1. NS4054 Fall Term 2015 Oil Markets: Crude Predicement

2. 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

3. 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

4. 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