-International oil prices dtermined by US prices. US was world's major source of oil products.
- 1859-1928 characterised by price wars between the Majors. Result of excess capacity, low marginal cost, oligopolistic structure. Result of price war is that similar mkt prices attained,but at lower level. Industry ch. uncertainty between the rival co. under the shadow of reduced profitability.
- solution is catelization - members agree on division of the market.
-ACHNACARRY AGEEMENT 1928.
For system to work need to protect intl. price system from increasing availability of crude oil from M.E., also signif. cheaper to produce than US.
Adopted US "GULF PLUS" system which was a BASING POINT PRICING system.
Product prices worldwide detmd by US domestic prices.
Any actual price difference accepted by PHANTOM FREIGHT RATE. Can bring low cost sources into the mkt without price competition.
Windfall profits to those with access to cheaper crude.
-Prices were product and not crude prices. Refineries located predominantly on the fields and it was its products that were traded and transported.
Crude oil moving in the affiliates of same co. in a vertically integrated structure. Almost no crude sold in open (armslength ) mkt.
-US domestic price detmd by D and S.
-LAW OF CAPTURE of oil rsulted in oversupply. Pro rationing introd. to restrain supply.
-Restrained supply, high prod. costs in USA: kept domestic and therefore intl. prices higher than would be in cpmpetitive intl. mkt.
-USA introd. pricing controls during WWII to keep domestic prices down.
-DUAL BASING POINT SYSTEM - lower-cost M.E. oil had natural mkt. defined by western & eastern watersheds.
-End of war, US removed price controls. Domestic prices rose sharply, mirrored intl. as co. tried to maintain link between US domestic & intl. prices. Link not perfect as M.E. expanded east and west.
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CHANGES & DEFENCE OF THE PRICE STRUCTURE 1945-1969
- 1948. Venezuela got 50% tax imposed on profits atrributable to crude prdn in replacent of royalties.
-No price from which to calc. profits bec. no intl. oil mkt for crude and vertically integrated co structure.
- Overcome this by using POSTED PRICES reflecting the mkt. value of crude.
-1950s: oil co. still try to maintaoin link with US domestic prices.
1957: US domestic prices increased followed by posted prices. Price increase not teneble in the intl. mkt. despite the major's ability to control supply via their horizontally integrated structures.
-Resulted in creation of OPEC Sept. 1960 . Aim of restoring cut posted prices and tax revenues of host gvts.
-Major's grip over excess capacity began to weaken as new entrants world mkt. Move started by USSR exporting oil to get hard currency.
-The growing supply, despite increased demand, meant that crude oil realised prices (mkt. prices on armslength) began to decline in 1960s. Encouraged more consumers to ch to oil. Threat of nationalisation induced co. to pump in anticipation.
-Oil is a depletable resouce. Oil produced today is lost forever. Decision whether or not to produce the barrel today involves comparing CURRENT prices with EXPECTED FUTURE prices.
-make use of the dicount rate. The percentage rate used to compute the PV of a cashflow expected in the future. The DR should reflect the opportunity cost of capital.
DR are specific to projects bec. they reflect the inherent risks,technical, political. The higher the risk, the higher the DR. Reflects people's view of the future. A high DR means future income is less vlauable than income now.
PV = FV
(1+r)
where PV= present value of the crude less cost.
FV= future value of crude less cost.
r = discount rate
N = no. years.
-reduction in the future expected value reduces the present value.
-increase in the future expected value increase PV, PV>Price t, s falls.
-a rise in the discount rate reduces PV.
-A fall in Discount rates increase PV.
-if current price less cost is > the PV ......more money made by producing crude now so supply increases.
-If current price less cost < PV......more money by postponing prdn so supply falls.
-Using this analysis the supply of late 1960s caused an erosion of price structure.
(a). Co. feared nationalisation so had a high discount rate, fall in PV, increased in supply, fall in price, increase in demand.
(i.e. the PV of a barrel produced in five years time would be zero bec. it would be the Gvt . selling the barrel).
(b). Perception in the 1960s that oil prices fall further. Expected future prices falling (as with higher discount rates) reduces the PV below current price encouraging futher prodn.
-1970s. Change of property rights. Nationalisation. Lower discount rate
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HOTELLING
-depletable resource. Increase in price of oil with rate of interest.
