1

Chapter 1

2

The Organization of Petroleum Exporting Countries (OPEC) is an

international Organization of eleven developing countries that influences

and maintains the price of oil through the control of production levels. The

Organization of the Petroleum Exporting Countries (OPEC) was created at

the Baghdad Conference in Iraq in September 1960. The founding members

of the organization were Iran, Iraq, Kuwait, and Saudi Arabia and

Venezuela. Current OPEC members are Algeria, Indonesia, Iran, Iraq,

Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and

Venezuela. Since oil revenues are so vital for the economic development of

these nations, they aim to bring stability and harmony to the oil market by

adjusting their oil output to help ensure a balance between supply and

demand. OPEC's eleven Members collectively supply about 40 per cent of

the world's oil output, and possess more than Three-quarters of the world's

total proven crude oil reserves. Therefore, people usually connect any oil

price change with the OPEC and there has been considerable curiosity and

concern about its behavior and role in the international oil market. The

principal aim of the OPEC is the coordination and unification of the

petroleum policies of member countries and determination of the best means

for safeguarding their interests, individually and collectively; ways and

means of ensuring the stabilization of prices in international oil markets with

a view to eliminating harmful and unnecessary fluctuations; secure a steady

income to the producing countries; an efficient, economic and regular supply

of petroleum to consuming nations, and a fair return on their capital to those

investing in the petroleum industry.

3

Importance of the study:

Petroleum is the bloodline for the world economy

in this modern world, and it has important role to every aspect of our lives.

For heating our homes and running cars, and flying planes, this helps in

transportation and fulfilling all the requirements of global village. The

growth of economy is engaged to these means of transportation. These

sources help in the exports and imports of the commodities and earn

valuable foreign exchange for the country. It is clear that petroleum and its

resulting products have helped shape the way modern society works.

However over time, existing petroleum reserves have dwindled in volume

and yield. Thus, the overall supply of petroleum and oil has often been able

to keep up with overall demand. And beside this One of the most powerful

entities that Influences the supply and effective prices of petroleum and oil is

the Organization of Petroleum Exporting Countries (OPEC).opec countries

at the end of 1999 had about 78% of proven oil reserves, but only 41% of

out (oystein noregn, crude power political and oil). The expected life time of

OPEC is close to 80 years at present output, almost double of the world

Average of 41 years. It is said that Non-OPEC countries has no long life and

they will not survive for long time and their power to influence the oil

market will finish soon so the whole authority will be in the hands of OPEC

members. And if the same dependence on oil remains the same in the future

there is no doubt that the OPEC members will rule on the world economy.

Any conscious or non conscious decision by OPEC relating to the petrol

price can effect the economic growth of a country. As rightly pointed by

international Energy Agency in 2004 that $10 rise in price of oil from $25 to

$35 the OECD countries are facing 0.4% cuts in their GDP. Moreover the

4

world needs for oil and rising prices can have significant inflationary effects

as higher cost of energy can show economic growth forcing consumers to

spend less on non-energy related goods and companies to reflect high energy

costs on their product. The importance of oil also Arises during Yom Kippur

war (october6, 1973) between Arab counties and Israel. The Arab members

of OPEC (known AOPEC) imposed embargo on America for the reason of

helping Israel. Which changed the shape of the war and war is suddenly

stopped. Because of the oil weapon. After the first price shock of 1973–

1974, OPEC was widely viewed by energy experts as a cartel with stability.

Its production of oil in 1973 was 30 629 (000) barrel per day (bpd), that

comprised 55% of the total world oil production (Harri Ramcharran, 2001).

Expectations of growing oil demand, rising prices and secured income from

oil revenues allowed OPEC members to spend and borrow freely. Elaborate

long-range structural, social and economic programs were implemented.

Objective of the study:

1) To study OPEC behavior under different historical oil crisis

2) To study impact of oil price shocks

3) And measure price relative for each oil shocks

Hypothesis:

The study will reveal that weather OPEC and its members has the power to

effect the oil prices

Methodology:

The data is secondary base. And the most helpful websites are

www.digitallibrary.edu

5

www.docstoc.com

www.osun.org

Organization of the study:

The first chapter is consisting of introduction to

the topic and importance of the study, objective of the study and hypothesis.

Second chapter is literature review. Chapter three has the 1970s oil crises

and four have 1980’s and fifth has 1990’s oil crises. And at the end there is

conclusion from the study.

