OPEC's failure to discipline itself clearly suggests that that organization refuses to acknowledge that Adam Smith is alive and well. Thus, the pain of Economics 101 is making itself felt through lower crude prices and a competitive fight for market share. The current fight by OPEC for increased market share is a direct result of its two quantum jumps in energy prices during the decade of the 1970s. The ten to twenty fold increase in oil prices set in motion irreversible forces that have changed the structural demand for energy which reduced by about 50% the historic growth relationship of energy to economic activity. in addition, the quantum jump in energy prices has encouraged the incremental supply of non-OPEC oil and non-petroleum energy at an annual rate of 1.0-2.0 million BD per year.
Since the beginning of 1986, OPEC in general, and Saudi Arabia and the Gulf States in particular, have made a decision to flood the market with oil and thereby reduce prices (rather than prorate production and increase prices) in an attempt to regain their historic market share of 54%, up from the current 31%. The degree to which they are successful at this game will depend almost entirely on the following factors:
the rapidity with which existing non-OPEC oil production declines;
the degree to which non-OPEC oil reserves are replaced; and
the degree to which the structural changes in demand will be re-altered at current prices of some 50% less than those experienced in late 1985.
This paper will discuss these issues by focusing on the forces of supply, demand and pricing and how they are changing the characteristics of the industry.
In April, 1986, the paper -OPEC AND ADAM SMITH" was delivered at the SPE's Symposium on Energy, Finance and Taxation Policies held in Washington, D.C. When that paper was written, the price of oil was $28 per barrel but under increasing downward pressure due to continuing declines in energy consumed per real GNP and continuing incremental supplies of non-OPEC oil. Briefly, that paper reached the following conclusions regarding the quantum jump in oil prices that occurred during 1973 and 1979, when real energy prices increased by 30% and 35%, respectively.
Demand - The energy intensity of the free world continues to decline (26% since 1973), resulting in oil's share of Free World energy market declining from about 55% to about 46%. By 1990, oil's share of market is expected to have continued to erode to 45% for the Free World and 36% for the total world.
Supply - The elevenfold increase in prices during the 1970's activated an accelerated exploration and production program whereby non-OPEC oil supplies increased by about 47%, to 25 million BD between 1973 and 1985. This increase, along with a 50% increase in production of the Centrally Planned Economies, totaled about 13 million BD, equal to the 52% decline in the demand for OPEC oil.
— Price - oil, like any other commodity, is price elastic.