Abstract

The dramatic drop in crude oil prices in early 1986 left many oil producers in a state of shock. Some producers who had accumulated large debt loads were left highly vulnerable to the resultant lower cash flows.

By examining the causes of the price drop and by attempting to forecast future crude oil prices, a producer can develop a production and marketing strategy to help avoid or lessen the impact of another drop in crude oil prices.

Introduction

By the end of the first quarter of 1986 the price of west Texas Intermediate crude on the New York Mercantile Exchange had dropped below US$11.00 per barrel. This unbelievable price decrease put many producers in a very tenuous position from which some are still trying to recover. It is possible for the price to fall again. By examining the causes of the price drop and the factors influencing world crude oil prices it is possible to develop a strategy to overcome the full effect of another drop.

HISTORICAL PRICE OF CRUDE OIL

Some of you may remember when the Edmonton per price of crude was $2.90 per barrel. In fact the price was stable at $2 .90 from 1962 until December, 1970 at which time the price increased by 25 cents per barrel. The next price increase didn't take place until November 6th, 1972 when the par price increased by 10 cents per barrel. That, in itself, wasn't too unusual but just two months later the price jumped again, this time by 20 cents per barrel. Suddenly crude prices were getting the attention of everyone. Then when the price increased on May 1st, 1973 by 25 cents per barrel and again on August 1st by 40 cents to $4.11 per barrel, the Federal Government stepped in. Instead of the producer getting the next increase of 40 cents per barrel, the Federal Government put an equivalent export tax on all crude oil exports on October 1st, 1973. What was causing crude oil prices to increase?

A man by the name of Ahmad Zaki Yamani was pushing for Saudi "participation" in Aramco, the Arabian Oil Company owned by Chevron, Texaco, Esso and Mobil. Aramco considered this "participation" as nationalization of their property and refused the proposed increase in Arab taxes. So on October 16th, 1973, OPEC announced that they were unilaterally implementing a price increase. OPEC had been created 13 years previously after Esso had made a price cut of 10 cents per barrel without consulting the producing countries.

The Arab Israel conflict also began to play an important part in world crude oil prices. The United States were supporting Israel in the conflict. This didn't sit well with King Faisal of Saudi Arabia and he tried to convince President Nixon and Henry Kissinger to stop the aid to Israel or face an oil embargo.

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