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Petroleum Price Elasticity, Income Effects, and OPEC's Pricing Policy

F. Gerard Adams and Jaime Marquez

Year: 1984
Volume: Volume 5
Number: Number 1
DOI: 10.5547/ISSN0195-6574-EJ-Vol5-No1-7
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Abstract:
A standard result from static economic theory is that a monopolist with zero cost will maximize profits by charging the price at which the demand has unit elasticity. Yet, the demand for petroleum, as seen by consumers, is price inelastic, and empirical estimates of the price elasticity for petroleum are typically less than one. Given the relatively low production cost for Middle East oil and the optimization rule referred to above, a natural question is whether OPEC, acting as a monopoly, has exhausted its potential for forcing price increases or whether it will ultimately be able to charge still higher prices as it tries to optimize its earnings. This possibility of higher oil prices is important for OPEC and for oil-consuming countries-for OPEC because the finite nature of resources implies that excess production today represents an irrecoverable loss; for consuming countries because of the high cost of oil and the adverse consequences of still higher oil prices on inflation and unemployment.

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Price Elasticity of Demand for Oil and the Terms of Trade of the OPEC Countries

M. M. Metwally and A. T. Arab

Year: 1987
Volume: Volume 8
Number: Number 1
DOI: 10.5547/ISSN0195-6574-EJ-Vol8-No1-4
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Abstract:
The price elasticity of demand for oil has changed significantly since the sharp rise in oil prices in late 1973. Although oil is still a necessary commodity with a price elasticity of less than one, the policies recently introduced by many importing countries to store oil and reduce its consumption, the continuous development of energy alternatives, and the increase in oil suppliers have contributed significantly to the rise in the price elasticity of demand for this vital commodity.

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OPEC Behaviour Under Falling Prices: Implications For Cartel Stability

Clifton T. Jones

Year: 1990
Volume: Volume 11
Number: Number 3
DOI: 10.5547/ISSN0195-6574-EJ-Vol11-No3-6
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Abstract:
The surprising extended decline in real oil prices during the 1980s has raised the question of OPEC's continued viability as a price-setting cartel. In response, Griffin's (1985) tests of alternative hypotheses about OPEC behaviour performed over a period of generally rising prices (1971:1-1983:III) are repeated for the more recent period of falling prices (1983:IV-198R�1V), yielding the same general conclusions: most OPEC members continue to behave in a 'partial market sharing" way, while most non-OPEC oil producers do not. Thus the evidence suggests that recent oil price reductions are more the result of deliberate output adjustments by the cartel than the unintentional outcome of a breakdown in cartel discipline on the way to eventual collapse.

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Future World Oil Prices and Production Levels: A Comment

Franz Wirl

Year: 1990
Volume: Volume 11
Number: Number 3
DOI: 10.5547/ISSN0195-6574-EJ-Vol11-No3-7
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Abstract:
In a recent paper published in this journal, Marsballa and Nesbitt (1986) present an economist's point of view of OPEC pricing. In particular, they compute profit maximizing price strategies using a dynamic representation of the world oil market. The purpose of this paper is not to dispute the calculated numbers but to question the qualitative validity of the calculated optimal paths. The claim of this note is that it is very unlikely to generate smooth paths -- e.g. the price strategies shown in their paper -- the presented framework.

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Is the World Oil Market "One Great Pool"?

Robert J. Weiner

Year: 1991
Volume: Volume 12
Number: Number 3
DOI: 10.5547/ISSN0195-6574-EJ-Vol12-No3-7
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Abstract:
Is there one, global market for crude oil? This appears to be the assumption made by most petroleum economists, stated succinctly by Adelman in a recent issue of The Energy Journak "The world oil market, like the world ocean, is one great pool" (July 1984, p. 5). Policymakers have often implicitly held the opposite assumption - that the world market is fragmented - as evidenced by the efforts of many importing-country governments to seek special arrangements for "secure supply" from exporters in the 1970s and early 1980s. Likewise, oil exporters have sought "secure outlets" for their crude in the late 1980s and early 1990s. These arrangements make no sense if the world crude oil market is integrated. In a similar fashion, a policy of diversifying suppliers, which is practised by many importers now, is senseless in a globally unified market.

