Give an outline of OPEC and the global petroleum industry. Explain oil price shock, supply and demand in the oil industry, and a harsh winter’s adverse effects on supply. Reveal OPEC’s monopolistic stranglehold on the market. Show how oil prices can and have been changed in the short and long run. Show the change in the US oil industry from the 1970s to the present. Provide some insight as to possible alternative

energy sources to oil.

The Organization of the Petroleum Exporting Countries (OPEC) is a voluntary inter-governmental organization that coordinates and unifies the petroleum policies of its member countries.

“Meets to promote stability and prosperity in the petroleum market, by unifying their petroleum policies.”

% world’s crude oil produced

% crude oil reserves owned

Lifetime of reserves at current prod. rate

OPEC member countries

40% 76.6% 80 years

Non-OPEC countries 58%

Less than 25%

15 years

OPEC can have a strong influence on the oil market.

An oil price shock is when the supply of oil decreases and the price of oil increases at the same time.

Oil shock is rooted in the fact that: gas as a normal commodity is price inelastic.

As price changes, the demand for gas changes very little.

Importing countries and consumers have less free money to spend on other things because of the higher price of gas during an oil shock.

Fuel demands of developing countries is increasing:

Worldwide demand for oil in 1998: 74 million barrels/day (bbl/d) Worldwide demand for oil in 1999: 75.3 million bbl/d (up 1.7%)

While demand was increasing, supply of oil was decreasing by 2.7% in the fourth quarter of 1999.

With winter on the way, demand will increase even more.

While the US has invested in oil pipelines to reduce costs and delay, most petroleum is transported by other means:

Oil tankers, semi-trucks, and railroad.

In the winter months, delay, equipment failure, and accidents are inevitable.

Rather than absorbing these costs, oil companies pass it along to consumers in the form of higher prices at the pump.

Problems concern overseas transport.

Problems at tanker ports.

Problems on railroads and highways.

These costs account for much of the higher petroleum prices encountered during the winter months.

Quantity

Price 1. Initial Low

Supply

2. Typical increase in Demand

3. 800,000 bbl/d – increase in supply

4. Winter – increase in Demand

5. Winter – decrease in supply

12 34 5

Q1 Q2

P1

P2

New price andquantity

While OPEC may not consider itself a monopoly, a study of the world oil price chronology from 1970-1999 indicates otherwise.

Spikes in oil prices coincide with political unrest in OPEC nations:

In 1990, oil prices rose 19 dollars/barrel (d/bbl) during Operation Desert Storm.

OPEC also uses price discrimination: In 2000, gas prices were on average $1/liter in Japan and Europe, while in the US they were on average $0.42/liter.

From here on out, the economics of the world oil industry will be evaluated assuming OPEC is a monopoly.

As a monopoly, OPEC can choose its price and quantity while facing only a declining market demand curve for oil.

Since a monopolist, having control of the market, can choose its supply at any price, increasing its output results in a lower marginal revenue, and thus a lower market demand price.

OPEC takes advantage of its power as a monopoly to adjust the world oil price.

On September 10, 2000, OPEC agreed to raise production quotas by 800,000 bbl/d in an attempt to lower crude oil prices.

Is this enough though?

Is this enough though? 1997-1998: record low gas prices coincide with a 2.5 million bbl/d increase. 1982: a 6 d/bbl decrease follows a 2.5 million bbl/d increase.

But these were increases of 2.5 million bbl/d, not 800,000.

In fact, total world consumption increased by 800,000 bbl/d from 1997-1998.

800,000 barrels supplied by OPEC is enough only to cover demand.

In a short run competitive market, improvement in technology increases supply, decreases ATC, and decreases price.

In the long run, decreased ATC is good.

Long run supply is ideally constant with no new technology (minimum efficient scale = constant returns to scale).

With the introduction of new technology, ATC would shift down.

This lower min. efficient scale allows more firms to enter the oil industry, and creates more competition for OPEC and more stability in the price of oil.

With the breakup of Standard Oil, US petroleum firms were competitive, but drastically smaller.

Proved unfortunate during the Oil Crisis of the 1970s, as our increased dependency on foreign oil left us vulnerable to the whims of the world market.

Our oil companies, while large, were still too small to exert enough influence to keep oil prices down.

Since that time, consolidation has had more freedom.

Ex. Exxon/Mobil merger, Marathon/Ashland merger, Royal Dutch-Shell/Texaco merger, BP/Amoco Merger. Brings stability to oil prices and increased efficiency within firms (by creating economies of scale).

Companies also purchasing more foreign fields and offshore rigs.

Ex. Marathon Oil.

In the 1970s: US had smaller, independent firms with no power.

“Petrodollars” used in massive spending sprees by rich foreign oil producing nations.

Today: US oil industry is stronger and more united, providing a better front against OPEC.

The global economy is larger and more efficient. “Petrodollars” no longer have the spending power they once did; foreign nations now aim at paying off debts.

Petroleum suppliers claim the present supply of oil will last for many years to come…

But what happens after those years are up?

Possible alternative technologies: Coal gasification and liquefaction Shale-oil recovery Organic wastes Synthetic oils Renewable resources such as solar and wind power

Investors are reluctant to finance new technologies because oil is still present in substantial quantities Synthetic oil is one of the most hopeful prospects, having gained popularity since the 1970s

Developed chemically from substances such as organic esters Not as cheap as natural oil, but has its benefits:

Little strain placed on environment Better for engines and in extreme temperatures

Alternate technologies are absent from the short run, and are currently in few peoples’ long run agendas

Considering an approaching winter and the problems that ensue, a continuing rise in worldwide demand for oil, and the gargantuan number of barrels produced per day, OPEC’s release of a measly 800,000 bbl/d will do little to help current oil prices. However, with the trend in consolidation of US oil companies, the US oil industry may soon offer OPEC enough competition where we won’t have to rely on them to decrease oil prices.