Oil prices are one of the most widely discussed commodities in the world. In the world that we live in, with its dependence on the transportation industry, oil prices drive the prices of almost every other commodity. The more the other commodity involved shipping, the greater the degree of the effect of oil prices. Oil prices have been controlled by a cartel consisting of the OPEC nations. Izabella Kaminsky explores the implications of cartel busting and its effect on oil prices in the article “When the cartel bursts, Brent edition.”
The first point that the article makes is that almost every nation can be considered a cartel. The purpose of the cartel is stability (Kaminska, 2014). The cartel works, as long as everyone is willing to play by the rules of the cartel. The stability of the group depends on the willingness of the group members to abide by the rules. The second point that the article makes is that the most common reason for the break-up of the cartel is when the members of the cartel begin to see more reasons to break the rules than to follow them (Kaminska, 2014). One example of this occurs when the break even rate can no longer be defended due to external competition. The cartel can only control the effects of outside competition if they control a majority of the commodity. This is the case with oil prices.
The third point brought out by the article is that historically several price drops have occurred. One example was in 2008. During the drops in price, demand rose (Kaminsky, 2014). This caused stocks price sin oil companies to rise, instead of fall with the prices. The rise in demand was more than enough to offset the revenues from price decreases. The fourth point of the article is that the oil price collapse of the Great Depression was a result of a rise in supply. Oil producing nations began to product more than American consumers could use. To counteract this glut, oil producers began to store their oil in storage tanks and develop a reserve (Kaminsky, 2014). This led to the ability to stabilize prices, at least to a certain degree in a shortage situation.
The theory that drives the first point of the article, regarding the cartel, is that market structures can have an impact on pricing within the industry. Research conducted over the last decade indicates that while pricing in the oil industry has become more volatile, the overall effects on the economy have become less dramatic (Hoffman, 2012). When one examines his factor more closely, dependence on oil has increased. It was found that oil price increases were more devastating to the overall economy than oil price decreases (Hoffman, 2012). Estimates of the defects of oil price elasticity were high, with a 10% increase resulting in a 2.9$% decline in GDP in the United States (Hoffman, 2012).
The third point made by the article is that price drops increase demand. This is consistent with current economic theory. These increases in demand had an impact on the market structure, increasing incentives for new non-cartel players to enter into the market. OPEC only produces 40% of the world’s oil, but they have 70% of the reserves (Berkmen, Ouilaris, & Samiei, 2005). In 2001, OPEC decided to cut production to manipulate price (Econolink, n.d.). This was a response to falling prices. The other oil producing countries, Russia, Norway, Mexico, Oman, and Angola often follow the lead of OPEC to keep market shares even. This exploration of oil prices demonstrates how market structure has an impact on market structure and on supply and demand. Supply and demand not only have an impact on oil prices, they have an effect on the overall economy, particularly those that are dependent on transportation. Supply and demand and market structure are interdependent in the oil industry. However, supply is not always a result of natural production tends. The oil industry has been the victim of price manipulation by a small group, who controls only a limited supply of this oil.
- Berkmen, P., Ouilaris, S. & Samiei, H. (2005, September 21). The Structure of the Oil Market and Causes of High Prices. International Monetary Fund. Retrieved from https://www.imf.org/external/np/pp/eng/2005/092105o.htm
- Econolink. (n.d.). Marketplace: Oil is a Slippery Business. Retrieved from http://www.econedlink.org/lessons/projector.php?lid=259&type=educator
- Hoffman, Robert. (2012). Estimates of Oil Price elasticity. International Association for Energy Economics. Retrieved from file:///C:/Users/Ginger/Downloads/121hoff.pdf
- Kaminska, Izabella. (2014, October 14). When the cartel bursts, Brent edition. FT Alphaville. Retrieved from http://ftalphaville.ft.com/2014/10/14/2005952/when-the-cartel-bursts-brent-edition/