OPEC OIL 2010 - Economic Events and the Impacts

7/31/2019 OPEC OIL 2010 - Economic Events and the Impacts

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OPEC OIL IN 2010: ECONOMIC EVENTS, TRENDS IN

DEMAND AND SUPPLY AND IMPACT ON PRICES

Etuwat James J.O., American University of Leadership, 2012

1.0 INTRODUCTION

This submission is on an organization known by its acronym OPEC but its full name is Organization of the

Petroleum Exporting Countries. The write up seeks to identify economic events related to 2010 that have

influenced the trends of the supply and demand of OPEC oil and the impact of these events on oil prices.

My focus will be on the period of 2010 and to an extent prior to that year.

According to their website (OPEC 2012)i, the Organization of the Petroleum Exporting Countries (OPEC)

is a permanent, intergovernmental Organization and was created in the Iraq capital of Baghdad after

endorsement of accord in 1960 by the founding members, Kuwait, Iraq, Saudi Arabia, Islamic Republic of

Iran and Venezuela. Others came in later in alphabetical order: Algeria (1969), Angola (2007), Ecuador

(1973), Gabon (1975), Indonesia (1962), Libya (1962), Nigeria (1971), Qatar (1961), United Arab

Emirates (1967). However, Ecuador deferred its membership in the period December 1992 to October

2007, Gabon ceased its attachment in 1995. Indonesia shelved its commitment from January 2009. At the

moment, OPEC has Member Nations. OPEC had its head office in Geneva, Switzerland, for five years

since its creation but transferred Vienna, Austria in 1965.

The governing charter of OPEC differentiates between the Founder Members and Full Members. The

Statute specifies that any country having a significant net export of crude petroleum, which has underlying

comparable concerns to those of Member Countries, may turn out to be a Full Member of the

Organization, on condition of approval by 75% of Full Members, together with the assenting votes of all

Founder Members. Still, Associate Members are provided for such that those countries that do not meet

the criteria for full membership, but are accepted under such particular conditions as may be stipulated by

the Conference.

The aims of OPEC include organizing and harmonizing oil policies among Member Countries, in order to

obtain fair and unwavering prices for petroleum producers; prudent, viable and constant delivery of

petroleum to utilizing nations; and a reasonable profit to investors (OPEC 2012).

The Council on Foreign Relationship (CFR 2012)ii

of the David Rockefeller Studies Program has it that oil

producers working exterior to the Organization of Petroleum Exporting Countries (OPEC), termed non-

OPEC countries in the past deliver to a level more than 60% of petroleum output. However, these non-

OPEC producers are said to have aged wells which have a reduced number of resourceful oil wells,


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increasing expenditure for new projects, and sometimes mounting demand at home that could reduce

exports. According to the U.S. Energy Department's Energy Information Agency (EIA), by 2006, the major

non-OPEC countries were Russia, the United States, China, Mexico, Canada, Norway, and Brazil (CFR

2012).

The 2010 world supply of oil came from the outputs of OPEC and non-OPEC countries as per figure

below:

2.0 ECONOMIC EVENTS

Innovating for Energyenergesis nouvelles(IFP 2009)iii, presents in a technical report, Panorama 2009:

Oil Supply and Demand, IFP, presents conceptual framework of the factors determining the oil price as

illustrated the figure below:

Source: IFP


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IFP identifies economic factors that determine the price of oil as: economic growth, the exchange rate of

the US dollar, taxes and subsidies and cost of services and equipment.

Economic Growth:

Economic growth is the main factor that drives prices and influences the progress of demand (IFP 2009).

As nations grow and industrialize their oil use increases along their economy (Trading Today 2012)iv.

Due to wide based crisis actions to stimulate growth, by particularly US and Japan, the global economy

grew by 4.7% more than double the forecsast rate of 0.8% (OPEC 2010). OECD countries made a trong

turnaraound from negative growth of 3.5% to positive grwoth of 2.8%. The OOECDs GDP peaked in

2010. The trends in GDP for OECD countries are presented herebelow:

Source: OECD 2012v: OECD Global Outlook 90


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Emerging markets economies have recovered above precrisis levels. Among emerging economies, BRICS

(Brazil, Russia, India, China & South Africa) led the growth. Small economies rich in hydrocarbons and

mineral resources also showed growth.

The US Dollar Exchange Rates:

The relationship between oil supply, demand and prices has been treated by Anas Alhajji (2012)vi. He

appears to have a comprehensible explanation. He asserts that whereas oil-exporters get income dollars

(or the euro parallel), they utilize various currencies to import goods and services. Any alteration in the

exchange rate of the dollar impacts the buying power and thus their real revenue.

