What determines the oil price? Part III

By | October 20, 2021

With state control over most of the world’s capacity for oil exports, the countries in OPEC were given increased opportunities to regulate production volume (volumes) and price in the market. After the war between Israel and Arab countries in 1973, the OPEC countries, under the leadership of Saudi Arabia and the country’s oil minister Sheikh Yamani, managed to push the price up from around $ 3 per barrel to around $ 12 . The price increase took place without the production volume being significantly reduced. This quadrupling of the price is often called the first oil shock , or OPEC I , and led to trade deficits and unemployment throughout the Western world. The price remained nominal at 13 dollars per barrel until 1979, which is equivalent to 50-60 dollars today.

When Ayatollah Khomeini took over Iran in 1979, he reduced oil production in the country from just over 5 million barrels per day to around 3.2. One motive was to lead Iran to a materially simpler and more religious society. When Iraqi President Saddam Hussein went to war against Iran the following year (1980), production in both countries fell by a further 4 million barrels per day due to. acts of war. According to ITYPETRAVEL, the Iran Revolution and the Iran-Iraq War (1980–1988) brought oil prices as high as $ 40 a barrel. This doubling of the price at the top of the first oil shock is often called the second oil shock , or OPEC II. The oil price had thus risen to something equivalent to over 100 dollars per barrel today.

With this high price, however, the demand for oil began to fall. In order to maintain it, OPEC production quotas were distributed among themselves (cartelisation). OPEC’s total production was then nearly halved from 31.5 million barrels per day (mf / d) in 1979 to 17 in 1985. The quota schemes led to conflicts between OPEC countries over how the burdens of lower oil recovery should be distributed.

At the same time, the high price encouraged energy saving, energy efficiency, development of new energy carriers and increased oil production outside OPEC . Norwegian oil production increased sharply during this period, while Saudi Arabia’s production fell from 10 mf / d to 3 mf / d. Eventually, the price collapsed in the winter of 1985-86 and fell to $ 15 a barrel after Saudi Arabia began marketing its oil sales (as opposed to politically determined) to increase production. The third oil shock was thus a sharp fall in prices, and has often been called OPEC III.

In the period 1986–2002, the price was nominally 15–25 dollars per barrel (equivalent to 30–40 dollars today). Low prices led to increased demand for oil and reduced development of alternative energy carriers and energy efficiency and savings. In the early 2000s, China and other emerging economies entered the world economy and further increased the demand for energy. In the period 2003–2008, the oil price rose to over $ 100 per barrel. The financial crisis in 2008 led to a relatively short-term decline in the price, which remained above 100 dollars until it began to fall again in 2014. Today, the price is around 50 dollars, in real value approximately at the level from the time between the two price shocks in 1970 -the number. It was not until 2016 that Iran returned to the market, after the sanctions against the country were lifted.

Today, OPEC’s market power has weakened – partly because oil in more and more sectors can now be replaced by other energy carriers. In particular, electricity produced by oil has been greatly reduced in the last couple of decades and replaced with gas and renewable energy sources. In addition, coal-based electricity production has increased. Oil consumption today concentrates on the transport sector (car, boat, aircraft) where commercial substitutes are still few.

The weakening of OPEC is also partly due to the fact that more manufacturers have entered the market. Particularly important is shale production in the United States. The USA is now self-sufficient in gas and will be able to become a net exporter of oil over a slightly longer period of time. OPEC countries thus have an interest in the oil price not being too high; it can increase the supply of shale oil – a competitor to OPEC oil. Slate production helps to set a limit to OPEC’s market power and ability to increase prices over time. Weakening of OPEC’s market power weakens especially the Middle East countries’ place in energy geopolitics. This means that supply and demand conditions – ie market conditions – now play a stronger direct role in pricing than before.

While it used to be the case that the oil price fairly directly affected other energy prices as well, today all energy prices (gas, electricity, coal, renewable, nuclear power) affect each other to a greater extent. However, oil prices are still the most important of these energy prices, and the Middle East is the most important single area for oil production in the world. Great political unrest or acts of war affecting the oil supply from there can still cause large price fluctuations.

What determines the oil price 3