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OPEC and Oil Prices
This presentation focuses on the
main supply and demand factors
that explain changes in
international oil prices, and also
how changes in oil prices affect
an economy
Oil Prices
P Oldfield 20011
Global Oil Industry: Current Market Supply
OPEC controls the majority of the low cost oil
supply in the world economy
Oil Prices
P Oldfield 20011
Proven Oil Reserves
Middle East producers who form the bulk of OPEC
hold 75% of the proven reserves of oil
Oil Prices
P Oldfield 20011
Oil Demand and Supply
!   OIL DEMAND
!   OIL SUPPLY
!   Strong link between the demand for oil !   Short run supply influenced by
and the rate of global economic growth
  Production decisions of OPEC and
Non-OPEC countries
(cyclical demand)
!   Oil is an essential input into many
industries – when the economy is
expanding, the demand for oil rises
!   Demand also affected by the relative
prices of oil substitutes (e.g. gas)
!   Changes in climate – e.g. affecting the
demand for heating oil
!   Speculative demand for oil (hoping for a
rise in prices on world markets)
Oil Prices
  Amount of spare production capacity
in the oil sector
  Production shocks (e.g. loss of
output from rig closures/wars etc)
!   Long run oil supply is linked to
  Depletion of proven oil reserves
  Investment spending on exploring
and then exploiting new oil reserves
  Technological change in oil
extraction (which affects the costs
of extraction)
P Oldfield 20011
Crude Oil – A Derived Demand
!   Crude oil has many uses. The global demand for oil is
derived from the uses to which oil is put
!   Gasoline: motor spirit/petrol
!   Middle Distillates:
  Diesel - vehicles and other motors/engines
  Jet fuel
  Kerosene – cooking/heating
  Heating Oil
!   Fuel Oil: boiler fuel for industry, power and shipping
!   Other: lubricants, bitumen etc
Oil Prices
P Oldfield 20011
Consumption of Oil in the Global Economy
Oil Prices
P Oldfield 20011
Long Term Rise in Oil Consumption
Oil Prices
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Demand Curve For Oil
The demand for oil is
inelastic in response to
price changes in the short
run
This is mainly because it
is an essential input into
many production
processes
Oil Demand
Price
$ per barrel
P3
P1
P2
D short-run
Q3
Q1
Q2
Demand for Oil
Oil Prices
P Oldfield 20011
Longer Run Demand – More Elastic
Longer run demand is
relatively more elastic if
non-oil substitutes
develop. Also greater
incentive to cut demand
by using more fuel
efficient technology,
smaller/hybrid cars etc
Oil Demand
Price
$ per barrel
P3
P1
P2
D long-run
D short-run
Q3
Q1
Q2
Demand for Oil
Oil Prices
P Oldfield 20011
Shifts in Oil Demand
The demand for oil might
shift out if there is:
(i) 
Economic growth –
in particular growth
in industries that are
heavy users of oil as
a factor input
Oil Demand
Price
$ per barrel
P1
(ii)  A rise in the price of
oil substitutes (e.g.
gas used in firing
power stations)
(iii)  An increase in the
speculative demand
for oil stocks
Oil Prices
D1
Q1
D2
Q2
Demand for Oil
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(Long run)Oil Supply
The oil supply curve
slopes positively from
left to right.
As oil prices increase
(following an increase
in total market demand
D1 – D2) so the
incentive to extract
more oil increases eg
more oil was pumped
from N. Sea due to rise
in oil prices in early
1970s
Price
$ per barrel
Oil Supply
P2
P1
D1
Q1
D2
Q2
Demand for Oil
Oil Prices
P Oldfield 20011
Shifts in Oil Supply
The supply of oil shifts
when the
conditions of
supply change
Price
$ per barrel
Oil Supply
S2
Eg:
(i)  The costs of
extraction
(ii)  Investment in new
oil fields and the
extra supply from
an increase in
capital investment
in the industry
Oil Prices
P1
P2
D1
Q1
Q2
Demand for Oil
P Oldfield 20011
OPEC AND THE GLOBAL OIL MARKET
Oil Prices
P Oldfield 20011
OPEC – Key Moments in its History
!   1960 – OPEC founded by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela
!   1973 – Sharp rise in oil prices cause world economic crisis
!   1990 - Iraq anger at Kuwait over-production sparks Gulf War and a
sharp rise in international oil prices
!   1998 - World oil price drops to $10 a barrel
!   2000 - Opec puts squeeze on production to boost prices
!   2001- Opec puts pressure on non member countries to cut production
!   2002/3 – Oil prices start to rise on back of rising demand and concerns
about supply effects of a US attack on Iraq. Subsequently falls due to
quick war, and so OPEC again squeezes S.
