OPEC OIL IN 2010: ECONOMIC EVENTS, TRENDS IN DEMAND AND SUPPLY AND IMPACT ON PRICES

Etuwat James J.O., American University of Leadership, 2012

1.0 INTRODUCTION This submission is on an organization known by its acronym OPEC but its full name is Organization of the Petroleum Exporting Countries. The write up seeks to identify economic events related to 2010 that have influenced the trends of the supply and demand of OPEC oil and the impact of these events on oil prices. My focus will be on the period of 2010 and to an extent prior to that year. According to their website (OPEC 2012) , the Organization of the Petroleum Exporting Countries (OPEC) is a permanent, intergovernmental Organization and was created in the Iraq capital of Baghdad after endorsement of accord in 1960 by the founding members, Kuwait, Iraq, Saudi Arabia, Islamic Republic of Iran and Venezuela. Others came in later in alphabetical order: Algeria (1969), Angola (2007), Ecuador (1973), Gabon (1975), Indonesia (1962), Libya (1962), Nigeria (1971), Qatar (1961), United Arab Emirates (1967). However, Ecuador deferred its membership in the period December 1992 to October 2007, Gabon ceased its attachment in 1995. Indonesia shelved its commitment from January 2009. At the moment, OPEC has Member Nations. OPEC had its head office in Geneva, Switzerland, for five years since its creation but transferred Vienna, Austria in 1965. The governing charter of OPEC differentiates between the Founder Members and Full Members. The Statute specifies that any country having a significant net export of crude petroleum, which has underlying comparable concerns to those of Member Countries, may turn out to be a Full Member of the Organization, on condition of approval by 75% of Full Members, together with the assenting votes of all Founder Members. Still, Associate Members are provided for such that those countries that do not meet the criteria for full membership, but are accepted under such particular conditions as may be stipulated by the Conference. The aims of OPEC include organizing and harmonizing oil policies among Member Countries, in order to obtain fair and unwavering prices for petroleum producers; prudent, viable and constant delivery of petroleum to utilizing nations; and a reasonable profit to investors (OPEC 2012). The Council on Foreign Relationship (CFR 2012) of the David Rockefeller Studies Program has it that oil producers working exterior to the Organization of Petroleum Exporting Countries (OPEC), termed nonOPEC countries in the past deliver to a level more than 60% of petroleum output. However, these nonOPEC producers are said to have aged wells which have a reduced number of resourceful oil wells,
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increasing expenditure for new projects, and sometimes mounting demand at home that could reduce exports. According to the U.S. Energy Department's Energy Information Agency (EIA), by 2006, the major non-OPEC countries were Russia, the United States, China, Mexico, Canada, Norway, and Brazil (CFR 2012). The 2010 world supply of oil came from the outputs of OPEC and non-OPEC countries as per figure below:

2.0 ECONOMIC EVENTS Innovating for Energy energesis nouvelles (IFP 2009) , presents in a technical report, Panorama 2009: Oil Supply and Demand, IFP, presents conceptual framework of the factors determining the oil price as illustrated the figure below:
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Source: IFP

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IFP identifies economic factors that determine the price of oil as: economic growth, the exchange rate of the US dollar, taxes and subsidies and cost of services and equipment. Economic Growth:
Economic growth is the main factor that drives prices and influences the progress of demand (IFP 2009).

As nations grow and industrialize their oil use increases along their economy (Trading Today 2012)iv. Due to wide based crisis actions to stimulate growth, by particularly US and Japan, the global economy grew by 4.7% more than double the forecsast rate of 0.8% (OPEC 2010). OECD countries made a trong turnaraound from negative growth of 3.5% to positive grwoth of 2.8%. The OOECDs GDP peaked in 2010. The trends in GDP for OECD countries are presented herebelow:

Source: OECD 2012v: OECD Global Outlook 90 Page 3 of 16

Emerging markets economies have recovered above precrisis levels. Among emerging economies, BRICS (Brazil, Russia, India, China & South Africa) led the growth. Small economies rich in hydrocarbons and mineral resources also showed growth. The US Dollar Exchange Rates:
The relationship between oil supply, demand and prices has been treated by Anas Alhajji (2012) . He appears to have a comprehensible explanation. He asserts that whereas oil-exporters get income dollars (or the euro parallel), they utilize various currencies to import goods and services. Any alteration in the exchange rate of the dollar impacts the buying power and thus their real revenue. He continues to state that in the brief-term, dollar decline does not impact supply and demand, but it has effect on speculation and venture in oil futures markets. As the dollar depreciates, commodities draw investors. Venturing in futures turns into both a hedge against a weakening dollar and a venture process that could harvest a lot of profit, especially in an environment of decreasing excess oil production capacity, rising demand, lowering interest rates, a falling real estate market, and chaos in the banking industry. He further says that in the extensive run, however, a frail dollar affects supply by depressing production, regardless of whether oil is owned and produced by national or international oil companies. A feeble dollar, besides, affects demand by raising consumption. The effect of a reduction in supply and a rise in demand is higher prices. 2010 /$ Exchange Rates
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Source: X-Rates http://www.x-rates.com/d/EUR/USD/hist2010.html

