SPE Member

Abstract

Unless OPEC can discipline itself to production levels that will result in the spot price of crude being equal to or greater than the contract price of crude, the demand for OPEC crude, along with the price of crude, will continue to erode for the remainder of the decade.

Because of the quantum jump in energy prices during the 1973-74 and 1979-80 periods, certain irreversible forces have been set in motion that have changed the structural demand for energy. These forces have resulted in a decline in energy demand per real GNP in the major industrialized nations of in excess of 24%, indicating price elasticities of between -0.3 and -0.5. This suggests that, regardless of the strength in the economies of the nations of the industrialized world, an "off oil" policy has been put into place through conservation, efficiencies, substitutions, put into place through conservation, efficiencies, substitutions, and new technology. Moreover, superimposed on this major structural change in demand for petroleum has been the amount of nonOPEC oil and nonpetroleum supplies coming into the market at an annual rate of 1.0-2.0 million BD per year.

The bottom line to these structural changes is pressure on OPEC to reduce production and/or prices in order to maintain its viability as an organization. Failure to exercise the discipline or proration suggests that Adam Smith's Economics 101 will continue to wind down oil prices for the remainder of the decade and possibly beyond. possibly beyond

Introduction

OPEC continues to have a big problem. The cartel either refuses to acknowledge that Adam Smith is alive and well or refuses to meet him. Simply stated, OPEC's quantum jumps in oil prices in 1973-74 and 1979-80 set in motion irreversible forces that have changed the structural demand for energy.

The two "oil shocks" which were experienced by the western industrialized world increased the real price of energy by about 30% in 1973-74 and another 35% in 1979-80. As a result, the demand for energy per real GNP declined by more than 14% between 1973 and 1980, and fell another 10% between 1980 and 1984. This suggested that an industry that heretofore considered itself insensitive to price changes was, indeed, price elastic, with elasticities of price changes was, indeed, price elastic, with elasticities of -0.50 between 1973 and 1980 and -0.30 between 1980 and 1984. That is, for every 10% change in the price of energy, the demand for energy per real GNP could expect to fall 3% to 5%. This change in demand has obviously impacted the marginal producer, namely OPEC, which saw demand for its supplies reduced producer, namely OPEC, which saw demand for its supplies reduced by 42%, to 18.3 million BD, between 1973 and 1984. In the absence of supply disruptions, it does not appear that demand for OPEC crude will increase for the foreseeable future, since the current price, even under a declining scenario, appears to be sufficiently price, even under a declining scenario, appears to be sufficiently high to attract additional supplies of nonOPEC energy.

Perhaps the ultimate impact from the alternation in structural demand for energy has been the institutional changes now taking place in the industry itself. After two decades (1950s-1960s) place in the industry itself. After two decades (1950s-1960s) of being volume-driven, and another decade (1970s) of being price-driven, the energy and energy-related industries are price-driven, the energy and energy-related industries are now undergoing a fundamental change.

P. 55

This content is only available via PDF.
You can access this article if you purchase or spend a download.