!   2007 onwards- increased demand from developing countries leads to
rapid increases in oil prices. P also rises due to speculative purchasing
on fear of instability in Middle East (Iraq) etc. Also as Oil is priced in
US$ the depreciation in dollar has caused a surge in dollar prices.
Oil Prices
P Oldfield 20011
OPEC and their control of Oil Supply
OPEC exerts control over the
oil supply:
• Supply perfectly inelastic as
Cartel fixes S. irrespective of
P
Price
$ per barrel
S1
S
Oil Supply
P2
• Reduces Supply
• P increases from P1 to P2
P1
D1
Q2
Q1
Demand for Oil
Oil Prices
P Oldfield 20011
OPEC and World Oil Supply
The total world supply of oil
is shaped normally as more is
supplied at higher prices-there
is no world cartel .
So in the recent case of Libya
in 2011, the political unrest
has reduced world oil supply
and thus the Supply has
shifted to the left
This boosts total income of oil
producers – but increases the
total cost to oil consumers
Price
$ per barrel
S2
S1
P2
P1
D1
Q1
Q2
Demand for Oil
Oil Prices
P Oldfield 20011
PES in Short run and Long run
Given that Opec’s Supply of oil is fixed in the short run
and therefore perfectly inelastic, how price inelastic is the
supply of oil overall?
Well it is hard to tell but much depends on how close the
industry is to full capacity. If there is spare capacity then
there is the ability to supply more and supply will be more
price elastic. Note that it is not just spare capacity in oil
extraction that is important, but also in oil refineries too.
Often bottlenecks in refining limit the PES of oil and lead
to volatility in oil prices.
Oil Prices
P Oldfield 20011
PES in Short run and Long run
Overall it is safe to say that Supply is more elastic in
the long run as a higher price leads to a greater
incentive to seek out new oil reserves. However in the
very long run, as oil reserves dwindle ultimately this
will not be the case.
So with both PED and PES being inelastic in the short
run, then prices will be volatile in the short run,
particularly as there is much speculation in oil, which is
one of the main reasons for short run volatility.
Note the recent unrest in Libya did not dramatically
reduce supply (libya only supplies 2% of world output),
and yet prices dramatically increased on speculation
that unrest may spread further in the Gulf.
Oil Prices
P Oldfield 20011
Global Oil Price Data in real terms (after
inflation taken into account)
Oil Prices
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Macro-Economic Effects of Higher Oil
Prices
!   Increased production costs, so firms’ profits fall,
leading to cuts in employment and investment
!   Higher petrol and heating oil prices reduce the real
incomes of households, squeezing consumer
spending
!   Real incomes fall for consumers around the world.
So overseas demand drops, hitting exports (a
component of AD)
!   Higher oil prices may also trigger a ‘wage-price
spiral’, prompting increased inflation and higher
interest rates
Oil Prices
P Oldfield 20011
Evaluation: The Significance of Higher Oil
Prices
!   Bring the following points into your evaluation:
(1)  Is the rise in oil prices short term or long term?
(2)  Do producers pass on higher costs to consumers? (depends on the
price elasticity of demand)
(3)  Can producers make cost savings elsewhere? (e.g. achieve higher
productivity to reduce costs)
(4)  Will interest rates rise if inflation increases? The Gov. might judge
that higher oil prices are short lived and do not require higher
interest rates (fear of recession)
(5)  Some firms benefit from higher oil prices
(a)  Increased profits for oil companies
(b)  Greater employment in oil firms!
(c)  Higher investment in oil exploration and extraction.
Oil Prices
P Oldfield 20011