Supply and Demand of Oil

Question 1

Impending scarity

Answer 1

impending scarcity determines real fluctuations
e.g. the 70s (oil price dropped due to the reserve production ratio) increased due to American shell oil (too much supply so prices fell hugely)
Hotelling model is inconsistent but gives a good insight

Question 2

Supply - incremental cost curves

Answer 2

different when total output (recovery) is being increased but period rate of output is constant
when the rate of output is increased but total recovery is constant
incremental cost curves (per barrel in PV)
ICC (incremental capital cost): what happens inside a reservoir, require more wells to be drilled
IOC (incremental operating cost): extend the life of the field and discount these costs, declines with higher rate of output (economies of scale)
ITC (incremental total cost): sum of both (ICC will dominate)

Question 3

Elasticity of supply

Answer 3

supply of oil prices is very unique (few studies)
VSR: days/weeks, supply is very inelastic production is 365 days per year and very capital intensive (costs if you shut down and restart)
SR: matter of weeks, limited but can drill some wells in existing fields, do not get a big increase in output (as you want to max the returns over the fields lifetime)
LR: months, new fields can be discovered , more elastic
VLR: years, much more elastic, new discoveries
in real terms biggest price increase was in Norway in the 70’s 400%

Question 4

Field recovery (increasing)

Answer 4

Primary: Oil comes up due to pressure about 5-15% of the oil comes up
Secondary: pressure falls so production falls, have to invest in water/gas (capital expenditures), about 30% of the oil will come up here
Tertiary: can inject polymers to get more oil out, a very costly process (enhanced oil recovery) need new technology
ICC follows field recovery (as more oil is extracted, the process is more capital intensive)
Never produce all the oil from a field
IOC falls as it won’t change much
to enhance recovery, need to extend the life of a field

Question 5

Incremental cost rate of output

Answer 5

ICC: drill more wells, costs come down as capital costs are already there. Economies of scale in a field so ICC would eventually come up (teeny bopper fields in the North Sea have huge economies of scale), goes down as it only attributes to the well cost
IOC: reserves are fixed so life of field is reducing (less years of operating costs)

Question 6

Demand (lots of studies)

Answer 6

SR: low elasticity as consumers cannot change the likes of their heating suppliers easily steep demand curve
LR: consumers can buy a more efficient car/heating (can adjust capital stock easier), less steep a 1% increase income, 1.17% increase in the gasoline (as long as income rises demand will also rise)
example: in 2014 there was a big rise in supply the US covered variable costs but not fixed costs so did not invest in new production until the price rose

Question 7

Supply and demand together

Answer 7

1990 Kuwait example (Iraq invaded Kuwait) - Iraq felt Kuwait was overproducing oil
need to experience a supply shock
Kuwait production of the market so supply moves to S1 and price moves up to P1 this causes a shift in demand and moves to D1 price then falls back
price volatility depends on: low price elasticity and the prevalence of a shock