OPEC Flashcards
(8 cards)
OPEC
The organisation of petroleum exporting countries
14 countries, controlling 40% of the worlds oil supply having a huge effect on world price
Oil price
oil price is set in the futures market (price is determined today but paid in the future) which gives comfort to bankers
two types of future traders: hedgers and spectators
hedger will buy now to protect against future price increases
spectators: not interested in the oil itself but buy the oil with view of making a profit
spot market - where oil is traded instantly for that price
OPEC
A cartel - decide collectively to raise or reduce production
founded in 1960 with the aim to act as one to secure stable prices as they did not think they were getting a good deal on oil prices
1973/74 oil prices rose by 400% first shock
1973: war between egypt and israel the price rose, OPEC increased the price of oil more, the government put a tax on the supply of oil so prices rose demand demand rose; price stayed high, market didn’t collapse
Excess production
Non-OPEC countries produced as much as they could, prices remained low
1998: Far east oil grew rapidly (growth curtail), GDP fell
1999: North Sea peak production
2014: shell oil production increasing, some wanted to cut production to keep prices high (saudi protested protection was not cut)
2015: a free world market, prices fell saudi prince saw this as a loss of revenue so OPEC agreed to cut the production levels
Models of OPEC behavior: Multiplant monopoly
Cartels behave as a multiplant monopoly: monopolistic firms that have their production divided and their own cost structure
Try and maximise profits from the enterprise (OPEC) as a whole
MC curves are summarized horizontally (3)
MR = MC gives maximum cartel profit, production takes place in the lowest cost location
have to allocate the total production between the member countries
If MC is above MR no Qm
Saudi has the biggest quota
Models of OPEC behavior: Target revenue model
Each member state has a target revenue that they each want to make
Q0 is less than required the country will seek a higher quota
Q* is a good place, this satifies the budget constraint
Q1 revenue greater than needed to satisfy the budget constraint (production could be cut)
when prices fall, cut production
difficult to find examples in history
Models of OPEC behaviour: Limit pricing model
Sold by a supplier to make the price low enough that others do not enter as it would be unprofitable
it is illegal in many countries, can lead to less profit in the short run
Non-OPEC will not restrain their output to help OPEC
non OPEC will produce where their MC = world price
demand for OPEC oil is found by subtracting the competitive fringe supply from the world demand
At price Pn (below cf) cannot produce at all leaving demand to be met by OPEC
at the other extreme, Ph the cf would supply the whole market
Between these two extremes, demand is found from subtracting cf from the world demand
OPECs limit price is found by MR=MC will set p* and q* to maximise their position since non-OPEC is there this puts the relationship between OPEC and non-OPEC in the center of the world oil price
Model of OPEC behaviour: limit price theory modified to include backstop technology
Backstop technology e.g. coal
the assumption is that reserves from backstop technology are very large and the supply curve is very elastic
the graph shows the demand for OPEC oil and the long run supply of backstop technology
if the long run supply curve of backstop tech occurs at price in excess of P* discussed in the previous issue then no problem arises for OPEC
suppose the Sb decreases until output reaches 0Qmin (after which MC is constant over the relevant range of output) and suppose that after Qmin the Sb is below OP* (OPECs limit price) OPEC would wish to choose a strategy to limit or prevent entry by producers of the backstop technology
the possibilities are as follows:
