispionline.it/en/publication/energy-politics-mena-region-hydrocarbons-renewables-36797
OpenAI, ChatGPT. (2024, September). Used for conversational assistance, providing summaries and enhancing the style of writing.
Pindyck, R. S. (1978). Gains to Producers from the Cartelization of Exhaustible Resources. The Review of Economics and Statistics, 60(2), 238-251. Retrieved from JSTOR.