He continues to state that in the brief-term, dollar decline does not impact supply and demand, but it has

effect on speculation and venture in oil futures markets. As the dollar depreciates, commodities draw

investors. Venturing in futures turns into both a hedge against a weakening dollar and a venture process

that could harvest a lot of profit, especially in an environment of decreasing excess oil production

capacity, rising demand, lowering interest rates, a falling real estate market, and chaos in the banking

industry.

He further says that in the extensive run, however, a frail dollar affects supply by depressing production,

regardless of whether oil is owned and produced by national or international oil companies. A feeble

dollar, besides, affects demand by raising consumption. The effect of a reduction in supply and a rise in

demand is higher prices.

2010 /$ Exchange Ratesvii

Source: X-RatesTM

http://www.x-rates.com/d/EUR/USD/hist2010.html


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Taxes and Subsidies

Taxation was generally termed by Pedro van Meurs (2009)viii

, as including all types of government

revenues derived from oil and gas production. Steve Rozner, (2009)ix, documented the modes of revenue

derivation globally as including: royalties, income tax, resource rent taxes, production sharing, state

participation and stability provisions.

Fiscal regimes in oil-rich countries

Source: EGAT/EG Fiscal Reform and Economic Governance Project,

http://www.fiscalreform.net/images/Files/bestpractices/taxing%20oil_presentation_090323.pdf

What is the impact of these revenue extractions from oil companies? In a California based research,

Nirupama S. Rao (2009)x

suggests that a 10 percent excise tax leads to a 2.4 percent reduction in

domestic oil production. It appears taxes have thus had a depressing effect on oil supply.

On subsidies, Douglas Koplow and Aaron Martinxi

of Industrial Economics, reporting for Green Peace,

assert that subsidies can depress oil prices, hindering market signals to governments, oil users and oil

suppliers to begin moving to alternatives. The Wall Street Journalxii

has added its voice on the issue of

subsidies. Quoting from International Energy Agency (IEA), the journal states that economic growth isnt

the only thing driving higher oil consumptionlarge fuel subsidies in many of these countries also play a

big part. The WST goes further to state that IEA reduced the 2011 oil demand projection for Iran by

140,000 barrels a day, approximately 8%, due to cut in the subsidy. Thus subsidies increase demand and

use of oil.


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Indices for Oil Equipment and Annual Operating Costs and Oil Prices in Real 1976 Dollars

Source: Energy Information Administration, Office of Oil and Gas

3.0 TRENDS IN DEMAND AND SUPPLY

In 2010, there was a slight increase in OPEC oil supply from 29,122,000 to 29,336,000 barrels per day

representing 0.73% increase in supply from OPEC alone. On the other hand, non-OPEC supply

increased more significantly than OPEC supply i.e. from 56,800,000 to 57,900,000 barrels per day

representing 1.93% increase in supply from non-OPEC countries. This percentage increase is more than

twice the percentage increase from OPEC countries. The figure below indicates the trends in global oil

supply during 2010 (OPEC 2012)xvi

. Whereas OPEC oil supply seems constant, non-OPEC supply is

apparently increasing as seen in the chart below:


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The demand for oil from OPEC increased during Q1 of 2010, peaked at the end of Q1 and began a

sustained drop to the end of the quarter as shown in the figure below:


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The oil supply from OPEC has basically remained constant, yet the demand for OPEC oil is increasing

and the global oil prices are increasing.

Economizing Problem

The world is faced with an Economizing Problem on oil. The global society has unlimited wants but withlimited resources. Oil is one of the scarce resources associated with global wants and needs. It can be

used for luxury like in the case of cruises or can be utilized for necessity as in the case of cooking. The oil

industry is associated with all forms of factors of production: Property (land and capital) and Human

Resources (labor and entrepreneur). The entrepreneur takes initiative, makes policy decisions, is

expected to be innovative and bear risks. In the oil industry, income is earned in the form of rent, interest,

wages and profit in various forms. For best results, the oil industry is supposed to fully employ its

resources and be in full production with productive and allocatve efficiencies. These aspects are

supposed to be based on the concepts of opportunity cost and comparative advantage for the production

possibilities alongside economic growth.

Opportunity Cost andProduction Efficiency

Employment Allocative Efficiency

Source: McGrawHill/Irwin 2002

These play out in the economic field of which there are two systems: the market system and command

system. These systems provide guidance for the flow of the oil amongst the resource markets,

households, businesses and product markets. In each area and step choices have to be made

(McConnellBrue 2001)xvii

. As mentioned earlier, when states develop and increase manufacturing, the

need for oil goes up along their economy (Trading Today 2012). Economic growth and the need to sustain

and accelerate it are some of the factors that increased the 2010 global demand for oil.