6

Chapter 2

7

Alhaji and huettener (2000) find that neither OPEC nor the OPEC core has

the properties of the dominate firms.

A; f A hajji and David huettener (2000) studied a comparison between opec

and other international commodity cartels to show weather OPEC is a cartel

or not but the analysis shows that difference between OPEC and other

cartels the results showed that theory of cartels as developed in the economic

literature does not fit open very well, particularly in comparison with other

commodity organization. And open is not a cartel because of the absence of

a dominate open market share, open’s overdependence on one commodity

for revenue and the fact that the elasticity of demand for OPEC oil is less

then one. And the oil companies cartel between the 1930 and 1960 fits the

cartels theory much better then OPEC the study showed that Saudi is more

Influential then other OPEC members’ .because Saudi Arabia meets al the

characteristics of a dominate producer by having relati8ely large market

share, excess capacity flexible behavior, the ability to move its prices by

increasing and decreasing production and operating on the elastic part of its

demand curve. And no other OPEC member has similar behavior.

Kohl (2002) argues that OPEC faces difficulties to stabilize oil prices with

Imperfect data and very limited instruments. He suggested the OPEC’s use

of production quotas as the only instrument to stabilize prices has not been

as effectible due to number f factors including geo-political unrest, changes

in demand, changes in Iraqi exports, and production o Non-opec countries

Santis (2003) the study attempted to explain why crude oil prices fluctuate,

the main cause being the quota regime which characterizes the OPEC

8

agreements. Given that the Saudi oil supply is inelastic in the short term a

shock in the oil market is accommodated by an immediate price change. By

contrast a dominant firm behavior in the long term causes an output change

which is accompanied by a smaller price change. The results of a general

equilibrium model applied to Saudi Arabia supported this analysis. Result

also indicated that Saudi Arabia does not have any incentive for altering the

crude oil market equilibrium as its welfare declines. A second set of

simulations is designed to understand what kind of OECD policy might help

to bring down prices. A tax cut would worsen the situation whereas policies

that increase the price elasticity of demand seem to be very effective.

Deaves and krinsky (2003) studies the effect of OPEC announcement on the

market and what will be the react of the market after the announcement at

the end of meeting. And he finds evidence that traders are under react to

OPEC Conference and this announcement leading to abnormal profit for

certain investors. The behavior of oil futures returns

Internal Energy Agency (May 2004) analyzed the effect of raise of oil price

from $25 to $35 because of OPEC supply management policies in. Due to

which economies show downwards. The results showed that OECD as a

whole losing 0.4%of the GDP. Inflation and unemployment also roused. The

GDP of Euro-zone countries fall by 0.5% and inflation rising by 0.5%

OCED imported more then half of its oil need in 2003 at a cost of over 260

million 2%greater the 2001. The USA will suffer the least with GDP falling

by 0.3% japans FDP fallen by 0.4%.the high oil price also effect the

developing countries more then OECD countries.

9

Pijush Paul (2005) analyzed that OPEC supply 40% of world’s oil supply

and hold 78% of resources and his analysis showed that OPEC fix oil price

in relations with non-opec courtiers and OPEC’s oil availability is enough

for next few decades and fast production decline in non-opec courtiers may

make OPEC as the key player to decide oil prices but OPEC as a group has a

limited success because of internal cheating it looks like OPEC is losing its

control to decide. The oil prices and market is deciding the price because of

growing demand.

Riza Demier and Ali M.kutan (December 2006) studied empirically the

effect of OPEC’s announcement on crude oil supply from OPEC and non-

opec oil producers. They obtained results that OPEC and no-opec country’s

announcement has effect on crude oil price. The study revealed that non-

OPEC related announcement has significant effects where as OPEC d not

seem to affect the crude oil price more significantly

Guidi et al (2006) looks at the significance of OPEC meetings, but mainly

from the point of view of the impact they have on stock market rather then

on crude oil returns, he divides the data from 196 to 2004 in period of

conflict and non conflict. And then compare the reaction of the stock market

in the US and UK to OPEC quota decision between conflict and non-conflict

Ronond li (2007) has examined two major implication of the dominant firm

model for OPEC and empirically tested .the first implication related to the

production level of the OPEC and each OPEC member country. Pairwise co

integration results indicates that the majority of the opec members do not

move together with the rest of opec in their production level in regards to the

10

role of opec global oil market. Secondly granger Causality results shows that

there is no statistically significant causality running from OPEC production

to non-Opec production and price level and dominant firm hypothesis is

more consistent with the non-opec producers then the OPEC.