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Testing Alternative Hypotheses of Oil Producer Behavior

Carol Dahl and Mine Yucel

Year: 1991
Volume: Volume 12
Number: Number 4
DOI: 10.5547/ISSN0195-6574-EJ-Vol12-No4-8
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Abstract:
Conventional wisdom holds that OPEC is a weakly functioning cartel with non-OPEC producers forming a "competitive fringe." However, several studies have challenged the cartel hypothesis for OPEC with a few even challenging the competitive hypothesis for non-OPEC producers. In this paper, we test competing hypotheses (which include dynamic optimization, target-revenue, competition, cartel, and swing production) for production decisions for both OPEC and non-OPEC producers. Recently developed cost data allow these tests to be done on the most general model to date. In our tests, we find no evidence for dynamic optimization. Formal target-revenue models are rejected, but there is some evidence that revenue targeting may influence production for some OPEC countries and a few non-OPEC countries. We find no evidence that any of the OPEC countries behave in a competitive manner. More surprisingly, we find no evidence that the fringe is competitive. Using co-integration tests, we are unable to find formal evidence of coordination in the form of strict cartel behavior or swing production among OPEC countries. Taken as a whole, the evidence suggests that loose coordination or duopoly is most consistent with OPEC behavior.

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Oil Production Outside OPEC and the Former Soviet Union: A Model Applied ot the U.S. and U.K.

John V. Mitchell

Year: 1994
Volume: Volume 15
Number: Special Issue
DOI: 10.5547/ISSN0195-6574-EJ-Vol15-NoSI-9
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Abstract:
Oil production in the area outside OPEC and the Former Soviet Union (FSU) has grown steadily for the past 30 years. This growth is expected to continue, despite the decline in oil prices since 1985. The steady growth in production contrasts with dramatic swings in oil prices. Non-price factors such as policies, enterprise behavior, and technical phenomena are important. This article sketches a model for tracing their interaction over time. The model is tested against the very different histories of oil production in the U. S. and U. K. The main conclusion is that non-price factors are important and differ between countries: in the U.S., environmental policy, and in the U.K., tax policy have been critical in determining oil production. The model may be extended to countries dominated by state oil enterprises, which account for most of the remaining production in this area, but this would require country-by-country analysis.

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Oil Industry Structure and Evolving Markets

Joe Roeber

Year: 1994
Volume: Volume 15
Number: Special Issue
DOI: 10.5547/ISSN0195-6574-EJ-Vol15-NoSI-14
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Abstract:
Of all the changes in the oil industry over the past 20 years, the most radical have taken place in the market, and in the formation of prices. These are both a response to and a cause of changes in industry structure. From plannable supplies at relatively stable prices, companies have had to learn to handle short term supplies in condition of extreme volatility. Management of the resulting price risk has become a central role of the companies' supply departments, and the use of paper markets (forward, futures and derivatives) has become an integral part of price formation. It is not impossible that the changes would be reversed, if the conditions that brought them into being-surplus production and de-integrated supply structures-were reversed in conditions of scarcity, but it is highly unlikely. Far more likely, is that risk management and the use of paper markets will increase in importance.

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Oil Price Forecasting in the 1980s: What Went Wrong?

Hillard G. Huntington

Year: 1994
Volume: Volume15
Number: Number 2
DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No2-1
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Abstract:
This paper reviews forecasts of oil prices over the 1980s that were made in 1980. It identifies the sources of errors due to such factors as exogenous GNP assumptions, resource supply conditions outside the cartel, and demand adjustments to price changes. Through 1986, the first two factors account for most of the difference between projected and actual prices. After 1986, misspecification of the demand adjustments becomes a particularly troublesome problem.

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Strategies for OPEC's Pricing and Output Decisions

Dermot Gately

Year: 1995
Volume: Volume16
Number: Number 3
DOI: 10.5547/ISSN0195-6574-EJ-Vol16-No3-1
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Abstract:
This paper examines OPEC pricing and output strategies, both to provide an understanding of OPECs unwise price doubling in 1979-80 and also to analyze what strategy might serve it best for the future. We focus on the unavoidable uncertainty regarding the underlying parameters that characterize the world oil market (price elasticities, income growth rates), and the sensitivity of discounted OPEC revenue to changes in these parameters, for various pricing strategies. In 1979-80, OPEC chose a high-price strategy, which could have yielded good results (like many other price-paths) if the market's underlying parameters had been more favorable. But the price elasticities of demand and non-OPEC supply were much higher than anticipated, so that OPEC did very poorly-not only in absolute terms, but also relative to what it could have achieved if it had set its price more cautiously. We search for a robustly optimal strategy for OPEC in the future, which will serve it well relative to other strategies, regardless of the true parameter values underlying the market (within some plausible range). We conclude that OPEC's interests will be served best by a policy of moderate output growth, at a rate no faster than that of world income growth. This will require that OPEC slow its rate of output growth since 1985, cutting it at least in half. Slowing its output growth will allow OPEC gradually to regain the market share lost after its disastrous 1979-80 price doubling, but without jeopardizing its revenue, as might a policy of more rapid increases in output. This will yield a consistently good result for OPEC, relative to alternative strategies, over a fairly wide range of demand and supply conditions.

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