Why have the downward pressure on prices seen in the 1960s been
reversed so dramatically?
Winter 1969. Demand higher than usual esp in W.Europe. Supply supressed because of tanker shortage. Resulted in increase in price and increase in profits for co. with access to Meditarranean crude - oil transported over shorter distance.
Libyians wanted an increase in posted prices to secure an increase in govt. take. Exxon set the first posted price in Libya 1961 ( used as a marker crude by other co. operating in Libya). Libyan Govt. always argued it was too low. Demands coincided with revoluntary overthrow of the monarchy.
January 1970 Libyan Govt. wanted higher prices from from the 21 oil co. Oil co. said that only they had the right to decide posted prices. September - agreed to new price terms. Start of the first oil shock.
Why did co. agree to Libya`s demands?
(a). For a lot of co. Libya was their main (if not only) source of crude in eastern hemisphere. Heavy capital investment in Libya - try re-coup a.s.a.p. Vulnerable to the Govt. in a way that major co. with excess capacity would not have been.
(b). Libya could impose production limits bec. not yet dependent entirely on crude as source of revenue. Aggravated sourec of Med. crude. Further reduced in May 1970: Syria stopped Saudia flow via the TAPLINE, following a breach of the line.
Result: strengthened Med. Crude prices.
(c). Major oil co. not adverse to price increase. Would constrain the independent co. in Europe from indulging in price competition in Eurpoe.
Response of OPEC:
members also wanted increase in posted prices to increase revenue. OPEC members decided on strategy of regional negoitiations with the 24 co. The 24 co. feared the successful divide and rule tactics employed by Libya that they formed the LONDON POLICY GROUP - insisting on unified global negotiations.
USA orig. supported the London Policy Group but late Jan 1971 it supported OPEC instead. Why?
- unified negotiations with such a diverse group would lead to results close to the demands of the producers.
- US Govt. seeking increase in oil price in pursuit of own interests and weakening the bargaining hand of the co. Why?
1960s
US domestic industry signif. decline.
Reserve base declining because:
- natural depletion process
- lack of exploration effort by oil co.
The result was increasing oil imports and implications for bal. of payments. Price of oil to US signif. higher than to Japan or W.Germany bec. of regulation and protection. Reduced X competitiveness of US goods. Substantial increase in intl. price would be paid for by Europe and Japan - providing boost for exploration and development.
The result was regional negotiations which lead to:
The Tehran Agreement Feb 1971
The Tripoli Agreement April 1971
- both were 5 year agreements concerning price increases and price escalation clauses.
Following this, world economic conditions were in a state of boom. Some countries introd. PRICE CEILINGS for conservation reasons.(Tehran Agreement short-lived).
Aug. 1971 US dollar moved to floating dollar exchange rate -effectively reduced the price of oil.
Geneva I 1972
Geneva II 1973
- OPEC negotiations to a/c for devaluation of the dollar.Note also USA inflation.OPEC receiving less in real taxes/barrel. Perian Gulf OPEC increased taxes above current market prices to give members larger share of profits. Realised market prices increased.. By 1973, some exceeded the post price.
OPEC members gained confidence and lead a Third World Crusade against exploitation. Willingt to exploit the monopoly power they have.
16 October 1973-
Gulf Ministers announced unilaterlly an increase in the price of Arabian Light by 70%. Other OPEC members followed. Many regaerd this as the start of the oil shobk but it is in fact the logical culmination of events in Libya 1970.
Arab Oil Embargo (in addtn to price increase).
Which was to have a market impact out of proportion to its effectiveness. Embargo on USA and Netherlands - but international
interconnections. Not enough.
Reduced supply availability - non-embargoed countires to be concerned about own supply of oil, less inclined to assist embargoed countries. Studies show the embargo to be unsuccessful.
What caused the supply reduction?
Embargo and increased demand for crude oil. Realised market prices cont. to rise. Market in situation in panic.
Dec 1973.
OPEC met in Tehran. Rather than risk openly splitting with OPEC, Saudi's agreed to an increase in price from $5.119/b to $11.651/b. First Oil Shock.
1973: Arab- Israeli War. Arab members of OPEC restricted supply.
Causes of the First Oil Shock s.t. controversy.
3 views:
(a). Price rise bec. genuine shortage of supply. This shortage at
the time viewed as result of cartel action by OPEC but OPEC had no production limiting/ sharing scheme.
(b). Has been shown that a fall in the discount rate or rise in the expected future price increases the value per barrel, thereby reducing current supply. Both occured during this period.
Producers s curves shift left along demand curve, which in the SR is inelastic w.r.t. price, hence sharp price increase.
Demand curve shifts because a fall in real income , but not enough to avoid the increase in price induced from the supply side.
First half of 1970s - Producer gvts took over oil production by nationalisation and participation. Some say that the govts had lower discount rate than oil co.