TM

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Taxes and Subsidies Taxation was generally termed by Pedro van Meurs (2009) , as including all types of government revenues derived from oil and gas production. Steve Rozner, (2009) , documented the modes of revenue derivation globally as including: royalties, income tax, resource rent taxes, production sharing, state participation and stability provisions.
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Fiscal regimes in oil-rich countries

Source: EGAT/EG Fiscal Reform and Economic Governance Project, http://www.fiscalreform.net/images/Files/bestpractices/taxing%20oil_presentation_090323.pdf

What is the impact of these revenue extractions from oil companies? In a California based research, Nirupama S. Rao (2009) suggests that a 10 percent excise tax leads to a 2.4 percent reduction in domestic oil production. It appears taxes have thus had a depressing effect on oil supply.
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On subsidies, Douglas Koplow and Aaron Martin of Industrial Economics, reporting for Green Peace, assert that subsidies can depress oil prices, hindering market signals to governments, oil users and oil suppliers to begin moving to alternatives. The Wall Street Journal
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has added its voice on the issue of

subsidies. Quoting from International Energy Agency (IEA), the journal states that economic growth isnt

the only thing driving higher oil consumptionlarge fuel subsidies in many of these countries also play a big part. The WST goes further to state that IEA reduced the 2011 oil demand projection for Iran by 140,000 barrels a day, approximately 8%, due to cut in the subsidy. Thus subsidies increase demand and use of oil. Page 5 of 16

Global subsidized consumption of fossil fuels amounted to US$ 557 billion in 2008. Of the countries xiii surveyed this represents 2.1% of GDP (PPP) on average (IEA 2008)

Cost of Services and Equipment According to the US Energy Information Agency (EIA) , the exploration and production expenditure of drilling onshore natural gas advancement well to a depth of 7,500 to 9,999 feet approximately doubled from 2003 to 2004 and was estimated to increase further. Petroleum Refinery construction costs also increased 17 percent from 2002 to 2005. Besides, EIA in 2010 reported that oil and gas well equipment and operating costs, as well as coal bed methane costs, ceased their upward trend from the 1990s and tumbled sharply in 2009. Oil lease equipment costs rose 17 percent in 2008 and fell 11 percent in 2009. Oil production equipment costs were impacted by steel prices which increased the cost for tubulars by 30-40 percent in 2008 and then tumbled in 2009 as seen here below.
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Indices for Oil Equipment and Annual Operating Costs and Oil Prices in Real 1976 Dollars

Source: Energy Information Administration, Office of Oil and Gas

3.0 TRENDS IN DEMAND AND SUPPLY In 2010, there was a slight increase in OPEC oil supply from 29,122,000 to 29,336,000 barrels per day representing 0.73% increase in supply from OPEC alone. On the other hand, non-OPEC supply increased more significantly than OPEC supply i.e. from 56,800,000 to 57,900,000 barrels per day representing 1.93% increase in supply from non-OPEC countries. This percentage increase is more than twice the percentage increase from OPEC countries. The figure below indicates the trends in global oil supply during 2010 (OPEC 2012) . Whereas OPEC oil supply seems constant, non-OPEC supply is apparently increasing as seen in the chart below:
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The demand for oil from OPEC increased during Q1 of 2010, peaked at the end of Q1 and began a sustained drop to the end of the quarter as shown in the figure below:

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From the figure below, it is apparent that there has been an 11% increase in OPEC oil prices from 75.4 $/b to 83.75 $/b against a backdrop of constant ammounts available from OPEC.

4.0 DISCUSSION: Why the trends in oil demand and supply and the impact on prices

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The oil supply from OPEC has basically remained constant, yet the demand for OPEC oil is increasing and the global oil prices are increasing. Economizing Problem The world is faced with an Economizing Problem on oil. The global society has unlimited wants but with limited resources. Oil is one of the scarce resources associated with global wants and needs. It can be used for luxury like in the case of cruises or can be utilized for necessity as in the case of cooking. The oil industry is associated with all forms of factors of production: Property (land and capital) and Human Resources (labor and entrepreneur). The entrepreneur takes initiative, makes policy decisions, is expected to be innovative and bear risks. In the oil industry, income is earned in the form of rent, interest, wages and profit in various forms. For best results, the oil industry is supposed to fully employ its resources and be in full production with productive and allocatve efficiencies. These aspects are supposed to be based on the concepts of opportunity cost and comparative advantage for the production possibilities alongside economic growth.

