OPEC’s Production Cut + Oil Price Decline = Kp Laughter

Lynne Kiesling

Seriously, I laughed on Friday when I read the headlines and articles about how OPEC cut its production targets, and yet world oil prices fell.

Why did I laugh? Largely because it’s a combination of factors that illustrates that market outcomes are consequences of the interplay of supply and demand. So much of the time we hear wailing and tooth-gnashing about OPEC, OPEC’s market power, how OPEC controls world oil markets … all from a supply-oriented focus (and one that ignores the relatively substantial oil supplies from non-OPEC countries).

This combination of falling demand expectations and OPEC’s attempts to exert some form of control over market outcomes illustrates the weaknesses in that argument, and in OPEC’s purported power. That’s what makes the economist laugh when they reduce output and price falls :-).

Plus, as Jim Surowiecki reminded us on Friday, “On top of that, traders know that the fact that OPEC is saying it’s going to cut production is no guarantee that its members actually will cut production. OPEC, like any cartel, has perennial problems with cheating.” One of my favorite classroom activities is to enable my students to create an unstable cartel, and to explore what they have to do and the extents to which they have to go to make the cartel persist. This period of low growth is going to show just how unstable a cartel they are.

Oh, and I agree with those who wish that Surowiecki’s “The Balance Sheet” blog had a robust RSS feed. When will the New Yorker buy a clue?

3 thoughts on “OPEC’s Production Cut + Oil Price Decline = Kp Laughter

  1. I don’t study these things for a living, so I may be off here, but if OPEC were at all serious, wouldn’t it require members to provide a daily automated electronic report of output from every single well?

    Aren’t they all running industry-standardized well-management software packages already?

  2. This is a really interesting occurrence, on both the producer and consumer sides of the market, due to the fact, as Dr. Kiesling states, that we hear so much about OPEC’s power in the market. So, OPEC saw the declining price of a barrel of oil (and a possible decrease in revenue), and chose to decrease overall supply in a bid to increase equilibrium price, following the law of supply and demand. However, the price still continued to decrease.

    Why? This, in my opinion, is all due to the determinants of demand in terms of buyer expectations. The public felt confident that the availability of oil in the future would stay relatively high, due to the facts mentioned above. As Mr. Surowiecki stated, OPEC countries historically cheat when they decide to cut back, giving off more oil than the cartel intended, and as Dr. Kiesling said, there are many other non-OPEC nations, Russia for example, that are able to supply a good amount of the needed oil.

    Because of this lack of a real decrease in future availability, consumers had faith that the price of a barrel of oil in the future would remain low. So, they continued to lower their demand for oil in the tougher economy. This lowering of demand while the supply curve remained in relatively the same position let the equilibrium price for a barrel to continue downward.

  3. Too many business leaders are guessing at future prices instead of figuring out how to make money regardless of price. As we’ve seen, prices can fluctuate wildly. Yet, how many businesses are doing scenario planning to develop winning strategies at everything from $30 to $300 per barrel? Too little scenario planning has gotten a lot of companies into deep trouble this last year. Read more at http://www.ThePhoenixPrinciple.com

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