Hamilton (2008) this paper examined the actors responsible of change in

crude oil prices. The paper reviewed the statistical behavior of oil prices and

relates these to the predictions of theory and looks in detail at key features of

petroleum demand and supply. He discussed the role of commodity

speculation, OPEC, and resource depletion. The paper concluded that

although scarcity rent made a negligible contribution to the price of oil in

1997,it could now begin to play a role. If demand growth resumes in china

and other courtiers at its previous rate , the scarcity rent will start to make an

Important contribution to the price, if not now cannot be far away.

Sharon xiaowen Lin, and Michael tamvakisa (24 April 2009) studied the

effect of OPEC announcement on the oil price. the study showed that such

announcement effect price returns but the magnitude of such effects varies

primarily according to the existing price regime quota cuts results in positive

price returns, except in weak market conditions, quota increase do not have a

Clear-cut-effect when prices are relatively high the quota increase are

relatively high. The quota increases do results in negative returns in weak

and normal market price that is neither too low nor too high. No changes in

quota seem to result in negative or insignificant result. The study showed

that there is no significant difference between OPEC and non OPEC crude in

relation to OPEC announcement and there is just a popular belief that OPEC

has superior information on oil price the analyzed showed that the

11

importance of OPEC announcement is depending on the context in which

they are made. Both the type of decisions9 cut, increase or no change and

price environment (relatively low, average, or relative high) are important

and necessary if one is to evaluate the role and impact of OPEC

announcement on crude oil market.

12

Chapter 3

13

1970’s oil crisis:

The 1970’s oil crisis started in October when the “ARAB”

member’s of OPEC imposed oil embargo on the USA in response to sending

military help to the Israel. The “Arab” member’s of OPEC created a new

organization at time which is known as oapec. (Organization of Arab

petroleum exporting countries). OAPEC consisting Arab OPEC plus Egypt,

Syria, and Tunisia. The oapec declared it would limit or stop oil shipment to

the united state and other countries if they support Israel.

In order to understand the main cause of the 1973 oil crisis one must first

know the history of the region and the Arab- Israeli conflict. World War II a

Zionist state, known as Israel, was created on 56% of the land that was

formerly known as Palestine. This state served as a homeland for Jews. The

local Arabs were enraged by the fact that the Palestinian land had been taken

to create this state. They refused to acknowledge Israel as an independent

state. The Arabs began to launch

Efforts to recapture the land that they felt were rightfully theirs. This created

the Suez-Sinai War. The British and the French sided with the Israelis in

order to punish Nasser for nationalizing the Suez Canal. The Israeli military

forces quickly defeated the Arabs. The Arabs responded to this defeat by

uniting. In 1967 Israel launched the Six-Day War, claiming much land. In

1973 Arab forces retaliated. On Yom Kippur, the holiest Jewish holiday,

Arab forces attacked, backed by Soviet technology (The Mid-east Oil

Crisis). Saudi Arabia's King Faisal swayed other oil supporting countries

into placing an embargo on crude oil to Western nations, in late October.

This was meant to punish the Western states that had supplies weapons and

14

aid to Israel (The Arab oil embargo of 1973-74). Arab oil-producing

countries wished to pressure the Western countries, specifically America

into demanding that Israel withdraw their troops from the Arab Territories

that they had occupied since 1967. This included the ones that the Israelis

had recently conquered. They used the embargo in this way as a political

tactic. They were also able to use the embargo for economic means. Once

they had placed the embargo on the west, the world's largest consumer of

oil, the Arabs realized the power that they had over the world through oil.

Once they had resumed shipments of oil they were able to keep the prices

high and make a larger profit. Panicking investors and oil companies added

to the surge in oil prices in the U.S. These causes plunged a nation where

everything seemed to revolve around cars into desolation and insecurity.

America found that it could no longer afford to thoughtlessly consume oil.

Philosopher E.F. Schumacher said of the crisis, "The party's over."

The imposition of embargo can result long run effect. Such as high

oil price, disturb supply, and can cause recession. With the expectation of

this effect European nations and Japan subsided from the US Middle East

policy.

