1. OIL DEMAND. Why the world worries about oil prices. IMF World Economic Outlook, Sept. 2003, Chapter 1

Transcription

1 Lessons 5&6: Oil 1. Demand 2. Supply 3. Shifting market power monopsony to monopoly 4. Leadup to the 1973 Crisis 5. The 1973 Crisis 6. The 1980s 7. The Gulf Wars

2 1. OIL DEMAND Why the world worries about oil prices IMF World Economic Outlook, Sept. 2003, Chapter 1

3 1. Demand Short run elasticity - holding investment constant Long run elasticity - allowing investment to adjust Adjustment costs, stagflation and security concerns Environmental concern Efficiency of taxation Economic growth and expanding demand What happens when oil runs out? - alternative sources of oil vs. alternative energy - free rider problems with developing alternatives

4 Demand for oil

5 International Gasoline Prices, 2006 Country U.S. Canada Mexico France UK Price/Gallon (incl. Taxes; Premium) Source: International Energy Annual 2007, DOE

6 Sources: European Commission, Oil Bulletin, and EIA, Weekly Petroleum Status Report, Table 16

7 World Oil Use: World Total Oil Consumption Year Source: EIA International Energy Annual 2005

8 2. Supply What are Reserves? - current reserves (profitable at current prices) - potential reserves (profitable at predicted prices) Concentration in Persian Gulf Depletion

9 World Oil Reserves (billions of barrels) Country Saudi Arabia (x $25/barrel = $6.6T) Iraq Kuwait UAR Venezuela Iran Mexico Libya China US Nigeria Source: EIA, DOE (US GDP was about 14T$ in 2007, World GDP was 53T)

10 3. Shifting market power: from buyers cartel to sellers cartel Bilateral oligopoly: Few buyers and sellers of crude oil Up to 1950: Buyers (Western oil companies) control crude oil prices Royalty system: Incentives to increase production. Weak governments: Direct control by Western governments, lack of unity among producers : Countries increase control Profit-sharing system: Incentives to affect prices (Demand for oil inelastic, supply of close substitutes inelastic) Increased competition in buyers: Oil companies had lower influence on crude prices : Producers begin to control prices (OPEC) Arab countries unified in cutting production: Development plans (Libya), Arab-Israeli conflict (Saudi Arabia). Renegotiation of profit shares, price setting mechanisms.

11 Monopsony

12 Organization of Petroleum Exporting Countries About 40% of world production, but 2/3 of reserves

13 Monopoly

14 Oil Prices Price/Barrel in $, 2007 inflation-ad $ $ $80.00 $60.00 $40.00 $20.00 $ Year U.S. cost of imported crude oil; Source DOE, IOGA

15 OPEC revenues

16 Oil Crises The meek shall inherit the earth, but not the property rights. - J. Paul Getty : Israeli Independence (Iraq pipeline shut off) : Nationalization of oil Industry in Iran (largest producer in the Middle east) 1956: Sinai Campaign (Suez Canal blocked, Iraqi pipelines shut down) 1967: Six day war (Suez Canal blocked) 1973: Yom Kippur war (OPEC embargo for 4 months, price increases) 1980: Iranian Revolution (supply cut, price increases) 1991: Expulsion of Iraq from Kuwait 2003: Iraq War

17 Real Oil Prices Source: Economist 8/27/05

18 4. Leadup to the 1973 crisis Increasing demand. Reduced political influence of importing countries. Change in Arab relations: Unity of action. OPEC: Rising share of world production and reserves. Existence of a dominant producer: Saudi Arabia Can enforce cartel agreements Lack of contingency plans in importing countries Small strategic reserves Optimistic political assessments about OPEC unity.

19 5. The 1973 Oil crisis OPEC s Tools: - oil embargo of US, Western Europe and Japan, - reduction of production by imposing quotas on members Results: Hike in prices Huge increase in revenues Worldwide economic crisis Change in energy policies of importing countries.

20 6. The 1980s 1979: Iranian Revolution - production falls from 5.2m bpd to nationalization of oil industry - Saddam Hussein gains control of Iraqi Baath party 1980: Iran-Iraq war - before war Iraq exports 3.4m bpd, Iran 1.5m - targeting of oil production and refining reduces exports of both countries by about 75%. - Iraqi production recovers by using pipelines through Syria, Turkey and Saudi Arabia By 1985 increased production by other countries, esp. Saudi Arabia, had reduced prices. Effect on importing countries less severe than in 70s, because of shift to more efficient transport, demand control policies, incl. taxes.

21 7. Gulf Wars 1 st Gulf War: brief and decided quickly enough to have small effect on supply - postwar sanctions reduce Iraqi oil exports from 3.5mbd to.5mbd - increased to 2.5mbd by 1999 under oil for food - Iraqi production capacity declines 2 nd Gulf War: long disruptions of Iraqi oil supply - slow reconstruction of Iraqi export capacity - current Iraqi production varies from 1 to 2.5 mbd Danger of future sanctions on Iran further reducing supply - how would that affect current price?