Crude oil prices exert a great amount of influence on the various risks in the oil industry such as the taxation system, finance, environmental problems etc. Furthermore, the prices directly reflect the structural changes in the oil industry.
Until the mid 1980s, crude oil prices had been influenced mainly by the suppliers, since there was very little price elasticity on the demand side. The current system under which the prices are decided in the world-wide free market has only had a short history.
It is likely that the free market pricing system will remain for a while, since consuming countries will continue to try to influence oil demands by promoting alternative energy, or by introducing stricter environmental laws.
If, however, the demand for OPEC crude increases drastically, the fundamental condition of the industry may once again allow the suppliers to control crude oil prices.
Structural changes in the oil industry will lead to the fluctuation of crude oil prices, but prediction will be diffcult since changes in the industry will not necessarily occur consecutively. The analysis of price determinants will therefore continue to be a crucial managerial theme for oil companies.
The oil industry consists of four sectors, which are, the upstream (exploration, development and production), transportation, refining, and marketing sectors. Each sector has common and/or individual risks whose impacts are various. To evaluate and manage those risks is a crucial task for participants in the oil industry. Among the various risks such as capital cost, taxation system, environmental programs, development of alternative energy and oil policies, the issue of crude oil prices is the single most important risk. It not only exerts great influence on the oil industry but also reflects structural changes in the industry.
The history of the crude oil market after World War II can be divided into the following four periods :
Before the first oil crisis (- 1973)
OPEC as price setter (- 1981)
Production quota system by OPEC (- 1985)
Market related pricing system (-present) The above mentioned periods definitely match with those of the structural changes of the industry. This close relationship indicates that top management of oil companies who are responsible for coping with structural changes of the industry should be well versed in the crude oil price mechanism.
This report i, divided into five sections which separately examine the history and mechanism of crude oil pricing. The first section describes the price theory of crude oil. The second and third explore the structural changes in the oil industry by focusing on the functions of OPEC, and the 'swing producer'.
The theory discussed in the first section is deductively applied here. The introduction of the current pricing