Unit 3: Why are oil prices falling?: on increases in supply and price warring oligopolies.. The Organization of Petroleum Exporting Countries (OPEC) is a group of oligopolistics firm colluding overtly to fix the price of a barrel of oil. An oligopoly is a firm within a market where there are only a few other major competitors, for example, where a market has a five-firm concentration ratio of 75%. Currently there are 12 members of OPEC and according to OPEC they control 81% of crude oil reserves. These large market shares result in these firms pricing and output decisions being inter-dependent, making price changes in these markets a risky business. If one of these firms reduces price, all the others, in absence of knowledge of how the other firms will respond, will be forced to follow suit or risk losing their market share - in which case, all firms would be worse off! This is why oil firms collude, agreeing to fix price to earn monopoly profits and agreeing not to undercut each other/ The problem is, sometimes these firms cheat! With discovery of new oil by US and China by firms outside of OPEC, world supply has for the moment put a downward pressure on world prices. China is finding oil supplies 14,000 miles away, aided by the global rout in prices that’s left producers vying for new markets. PetroChina Co. said it bought Colombian crude for a northern refinery for the first time because it was good value. The transaction underscores how the world’s second-biggest oil consumer is benefiting as producers from the Middle East to Latin America vie for customers in Asia. - The Economist According to the Economist the price of Brent crude fell over 25% from $115 a barrel in mid-June to under $85 in mid-October, before recovering a little. A Price War between Interdependent Firms: Falling world prices have caused OPEC firms to cheat and reduce price below the agreed cartel price. Particularly, because the risk of other OPEC members cheating and undercutting the agreed price has increased with the falling prices and they dont know how they will respond - this is the Prisoners Dilemma! Saudi oil companies have responded to non-cartel rivals by increasing production by half a percent (reducing price) causing other OPEC members to follow suit to protect their market share! Check out the Economists articles on the winners and losers of falling oil prices and their fantastic infographic on the instability of the oil market: economist/news/international/21627642-america-and-its-friends-benefit-falling-oil-prices-its-most-strident-critics?fsrc=scn/tw/te/pe/ed/winnersandlosers
Posted on: Fri, 31 Oct 2014 10:16:51 +0000
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