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On the supply side, OPEC as a corporate entrepreneur displayed aspects of capitalist economic system.

They produce oil according to policy and their 2010 practice was to maintain oil supply at a constant flow.

The associated impact has been increase of the oil prices.

Choices were thus continuously made in 2010 by the producers and consumers.

Market, Demand and Supply

In the market setting, the Law of Demand declares that as Price Falls, Quantity Demanded Rises and as

Price Rises, Quantity Demanded Falls and of supply says as price rises, quantity supplied rises and as

price falls quantity supplied falls (McConnellBrue 2001).


However, this is not the case in the global market because both demand for oil and its prices are rising.

The trend of oil price rise is higher than the demand increase. Normally demand is determined by tastes

and preferences, number of buyers, incomes, normal (superior) & inferior goods, prices of related goods,

substitutes & complements, unrelated goods and expectations. Oil seems to defy the above factors

especially in the area of viable substitutes.

Also, the customary determinants of supply are resource prices, technology, taxes & subsidies, prices of

other goods, price expectations, and number of sellers. Again, oil was unpredictable here, in that though

the price rice is high, its supply was constant. Whereas non-OPEC supply rose slightly, OPEC supply was

constant. It is thus evident that there was shortage in the supply of oil in the world market. The equilibrium

price may continue to shift as the world continues to experience oil rationing.


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Demand and Supply Elasticity and Government Set Prices


The figures above display different trends of price elasticity of demand. In relation to demand and supplyin 2010, oil demand is to some degree inelastic to price and thus exhibits signs of being a necessity. With

the nature of oil, it is not uncommon to observe price controls & shortages, rationing problems and

contraband markets

Consumer Behavior and Utility Maximization

Oil consumption by quarter and region, y-o-y growth Non-OECD oil consumption by region and quarter, y-o-y growth

Source: OPEC 2010

The top left figure above from OPEC 2010 indicates that the global growth of oil consumption is falling

almost parallel to OECD consumption. It implies that general global needs and specifically OECD needs

and wants for oil were almost saturated. However, for non-OECD, the marginal growth of oil consumption

is rising, implying that their taste for oil is fairly increasing. Besides, a closer look at the graph on the right


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above shows that the growth of China oil consumption is increasing. It implies that Chinas marginal utility

of oil was yet to be satisfied by the end of the year.

Implications

Douglas Sutherland et al, 2004, have documented oil price trends, the elements influencing the pricesand the economic impacts in OECD Economic Outlook No. 76. I basically agree with the authors. In the

publication, they assert that the oil price has grown considerably; world reliance on oil will persists, with

increasing dependence on OPEC and a probable trend increase in the oil price especially if the rise is

robust and oil-intensive. They further state that non-OPEC supply and demand responses constrain

OPECs market clout but fickleness and unpredictability depresses investment and that hindrances have

put upward burdens on prices.

The authors also point out that the connection between the oil price and core inflation has weakened and

oil price surprises tend to have only a modest effect on production, that the oil intensity of manufacturinghas fallen but the world economy will stay dependent on oil, of which there are sizeable reserves that are

mainly in the Middle East therefore enabling OPEC the opportunity for market control though constrained,

especially in the longer run. They maintain that in the baseline projection, the oil price will get to $35 in

2030. They say that this may probably become an equilibrium price and that it is dependent on OPEC

action.

In their report, the authors articulate that there is particular uncertainty about non-OECD demand in that

OPEC has a concern in limiting large price changes and will probably block prices from increasing too

much. However, the authors say that short-term price flux, limitation of forecast can constrain investment.

Douglas Sutherland et al, 2004 further add that the oil price has risen in excess of implications by

demand-supply relationship and is driven by a more stalwart demand, a constrained ability to react on

the supply side, low oil industry stores , transportation hindrances and regional supply deficiencies.

In addition, they voice that geopolitical anxieties have raised doubt in tandem with the probable

contribution of speculation. They project that the departure from the equilibrium price could be

protracted and declare that the oil price/output association has declined in that price increases may have

a greater effect than decreases. (Douglas Sutherland et al, 2004)xviii

5.0 CONCLUSION

OPEC is an institution at the epicenter of geo-oil interactions. There were trends of oil supply and demand

with the associated movements of price with the underlying economic events of growth in economies, the


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transtions of the exchange rate of the US dollar, various regimes in taxes and subsidies and increasing

and later falling cost of services and equipment. These elemnts provided a framework for oil as resource

to behave the way it did in 2010.


