2020 OIL CRASH
reduces oil prices in the USA, but increases prices in foreign countries, and vice versa. Market speculation and currency exchange rates usually cause short-term price fluctuations, which are nevertheless significant for investors.
Supply and demand relations have their intricacies; one cannot project oil prices linearly for the long term simply based on the present ratio of supply and demand (Sorkhabi, 2008). Cheap oil prices will encourage more oil consumption which will then raise prices to some extent (what is called “price elasticity of demand”). Moreover, if oil prices are lower than the cost of oil production and distribution, oil companies will reduce their investments in exploration and production; this will, over time, create supply shortages in the market which will then elevate prices
On the other hand, expensive oil will compel people and industries to use less oil, and reduced demand will lower oil prices (again price elasticity). In the case of long-term extremely high oil prices, industries will find it profitable to develop non-oil energy resources. This will, in turn, decrease oil consumption as well as oil prices. However, high oil prices and high demand levels will also encourage oil companies to increase their investments in oil exploration, although it will take several years for the new reserves to come to the market (except for shut-in wells waiting for high prices).
The first oil shock in 1973 had long-standing impacts on the oil economy (Sorkhabi, 2015; Jacobs, 2016). Prior to the 1970s, thanks to the international oil companies controlling the Third World oil reserves, oil was cheap, plentiful, and dependable. The relationship between economic growth and inflation was thus simple: When the economy was strong, inflation would pick up; when growth was slow (characterized by rises in inter- est rates and tight money supply), inflation would fall (Leeb and Leeb, 2004). However, since 1973 oil has acted as a vari- able parameter in the world economy. Stock market analysts Stephen Leeb and Donna Leeb have called it the Oil Factor. Because oil is a primary commodity, rapid rise in oil prices causes inflation. Leeb and Leeb (2004) argued that since 1973 whenever oil prices skyrocketed for a considerable period of time stock markets plunged. This book was published a few years before the 2008 economic recession, which was largely blamed on the real estate market crash and associated bad loans made by banks (Sorkin, 2010; McLean and Nocera, 2010). It is notable that oil prices prior to the late-2008 stock market crash were on a constant rise from $20s in 2000 to as much as $140 a barrel in mid-2008.
When the stock market plunges, as happened in early 2020, it also brings down oil prices because of reduced demand. Similarly, oil price crashes adversely affect other stocks and investments sensitive to oil. Long term oil price changes reflect fundamental supply and demand factors. If supply and demand are in equilibrium, the market is stable, and price increases will largely reflect inflation over time. These are optimal conditions for both producers and consumers because market volatility and uncertainties cause disruptions. Just as producers of other commodities do not flood the market with their products but rather maintain a balance between their manufacturing and sale, the oil industry as a whole also requires market stability (Fig.1).
The Rise and Fall of OPEC
OPEC stands for the Organization of the Petroleum Exporting Countries. It was formed in 1960 (now sixty years ago) by five major oil producing countries, Iran, Iraq, Kuwait, Saudi Arabia and Venezuela, as a club to protect their oil
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Jul.Aug.Sep 2020
Figure 1- Cover page of Time magazine (dated 14 April 1986) pub- lished during the major oil market crash of 1986.
resources and interests against the major international oil companies (dubbed as the “Seven Sisters”) that controlled the bulk of production and sale of world oil from the Third World countries (Sorkhabi, 2010). Currently OPEC includes 13 members: Algeria, Angola, Congo-Brazzaville, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, UAE, and Venezuela.
In 2018, OPEC members possessed 1,242 billion barrels (71.8% of world’s proven oil reserves) and produced 39 million barrels of oil a day (41.5% of oil production) (BP, 2019). OPEC rose to its peak power during the first (1973) and second (1980) oil shocks; however, since the 1986 oil market crash, OPEC’s power has declined as oil production from non-OPEC produc- ing countries and companies has grown, and also because of conflicts among OPEC members.
While in the West, the public perception is that OPEC is an oil cartel trying to control oil prices and sale, OPEC views itself as a force for market stabilization and smooth flow of oil. Some experts consider OPEC as a failed cartel. In any case, in recent years, OPEC has invited collaboration from other large oil producers in order to stabilize oil markets. In 2016, OPEC Plus formed with participation of Russia, Azerbaijan, Bahrain, Brunei, Kazakhstan, Malaysia, Mexico, Oman, Sudan and South Sudan as observers. Since then, OPEC’s policies have been in effect set by Saudi Arabia and Russia, two of the world’s top oil producers. In late 2016, these two countries agreed to regulate oil production to keep oil prices at a reasonable level for the producers.
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