International Oil Industry and the Organization of the Petroleum Exporting Countries - Report Example

The Price and Output of Oil in the Next Five Years Organization of the Petroleum Exporting Countries (OPEC) is a cartel aimed at coordinating and unifying the petroleum policies that govern the member countries in ensuring stabilization of the markets of the oil so that they secure an economic, efficient and a constant supply of the petroleum to the consumers, a stable income to the producers and a good return on capital to the ones investing in petroleum industry (The Economist Newspaper Ltd, 2004, pp.8378-8381). Demand and supply characteristics of oil The market for the oil is very unusual. In the short-term, both the supply and demand are highly inelastic. This is because it is not easy to adjust the use of oil and it's by product. The oil users are shocked by the high prices but due to their habits and commitments that determine their use of energy, they take time to adjust. The factors that lead to affect the demand for oil include the cyclical demand, the prices of the substitutes, changes in climate and the market speculation. When there is an increase in the prices of oil the demand remains constant. A very large change in the price of oil leads to a very minute impact on the demand and therefore the short-term demand curve is shown like this: The supply of the conventional oil is relatively inelastic. This is so because the actual total cost of pumping the marginal barrel of the oil is comparatively low, once all capital expenses of building and prospecting an oil rig has been established. The oilfield will always cost the same roughly to operate whether producing at full capacity or at 50 percent capacity but in most cases the producers try their best to produce at the maximum sustainable rate. The short-run supply of oil is affected by the profit motive, spare capacity, stocks available for the immediate supply especially from the oil refineries and the external shocks (Zucchetto, 2006, p.45). The result of the demand and supply trends is that the oil market is affected and operates at a point where the small changes either to the supply curve or to the demand curve usually causes very large changes in the clearing price. The high demand of oil matched against the inelastic oil short run supply drive the market prices higher as depicted by the diagram below. A rise in demand causes a decrease in oil stocks at the main global refineries and forces the prices higher. It acts as an indicator to suppliers to increase production. There are time lags amid a change in price and the extra supply coming on stream. The demand for the oil is price inelastic. The combination of an inelastic supply and demand helps to clarify some of the instability in world oil prices (The Economist Newspaper Ltd, 2004, pp.8378-8381). Adding new capacity is expensive and time-consuming. Over time, both the businesses and the individuals have their ways of cutting back the oil consumption due to the high prices; this promotes new investments in production and the discovery of new sources of the market. This gradually restores the supply-demand balance. Changes in the supply curve can be caused by some restrictions on the supply made by the sellers' cartels. An example is the oil shocks of 1973 where OPEC announced that it would not sell any more oil to the US and would limit the overall oil output. This in turn meant that for a given price level, the oil supplied would be less because the supply curve shifts upwards. The changes on the supply caused by natural factors like the Hurricane Katrina which totally knocked out the production of oil in the Gulf of Mexico. The supply curve is shifted to the left and therefore the prices rise. An increase in the market due to some emerging markets causes the demand curve to move to the right such that for any level of price given, the more the oil is demanded. In the long run the demand and the supply of oil is remarkably elastic, there is no over supply or under supply it is only the price at which the market clears. A high oil price in the long run encourages the consumers to reduce their energy consumption and also to shift to other types and forms of energy. The long term supply is affected by reserves, exploration and technology levels (Mankiw, 2008, pp.67). Elasticity There is no elasticity in crude oil pricing. Up until latest years when global need for the oil would range with cycles in the economy it was just a matter of faucet, thus getting more or less oil from the ground from accessible wells to satisfy the demand, with small effect on price and this is how the theory of elasticity comes in. the demand and the price of the oil is not tied together with a rubber band that stretches. When oil is cheap, the oil companies cannot justify deep water exploration projects. Though the demand of oil is quite high, there may be no new oil and also the old fields are declining therefore it is not possible to increase the production. In the long term anyway, high prices will lead to new oil exploration ventures. This is by using the market theory. The price elasticity of the oil demand measures the percentage change in the quantity that is demanded which is then divided by the percentage change in the price as it moves along the given demand curve. Combining the income and price elasticity which are both below unity, they bring about the broad trends that we se in the share of the oil purchases in the total expenditures over time. The price inelasticity of oil means that when the price of the oil rises, the total expenses on oil also rises. Income inelasticity of oil means that as Gross Domestic Product increases, the share of the oil expenses should fall. The cross price