Analysis on OPECs decision not to reduce oil production

Concepts used: Supply and Demand, PED and Market Share.

Recently, oil demand growth slowed down as alternative energy sources get more
popular and oil demand growth slowed in China. As demand for oil increased, consumers
are more willing and able to purchase crude oil at each price, ceteris paribus. Thus, the
demand curve for oil shifts rightwards from DD0 to DD1.
Production of shale oil in the US, a substitute for conventionally drilled oil, increased
from 500,000 barrels/day in 2010 to 2,750,000 barrels/day in 2014. The unit price of oil
decreases as supply increases, hence consumers are more willing and able to purchase oil at
each price, ceteris paribus.
Additionally, supply of oil has increased due to oil drilling technological
advancements, increasing oil production efficiency, lowering the cost of production of
conventional crude oil. As a result, conventional crude oil producers are more willing and
able to produce a greater quantity of oil at each price, ceteris paribus, shifting the supply
curve for oil rightwards from SS1 to SS2.
The combined shifts of both supply and demand curves reinforce each other in their
effect on quantity as shown by the increase in equilibrium quantity from Q0 to Q1. The
increase in demand is significantly less than the increase in supply, thus the oil price has
fallen significantly from P0 to P1.

Due to low oil prices, OPEC discussed if they should cut down on the oil production,
which shifts the supply curve leftwards from SS0 to SS1, forming new equilibrium price and
quantity with DD at P1 and Q1 respectively.

Price elasticity of demand (PED) for oil measures the degree of responsiveness of
quantity demanded of oil to a change in its own price, ceteris paribus. As oil is consumed in
many industries and for transport, the demand for oil is price inelastic due to high necessity.
Total revenue is a product of unit price and quantity sold, OPEC countries enjoy increased
total revenue of (A B) as the demand for oil is price inelastic. This means that as price of oil
changes, quantity demanded changes less than proportionately. Thus, the decrease in
equilibrium quantity demanded brought on by the leftward shift of the supply curve has less
effect on total revenue than the increase in price.

Thesis:
OPEC decided not to reduce oil production as it would cut OPECs market share of oil.
Market share is the percentage of a markets total sales earned by a particular company
over a specified time period. If OPEC reduces oil production, reduces oil supply and
increases equilibrium price, most benefits will go to oil producing non-OPEC countries such
as Iran and Russia, OPECs main rivals. As such countries can now sell the same quantity of
oil at a higher price, their total revenue and market share significantly increases. Meanwhile,
OPEC countries sell only a limited quantity of oil at a higher price, enjoying a less significant
increase in total revenue, losing market share.
Additionally, by maintaining low oil prices, OPEC remains competitive against US
shale oil companies, their largest rivals in the oil market. Keeping oil prices low forces shale
oil to become less profitable, hence slowing the production growth of shale oil companies,
allowing OPEC to gain their market share.
Therefore, OPEC should not decrease its oil production.

Anti-Thesis:
However, OPEC should decrease oil production as many members depend on high oil
prices to balance their budgets. Many OPEC countries have to sell above market equilibrium
price in order to avoid budget deficits.

Therefore, OPECs decision to not reduce production of oil is not justified as doing so
harms them economically.
Evaluation:
Even though the choice to not reduce production of oil will impact the economies of
the OPEC countries, this is only short-term and its disadvantages are outweighed by the
benefits of reducing competition from US shale companies in the long run. Hence, we agree
with OPECs decision.