Opportunity Cost and Production Efficiency

Employment
Source: McGrawHill/Irwin 2002

Allocative Efficiency

These play out in the economic field of which there are two systems: the market system and command system. These systems provide guidance for the flow of the oil amongst the resource markets,
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households, businesses and product markets. In each area and step choices have to be made (McConnellBrue 2001) . As mentioned earlier, when states develop and increase manufacturing, the

need for oil goes up along their economy (Trading Today 2012). Economic growth and the need to sustain
and accelerate it are some of the factors that increased the 2010 global demand for oil.

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On the supply side, OPEC as a corporate entrepreneur displayed aspects of capitalist economic system. They produce oil according to policy and their 2010 practice was to maintain oil supply at a constant flow. The associated impact has been increase of the oil prices. Choices were thus continuously made in 2010 by the producers and consumers. Market, Demand and Supply In the market setting, the Law of Demand declares that as Price Falls, Quantity Demanded Rises and as Price Rises, Quantity Demanded Falls and of supply says as price rises, quantity supplied rises and as price falls quantity supplied falls (McConnellBrue 2001).

Source: McGrawHill/Irwin 2002

However, this is not the case in the global market because both demand for oil and its prices are rising. The trend of oil price rise is higher than the demand increase. Normally demand is determined by tastes and preferences, number of buyers, incomes, normal (superior) & inferior goods, prices of related goods, substitutes & complements, unrelated goods and expectations. Oil seems to defy the above factors especially in the area of viable substitutes. Also, the customary determinants of supply are resource prices, technology, taxes & subsidies, prices of other goods, price expectations, and number of sellers. Again, oil was unpredictable here, in that though the price rice is high, its supply was constant. Whereas non-OPEC supply rose slightly, OPEC supply was constant. It is thus evident that there was shortage in the supply of oil in the world market. The equilibrium price may continue to shift as the world continues to experience oil rationing.

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Demand and Supply Elasticity and Government Set Prices

Source: McGrawHill/Irwin 2002

The figures above display different trends of price elasticity of demand. In relation to demand and supply in 2010, oil demand is to some degree inelastic to price and thus exhibits signs of being a necessity. With the nature of oil, it is not uncommon to observe price controls & shortages, rationing problems and contraband markets Consumer Behavior and Utility Maximization

Oil consumption by quarter and region, y-o-y growth

Non-OECD oil consumption by region and quarter, y-o-y growth Source: OPEC 2010

The top left figure above from OPEC 2010 indicates that the global growth of oil consumption is falling almost parallel to OECD consumption. It implies that general global needs and specifically OECD needs and wants for oil were almost saturated. However, for non-OECD, the marginal growth of oil consumption is rising, implying that their taste for oil is fairly increasing. Besides, a closer look at the graph on the right

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above shows that the growth of China oil consumption is increasing. It implies that Chinas marginal utility of oil was yet to be satisfied by the end of the year. Implications Douglas Sutherland et al, 2004, have documented oil price trends, the elements influencing the prices and the economic impacts in OECD Economic Outlook No. 76. I basically agree with the authors. In the publication, they assert that the oil price has grown considerably; world reliance on oil will persists, with increasing dependence on OPEC and a probable trend increase in the oil price especially if the rise is robust and oil-intensive. They further state that non-OPEC supply and demand responses constrain OPECs market clout but fickleness and unpredictability depresses investment and that hindrances have put upward burdens on prices.

The authors also point out that the connection between the oil price and core inflation has weakened and oil price surprises tend to have only a modest effect on production, that the oil intensity of manufacturing has fallen but the world economy will stay dependent on oil, of which there are sizeable reserves that are mainly in the Middle East therefore enabling OPEC the opportunity for market control though constrained, especially in the longer run. They maintain that in the baseline projection, the oil price will get to $35 in 2030. They say that this may probably become an equilibrium price and that it is dependent on OPEC action.

In their report, the authors articulate that there is particular uncertainty about non-OECD demand in that OPEC has a concern in limiting large price changes and will probably block prices from increasing too much. However, the authors say that short-term price flux, limitation of forecast can constrain investment. Douglas Sutherland et al, 2004 further add that the oil price has risen in excess of implications by demand-supply relationship and is driven by a more stalwart demand, a constrained ability to react on the supply side, low oil industry stores , transportation hindrances and regional supply deficiencies.