elasticity of oil is the impact the price of oil will have on demand for the other good either complementary or substitute in percentages, all other factors held constant (Turvey, 1980, pp.78). OPEC sets quotas for the crude oil that they want to produce in order to stabilize the price at the target level. It acts as the swing producer especially in the world oil market and controls the world supply curve that is easiest to alter and if it requires that prices remain high then it controls the controls tightly the short run productions in order that demand does not exceed the supply. OPEC should tread on an excellent line because if the prices remain high for a long time, then the consumers will start looking for other substitute sources of energy. There is a microeconomic consequence of the high price in oil because crude oil has very many uses in different industries and markets and therefore changes in the world prices of oil have effects on microeconomics of the said sectors of the economy. Crude oil is used in gasoline, middle distillates, diesel, jet fuel, kerosene, heating oil, fuel oil and to make lubricants and bitumen. In some industries, the high price leads to supply-side shock that lead to high input costs. In a profit maximizing firm, the increase in costs leads to an increase in price and subsequent reduction of the equilibrium level of output. The degree to which a big business is able to pass on a boost in expenses depends on the price elasticity of the demand for the products. If demand is price inelastic, then the supplier may choose to pass on all or some of any increase in variable costs to the customer of the final product. Though gas and oil prices have been very elevated, we have not found a dramatic rise in inflation, additional factors have helped to keep inflation under manageable levels (Case & Ray, 2008, pp.5). OPEC is an example of an oligopoly but today and in the next five years, the crude oil market portrays a behavior that is almost like the perfectly competitive market where price is determined by the supply and demand and the producers sell as much as they want at some spot price. In the 1970s, it imposed the well-coordinated oil embargoes which also constricted the oil supply in the world. The demand for oil is expected to increase in the future oil as many countries develop hence the need for energy. It is also expected that the available oil reserves will be enough o cover all this demand. In the period between 2002 and 2010, the demand per day for oil is expected to rise at the rate of 12 million barrels everyday. This is an annual growth of 1.5 mb/d. in the following decade, it is expected that demand will further grow by 17 mb/d to 106 mb/d by the year 2010. By 2025, it is expected that it will rise to 115 mb/d. This increase will be mostly caused by the developing countries. It is not clear on the future economic growth for the UK economy, in this case assuming that it is the only economy affecting OPEC, this uncertainty on the government policies and development rate and coming up of other technologies brings up a question on the required level of investment in the future. Such uncertainties together with long lead times bring a complication to the issue on maintaining market stability. In the short-run, the prospects show the need to maintain a spare capacity that is not too high and that is consistent with constant market stability. In terms of macroeconomics, the oil has really helped to maintain the economic growth of the member countries of OPEC and is expected to continue doing so until the oil is depleted. The increasing demand for the oil by mostly the developing countries is helping in the economic growth due to the proceeds made from the sale of oil at high prices. Incase the prices then go down in the next five years we expect a very sharp drop in inflation. This will not happen because the OPEC plans on substantial output cuts. This will ensure that the output and employment gains will be relatively large and this will lead to an increase in the economic growth. The OPEC cartel is aiming at economic recovery by ensuring that the prices of oil remain constant at $70-$80 to allow producers to continue investing and recovery of the consumers. By use of the Philips curve, inflation level is predicted to fall whereas unemployment levels will be falling more so in the United Kingdom. After OPEC cuts its production, there would be a monetary and a fiscal impact that will contribute to some increase and the stabilization of oil price. Oil prices have an overall effect on the prices of other commodities in the United Kingdom. In UK and many other countries, when the prices of oil increase, there is a subsequent rise in the inflation levels leading to an increase in the rates of interest. Thus development will be evident as people have money. They will however spend most of this in oil and this will eventually lead to the expansion of production of oil. The prices will also tend to be high if OPEC does not respond fast by increasing the production leading to less oil and hence high prices. References Case, KE and Ray, CF 2008, Principles of Economics, Prentice Hall. Gately, D, and Hillary, G H 2002, The asymmetric effects of changes in price and income on energy and oil Energy journal, 23(1) pp19-55 Mankiw, GN 2008, Principles of Economics, Cengage Learning. Martin, KV 2003, Prices for Oil, Michigan University press. The Economist Newspaper Ltd., 2004, the Economist, Volume 371,Issues 8378-8381. Turvey, R 1980, Demand and supply, G. Allen & Unwin. Zucchetto, J 2006, Trends in oil supply and demand, potential for peaking of conventional oil production, and possible mitigation options: a summary report of the workshop, National Academies Press. Read More