Volatility of the oil market and Petroleum Exporting Countries

The article talks about the volatility of the oil market and the Organisation of the Petroleum Exporting Countries (OPEC)'s attempts to counter the latest dip in oil prices. Oil prices were on a high at the beginning of the year at around $150 per barrel and now falling indiscriminately have reached $47, at the lowest level since May 2005.

The oil market is an oligopoly as the industry has quite a few firms but a large proportion of the industry's output is shared by just a small number of firms. Oil is one of the most heavily traded commodities in the world. Demand for oil is generally price inelastic due to its versatile uses. Fluctuating prices have important effects for oil producers/exporters and many countries that remain dependent on oil as a key input in their energy, manufacturing and service industries. The drastic fall in prices can be accredited to the slump in demand for oil all over the world. Except for certain regions like China, which have remained unaffected from the global recession so far, the reduced economic activity has had a direct effect on the demand, especially in the US. To add to the industry's woes the new refineries and oilfields will start production soon leading to an increase in supply and further fall in prices.

As illustrated in the , oil supply increases marginally(S to S1) but the fall in demand (D1 to D2) causes the price of oil to fall considerably (P1 to P2).

Collusive oligopolies exists when the firms in an oligopolistic market collude to charge the same prices for their products, in effect acting as a monopoly, and so divide up any monopoly profits that may arise, as illustrated below.

A collusive agreement taken to the extremes result in a cartel. Since this result in higher prices and lower outputs, this is usually deemed to be against the interest of consumers and so collusion is generally banned by governments and is against the law in majority of the countries. Formal collusion between governments may be permitted. The prime example is OPEC, which sets the production quotas and prices for the world oil markets.

The OPEC has a very efficient control over the oil market as it has a substantial share of it. The OPEC tries to maintain a stable price of oil within a specific price band and is helped by the fact that the demand for oil generally remains quite stable.

In case the oil prices go too low, it reduces supply in turn causing an increase in price, and, in case of price rise the OPEC can increase the supply so as to reduce the price. The issue of the current dip in crude oil prices is being addressed by the OPEC but due to the transportation time the reduction in supply takes time to affect the prices leading to the inelasticity of supply.

In spite of these time lags, the OPEC can stabilize oil prices by reducing the production quotas of the member countries, in turn reducing the supply of oil.

The reduction in supply would shift the supply curve to the left S1 to S2 (shown in the above), demand remaining the same, causing the price to go back to the equilibrium level. The only threat of the scheme would be the unwillingness of member nations to reduce production as oil forms the backbone of various countries, Moreover, the various incentives of cheating in a cartel is always present. In case some of the countries refuse to increase their prices and continue to produce at a large scale then they could earn abnormal profits. But that would mean that other countries would miss out on the opportunity and soon lower their prices too and the global economy would continue to suffer.

It seems that it will take at least another financial year for the oil prices to stabilize. This is not the first occasion when the oil industry is going through such a crisis. The OPEC has successfully steered the industry out of it in the past, notably in 1998 and 2001. At the current state of affairs, the fall in price is stable and the possibilities of resurrection are dim as at this stage of the global economic recession an increase in oil prices to the extent to which Saudi Arabia suggests could fuel further inflation.

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