OPEC and Oil
Lecture 10

Oil Exporting Countries

1. Oil is a depletable resource
   1. Oil supplies will become smaller over time
   2. Discoveries of new oil reserves will become fewer and smaller
   3. Hotelling's Rule – as petroleum is depleted, petroleum prices will increase over time
      1. Petroleum becomes more scarce
2. Oil is a magnet for conflict
   1. Oil industry dominated by
      1. Multinational corporations
      2. Governments
         1. Organization of Petroleum Exporting Countries (OPEC) – nations (not businesses) formed a cartel
            1. Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela
         2. Cartels cut back on production, causing oil market price to increase
         3. Each OPEC member has quotas
         4. Earn large profits
         5. Formed in 1960s
            1. OPEC members nationalized their petroleum industries
            2. Nationalize – gov. takes over
         6. Successful because Saudi Arabia restricted its own national production
            1. Saudi Arabia dominates oil production in OPEC
         7. Be careful
            1. OPEC and all oil producing countries and companies benefit from higher petroleum price
            2. Oklahoma, Texas, and Louisiana greatly benefited from higher oil prices
   2. OPEC created three oil crises
      1. First oil shock occurred in late 1973
         1. OPEC imposed an oil embargo to the U.S. and other countries
         2. Oil became a political weapon
         3. U.S. supported Israel in Yom Kippur War
         4. Barrel of oil jumped from $2.90 per barrel to $11.65
            1. 400% increase
         5. Oil companies went along with the price hikes
         6. Led to a recession
      2. Second oil shock in early 1980s
         1. Oil price went from $13 to $34
         2. Created hardship on many countries
         3. Oil companies greatly benefited
            1. Oil companies purchased futures contracts
            2. Bought oil for contract price and re-sold on spot market for very high prices
               1. Futures – derivatives market – buyers and sellers agree in a contract today for a future transaction
               2. Can sell these contracts on the market
               3. Spot market – current prices from demand and supply
            3. OPEC placed surcharges on top of oil prices
               1. OPEC was obligated to sell at the price in the futures contract
      3. Third oil shock in 1999
         1. Oil price increased from $12 to more than $20
         2. U.S. went into a recession in 2001
      4. The high oil prices in 2007-2008 is caused by the rapid growth of China and India
         1. Rapid growth requires more energy
         2. China has some petroleum reserves
         3. India has very little
      5. A nation's military and economic powers became dependent on critical resources like petroleum
3. Oil Exporting countries
   1. Use oil to finance government revenue
   2. This is why gov. tends to control its petroleum industry
   3. Gov. can keep taxes low and provide many benefits to its citizens
   4. High oil prices creates an inflow of currency
      1. "Petrodollar recycling" – oil rich countries had to lend money to oil-poor customers
      2. Invested heavily in industrial countries
         1. Real estate, stocks, bonds, and gov. bonds
   5. Finance the traditional Islamic state
   6. Import workers for menial labor

Cartels

1. Problems with Cartels trying to maintain high market prices
   1. Elasticity
      1. Inelastic – price changes causes the consumption of oil to drop by a little in the short run
      2. More elastic – price changes causes the consumption of oil to drop by a large amount in the long run
         1. Investment in fuel efficient automobiles, factories, and heating plants
         2. High prices cause consumers to conserve more
         3. Reduce the world oil demand
   2. As the number of firms increases, collusion becomes less effective
      1. More difficult to communicate, negotiate, and reach agreements.
      2. Firms have different market shares, different costs, etc
      3. Many time OPEC could not agree on production quotas
   3. High prices spur oil production in non-OPEC nations
      1. Mexico, Norway, Britain, and the United States to develop new oil fields
      2. High extraction cost
         1. Stormy North Sea
         2. Alaskan North Slope
      3. The U.S. created the Strategic Petroleum Reserve
         1. Storage of oil in salt domes in Louisiana
         2. Debatable whether the U.S. has enough to offset a supply disruption
   4. High prices spur innovation
      1. Firms use technology to find oil reserves
      2. Reduce chance of drilling for dry holes
      3. Allows extraction in difficult places
   5. OPEC members cheated on quotas
      1. Prices came down
      2. Saudi Arabia had to cut back to keep petroleum price high
   6. Iraqi President Saddam Hussein was angry
      1. Thought Kuwaiti was cheating on its oil production quotas
      2. The lower petroleum price cost the Iraqi state treasury billions in lost oil revenues
      3. Kuwait was pushing too hard for repayment of loans made to Iraq during the Iran-Iraq War
      4. Iraqi invaded Kuwait in 1991
      5. Petroleum prices spiked, but quickly dropped again
      6. Saddam Hussein had very few supporters in the Arab world
   7. Encourage biofuels
      1. Biodiesel
         1. Made from vegetable oil and animal fats
         2. Renewable resource
      2. Ethanol
         1. Made from sugar and starch crops
         2. Renewable resource
      3. Biofuels recycle carbon dioxide from the air
         1. Could reduce greenhouse gas emissions
         2. Could mitigate global warming
2. What if OPEC dumped oil onto the world markets?
   1. OPEC can sell oil profitably for prices as low as $2 per barrel
   2. Production costs
      1. U.S. is $10
      2. Canada is $11
      3. Russia is $14
   3. Consumers would benefit
   4. Could bankrupt the non-OPEC firms if it can sell for cheap price for extended period of time
      1. Russia depends upon oil exports for almost half of its hard-currency export earnings.
      2. How would Russia make up the short fall?
         1. Could dump other products on world markets, driving down those prices
         2. Russia could enter a deeper recession
         3. Russia could revert back into an authoritarian state
         4. Could sell weapons or technology to less developed nations