1a. The oil industry took advantage of the relative elasticity of demand with regard to oil in order to drive up its revenues and profits. It was able to do this because oil demand is relatively inelastic and lacking in substitute commodities, at least in the short-term.
There were two steps to the industry's strategy. To begin with, the industry decreased the amount of oil supplied to the market. Since demand was relatively inelastic, the market was willing to pay higher prices for the oil that was now available. At the same time, the costs associated with producing the oil did not increase, so the oil industry as a whole realized increased revenues without increasing costs. This increased the profit to the industry.
In order for this strategy to work, there must be careful coordination among all members in the industry. This is where the cartel becomes effective. If any member of the industry is able to defect from the shortage situation, it could realize increased revenues by increasing the supply of oil. Cartel members would then be forced to lower their prices to match the defector or lose revenue.
1b. The federal government and state governments have assisted the U.S. oil industry in controlling the supply of crude oil, although whether this was their intention is unclear. Oklahoma put in effect a prorationing law which permitted the state regulatory commission to determine total state output and allocate that total well by well. Texas issued a similar law in 1930, ordering that state production be limited to market demand. The Supreme Court upheld challenges to the Oklahoma law, indicating that the limited production prevented physical waste. Price effects were judged to be incidental. Major producing states later adopted conservation statutes that include the market demand provision, and the federal government passed a law which made it illegal for oil produced over and above state quotas to be shipped acr...