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6.0 REFERENCES

iOPEC (2012) Member Countries, Organization of the Petroleum Exporting Countries, ,http://www.opec.org/opec_web/en/about_us/25.htm

iiCFR (2012) Non-OPEC Oil Production, David Rockefeller Studies Program, http://www.cfr.org/natural-

resources-management/non-opec-oil-production/p14554

iiiIFP 2009: Oil Supply and Demand, Panorama, Innovating for Energyenergesis nouvelles, IFP

http://www.google.com.na/url?sa=t&rct=j&q=oil%20supply%20and%20demand&source=web&cd=17&ved=0CKYB

EBYwEA&url=http%3A%2F%2Fwww.ifpenergiesnouvelles.com%2Fcontent%2Fdownload%2F67676%2F1470144%2

Fversion%2F2%2Ffile%2FPanorama2009_04-Oil_supply_and_demand.pdf&ei=bbx-T8-

8GeGS0QXvzM2cBw&usg=AFQjCNFrpYJayyfPlErGFUAvapbPhuLjDA&cad=rja

ivTrading Today (2012) Oil Supply and Demand, http://www.tradingtoday.com/26-oil-supply-demand

vOECD 2012: Economic Outlook Flash file (EO 90)

http://www.oecd.org/document/18/0,3746,en_2649_37443_20347538_1_1_1_37443,00.html

viAnas Alhajji (2012): How Does the Weak Dollar Affect Oil Prices? Project Syndicate,http://www.project-syndicate.org/commentary/how-does-the-weak-dollar-affect-oil-prices-

viiX-rates

TM(2010) Monthly Exchange Rates Average,http://www.x-

rates.com/d/EUR/USD/hist2010.html

viiiPedro van Meurs (2009):Trends in international oil and gas taxation, Gubkin Oil and Gas UniversityMoscow

ixSteve Rozner, (2009), Taxing Oil: Issues and Trends,

Best Practices in Governance, EGAT/EG Fiscal Reform and Economic Governance Project USAIDhttp://www.fiscalreform.net/images/Files/bestpractices/taxing_oil--issues_and_trends_%28march%202009%29_for_web.pdf

xNirupama S. Rao (2009) Taxation and the Extraction of Exhaustible Resources: Evidence FromCalifornia Oil Production, MIT 2009http://economics.mit.edu/grad/nirupama/job

xi Douglas Koplow and Aaron Martin Fueling Global Warning: Federal Subsidies to Oil in the United

States Industrial Economics for, Green Peace

http://archive.greenpeace.org/climate/oil/fdsub.html

xiiWall Street Journal (2012) Oil Demand Growth Vulnerable to Subsidy Cuts,

http://blogs.wsj.com/source/2011/02/10/oil-demand-growth-vulnerable-to-subsidy-cuts/

xiiiIEA 2008, Global fossil fuel subsidies and the impacts of their removalOffice of the Chief

Economist, International Energy Agency

xivEIAImpacts of Rising Construction and Equipment Costs on Energy Industries

http://www.eia.gov/oiaf/aeo/otheranalysis/figure_12.html
http://www.x-rates.com/d/EUR/USD/hist2010.htmlhttp://www.x-rates.com/d/EUR/USD/hist2010.htmlhttp://www.x-rates.com/d/EUR/USD/hist2010.htmlhttp://www.x-rates.com/d/EUR/USD/hist2010.htmlhttp://economics.mit.edu/grad/nirupama/jobhttp://economics.mit.edu/grad/nirupama/jobhttp://economics.mit.edu/grad/nirupama/jobhttp://www.x-rates.com/d/EUR/USD/hist2010.htmlhttp://www.x-rates.com/d/EUR/USD/hist2010.html


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xvEIA 2010: Oil and Gas Lease Equipment and Operating Costs 1994 Through 2009, Energy

Information Administration,

http://www.eia.gov/pub/oil_gas/natural_gas/data_publications/cost_indices_equipment_production/current

/coststudy.html

xvi OPEC (2012)Annual Report 2010, Organization of the Petroleum Exporting Countries,

http://www.opec.org/opec_web/en/publications/337.htm,

http://www.opec.org/opec_web/static_files_project/media/downloads/publications/Annual_Report_2010.pdf

xviiMcConnellBrue (2001) : Economics - Principles, Problems and Policies, 15th Edition, Chapter 2

The Economizing Problem, The McGrawHill, Companies, 2001

xviiiDouglas Sutherland, Anne-Marie Brook, Robert Price, , Niels Westerlund and Christophe Andr(2004) Oil Price Developments: Drivers, Economic Consequences And Policy Responses,OECD

Economic Outlook No. 76, OECD Economics Department Working Papers 412, OECD Publishing,http://www.oecd.org/dataoecd/19/6/34080955.pdf

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