NS4054 Fall Term 2013 Oil Markets: Crude Predicement

Crude Predicament I Robert McNally and Michael Levi, A Crude Predicament: The Era of Volatile Oil Prices example of inelastic supply and demand, together with price stabilization schemes Article deals with increased volatility in oil markets Textbook economics says prices rise and fall in order to balance supply and demand However in oil market supply and demand are slow to respond to price shifts Takes years to develop new resources Demand often inelastic When demand falls suddenly, takes time for suppliers to cut production Means prices undergo big swings before balance restored – Result: oil prices tend towards extremes 2

Crude Predicament II Traditionally oil producers able to find new oil faster than demand grew – price bursts would wipe out profits and investments – followed by rises in demand then booms Producers thus sought to put floor on prices by holding oil off market Also sought to limit competition by placing caps on price and adding extra oil to markets during tight times 1930s – mainly Texas Railroad Commission After 1972 largely OPEC with Saudi Arabia the country with spare capacity After 2003 with Iraq out of market, little spare capacity Rapid world growth – prices up to $147/barrel in 2008 Saudis less willing to develop spare capacity -- expensive No other producers can fill Saudi Arabia’s role – Russia unreliable 3

Crude Predicament III Policy Actions Governments can provide more and better information on supplies – avoids panic buying Assure good futures/hedging markets Don’t use strategic reserve to suppress oil prices Develop alternative supplies – shale Canadian Oil Sands Encourage the phasing out of subsidies – IMF, World Bank Encourage conservation, fuel efficiency Retrospect – many problems discussed may be lessening due to the rapid development of shale oil/gas supplies in U.S. and other parts of world 4