Accepted in theory but in practice the econ. theory of politics casts doubts on the long-sightedness of govts. This view stems from three sources.
source 1.
Growth of the environmental lobby.
source 2.
Oil co. conceterd camapaign to generate fear of shortage so that govts. more generous in fiscal treatment of oil industry and de-regulae the industry.
source 3.
Fears of politically induced shortages, leading to higher prices following the Arab oil embargo.
(c). Many oil co. had become target revenue earners reluctant to accumulate foreign assets. Would stop production once acquired enough revenue for their domestic needs. If prices rise, can securesame revenue with lower production levels.
But there was no real oil shortage in 1973 apart from Nov. and Dec.
Both buyers and sellers of crude wanted higher prices. The buyerse were the oil co. who had lost a signif. proportion of their crude. (ownership changes in early 1970s). Bec. of the adv. of verical integration, they sought new sources. But new sources in high-cost regions (Alaska) -need high price to be viable.
Higher prices mean that oil co. crude-producing division became more profitsable.
Refining operations would then face higher costs but these can be passed onto the consumer.
US govt. welcomed the higher prices but alarmed at the scale of increase in 1973.
THE AFTERMATH OF THE FIRST OIL SHOCK 1974-1978
The natural downward pressure reasserted itself but from a higher base.
Key mechanism- joint control of supply (horizontal integration) -kept excess capacity in check in 1950s, 1960s had been swept away due to change in ownership.
Vertical integration is the controlling mechanism that remained. Controlled excess capacity by encouraging co. to lift only sufficient for their own refining opeartions. This limits the ARMSLENGTH crude market.
Why did V.I. remain?
-reluctance of producing govts to market own oil.
-due to inexperience.
-market weak.
-govt. officials frigtened of being accused of corruption given the esoteric exercise.
Swing producer
- Saudi's agreed to act as swing producer.
If excess supply pressured the pricing structure, the Saudi's would cut back its production to ease the pressure.
Role of OPEC in Pricing.
Announce new marker price at end of meeting. Price usually fozen, sometimes a small increase. But Dec 1976, Saudis asnd UAE broke from OPEC with only a 5% increase c.f. to 10% of others. View that OPEC detmd prices, behaving like a cartel.
In theory, a formula existed that could be used to arrive at
differentiated prices once market price set. In practice, other producers of crude charged simply what the market would bear given the characteristics of crude. If prices too high, co would refuse to lift.
Co. would be theoretically short of crude and could apply to
Saudi's to make up shortfall. Sysem seldom invoked: the threat was sufficient to to control pricing of other crudes.
View that OPEC less important than suggested.
After 1973, combination of controlling mechanisms curtailed the excess supply. Prices did erode in real terms but it was a slow decline, not a collapse.
THE SECOND OIL SHOCK 1974-1981
Controversy in interpretation.
October 1978 - Iranain oil workers on strike. Production fell from 5.5m/bd to almost zero.
Other OPEC countires expanded output but Saudi expandsion erratcic - technical problems. And political decisions following Egypt-Isreali peace treaty.
Panic in market. Stocks at low levels. Spot crudeoil virtually disappeared - and it is spot product prices that lead to an upward movement in price structure. Hence market saw a scramble for products and crude oil by both producers and govts.
Some oil producers imposed premiums on official selling prices.
AS prices increased in the spot market,producers began taking over crude oil marketing.
Saudi's tried to stem the rise in prices fearing long term effects. October 1981 , OPEC agreed to marker price of $ 34/b.
The difficulty in explanation:
Price rise generated by perceptions and expectations. Views formed in situation with inadequate and inaccurate info and general atmosphere of panic.
We can explain the shortfall of crude.
.
Unfullfilled demand from the thr term market spilled into the spot market causing prices to rise. Gvt. take-over of crude marketing reduced the term market availability even more. In spot market, demand and supply increasing, but D>S bec. of Iranian shortfall.
The result when the situation settled following OPECs meeting 1981 was a price structure that bore no relation to anything.
Downward pressure on prices reasserted on a higher base.
Demand for oil falling bec.of recession, fuel switching, conservation.
Gulf war removedsome crude from intl. market. But more than off-set bec. expandsion of non-OPEC crude.
Indiv. OPEC countries production policies under the sovereign control of each member. 1973-1980 signif. increase in market share of Saudi Arabia, Indonesia bec. of Gulf War.
THE AFTERMATH OF THE SECOND OIL SHOCK
Weakening of V.I. as govts took control of marketing crude.
Only Saudi swing role to control excess supply.
Discrediting of long term contracts. Move to ST contracts and spot market - price structure responded faster to market conditoins.
BNOC obliged to take UK govts royalties from lifting crude. Had no refinery or storage capacity - forced to sell back crude. If co. thought price too high, BNOC had to announce official reduction in price or sell on spot market. Created competitive pressurs on African producers whose crude quality similar to North sea crude.