In addition, they voice that geopolitical anxieties have raised doubt in tandem with the probable contribution of speculation. They project that the departure from the equilibrium price could be protracted and declare that the oil price/output association has declined in that price increases may have a greater effect than decreases. (Douglas Sutherland et al, 2004)
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5.0 CONCLUSION OPEC is an institution at the epicenter of geo-oil interactions. There were trends of oil supply and demand with the associated movements of price with the underlying economic events of growth in economies, the

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transtions of the exchange rate of the US dollar, various regimes in taxes and subsidies and increasing and later falling cost of services and equipment. These elemnts provided a framework for oil as resource to behave the way it did in 2010.

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6.0 REFERENCES

OPEC (2012) Member Countries, Organization of the Petroleum Exporting Countries, , http://www.opec.org/opec_web/en/about_us/25.htm
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CFR (2012) Non-OPEC Oil Production, David Rockefeller Studies Program, http://www.cfr.org/naturalresources-management/non-opec-oil-production/p14554
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IFP 2009: Oil Supply and Demand, Panorama, Innovating for Energy energesis nouvelles, IFP http://www.google.com.na/url?sa=t&rct=j&q=oil%20supply%20and%20demand&source=web&cd=17&ved=0CKYB EBYwEA&url=http%3A%2F%2Fwww.ifpenergiesnouvelles.com%2Fcontent%2Fdownload%2F67676%2F1470144%2 Fversion%2F2%2Ffile%2FPanorama2009_04-Oil_supply_and_demand.pdf&ei=bbx-T88GeGS0QXvzM2cBw&usg=AFQjCNFrpYJayyfPlErGFUAvapbPhuLjDA&cad=rja
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Trading Today (2012) Oil Supply and Demand, http://www.tradingtoday.com/26-oil-supply-demand

OECD 2012: Economic Outlook Flash file (EO 90) http://www.oecd.org/document/18/0,3746,en_2649_37443_20347538_1_1_1_37443,00.html

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Anas Alhajji (2012): How Does the Weak Dollar Affect Oil Prices? Project Syndicate, http://www.project-syndicate.org/commentary/how-does-the-weak-dollar-affect-oil-pricesvii

X-ratesTM (2010) Monthly Exchange Rates Average, http://www.xrates.com/d/EUR/USD/hist2010.html

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Pedro van Meurs (2009):Trends in international oil and gas taxation, Gubkin Oil and Gas University Moscow
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Steve Rozner, (2009), Taxing Oil: Issues and Trends, Best Practices in Governance, EGAT/EG Fiscal Reform and Economic Governance Project USAID
http://www.fiscalreform.net/images/Files/bestpractices/taxing_oil--issues_and_trends_%28march%202009%29_for_web.pdf
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Nirupama S. Rao (2009) Taxation and the Extraction of Exhaustible Resources: Evidence From California Oil Production, MIT 2009 http://economics.mit.edu/grad/nirupama/job
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Douglas Koplow and Aaron Martin Fueling Global Warning: Federal Subsidies to Oil in the United States Industrial Economics for, Green Peace
http://archive.greenpeace.org/climate/oil/fdsub.html
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Wall Street Journal (2012) Oil Demand Growth Vulnerable to Subsidy Cuts, http://blogs.wsj.com/source/2011/02/10/oil-demand-growth-vulnerable-to-subsidy-cuts/
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IEA 2008, Global fossil fuel subsidies and the impacts of their removal Office of the Chief Economist, International Energy Agency
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EIA Impacts of Rising Construction and Equipment Costs on Energy Industries http://www.eia.gov/oiaf/aeo/otheranalysis/figure_12.html

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EIA 2010: Oil and Gas Lease Equipment and Operating Costs 1994 Through 2009, Energy Information Administration, http://www.eia.gov/pub/oil_gas/natural_gas/data_publications/cost_indices_equipment_production/current /coststudy.html
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OPEC (2012) Annual Report 2010, Organization of the Petroleum Exporting Countries, http://www.opec.org/opec_web/en/publications/337.htm,
http://www.opec.org/opec_web/static_files_project/media/downloads/publications/Annual_Report_2010.pdf
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McConnellBrue (2001) : Economics - Principles, Problems and Policies, 15th Edition, Chapter 2 The Economizing Problem, The McGrawHill, Companies, 2001
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Douglas Sutherland, Anne-Marie Brook, Robert Price, , Niels Westerlund and Christophe Andr (2004) Oil Price Developments: Drivers, Economic Consequences And Policy Responses, OECD Economic Outlook No. 76, OECD Economics Department Working Papers 412, OECD Publishing, http://www.oecd.org/dataoecd/19/6/34080955.pdf

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