On October 16, 1973, OPEC announced a decision to raise the

price of oil by 70% to 5.11%a barrel. Arab oil ministers’ agreed to the

embargo, a cut in production by 5% from September’s output. And to

continuous to cut over time in 5% until their economic and political

objective were met

15

The effect of embargo: The effects of embargo were immediate OPEC

forced oil companies to increase payments. The prices of oil raised in 1974

nearly to $12. These increases in oil prices has a dramatic effect on the oil

exporting countries, and especially for Middle East who had been dominated

by the industrial powers have controlled the important commodity. The

follow of capital is reserved and they become rich. Some income was given

to the underdeveloped countries that is much hit by high oil price and has

low price of their exporting commodities and raw material and western

demand for their product. And much money is spend n the purchase of

weapon

The control of a vital commodity become known as the “oil

weapon” which came in the form of an embargo and cut back in oil

production from the Arab states to select industrial government of the world

to preserver Israel during the fourth Arab Israeli war in October in October

1973.A few month later, the crises stopped . The embargo was lifted in

March 1974 after negotiations at the Washington oil summit, but the effect

of the energy crisis continued through 1970s. The prices of energy continued

increasing in the following year, aimed the weakling competitive position of

the dollar in world market.

Effect of embargo on USA efforts by government to handle the situation: The immediate results of the Oil Crisis were dramatic.

Prices of gasoline quadrupled, rising from just 25 cents to over a dollar in

just a few months. The American Automobile Association recorded that up

to twenty percent of the country’s gas stations had no fuel one week during

the crisis. In some places drivers were forced to wait in line for two to three

16

hours to get gas. The total consumption of oil in the U.S. dropped twenty

percent. This was due to the effort of the public to conserve oil and money.

There was an instant drop in the number of homes created with gas heat,

because other forms of energy were more affordable at this time (Arab Oil

Embargo of 1073-74). The U.S. government went to desperate measures to

improve the situation that America found itself in. Congress issued a 55mph

speed limit on highways. This was a good thing. Not only did oil

consumption go down, but fatalities decreased overnight. Today's fuel

economy stickers come from the effort to preserve oil in the 70's. Daylight

savings time was issued year round in an effort to reduce electrical use.

These changes were made in hopes of preserving oil. Tax credits were

offered to those who developed and used alternative sources for energy (The

Arab Oil Embargo of 1973-74). These included solar and wind power.

Nixon, who was president at that time, ordered the department of defense to

create a stockpile of oil in case the country needed the military to carry it

through a time of chaos. There was a large cutback in oil consumption.

Emergency rationing books were printed although they were never necessary

due to the end of the embargo. Nixon formed the Energy Department and it

became a cabinet office. It developed the national energy policy. They made

plans to make the U.S. energy independent (The Arab Oil Embargo of 1973-

74). Gasoline companies and stations also did all that they could to preserve

oil. Nixon had issued a voluntary cutback on the consumption of gasoline.

Gas stations would voluntarily close on Sundays. They refused to sell to

customers who weren’t regulars. Gas stations also wouldn't sell more than

ten gallons of gasoline to a customer at a time. They felt that these efforts

would help the public to become more fuel-efficient (The Arab Oil Embargo

of 1973-74). The public helped to retain energy as well. Families turned

17

their thermostats down to sixty-five degrees. The rise in oil prices also

caused the public to be more fuel-efficient. Companies and industries

switched their energy source to coal (The Arab Oil Embargo of 1973-74).

People searched for alternative energy sources. People traded their

mammoth cars that had thoughtlessly been speeded down highways to over-

heated homes in the suburbs for smaller more fuel-efficient models.

The 1973oil crisis and recession in the united state: 1970’s was a period

of economic recession in much of the western countries. And putting and

end to the boom after world war two and it was different from any previous

recession. This was a periods of stagflation where there was high

unemployment and high inflation. The main causes of the stagflation were,

the Vietnam War, 1973, fall of Bretton wood system and 1973’s oil crisis.

According notational bearue of economic research, the recession in the

united state lasted from november1973tomarch 1975. During recession, the

GDP of US fell by 6% the unemployment was9 %.

1973 oil crisis and stock market crash: The 1973 oil crisis affects all the

major stock market in world, including particularly UK. It was on of the

worst market downturns in modern history. The crash came after the

collapse of Breton wood system in the previous two year and it is

compounded by the outbreak of the 1973 oil crises of that year.

In the 694 days between 11 January 1973 and 6 December 1974, the New

York Stock Exchange's Dow Jones Industrial Average benchmark lost over

18

45% of its value, making it the seventh-worst bear market in the history of

the index (Woodard, Dustin."1973-1974 Stock Market Crash). 1972 had

been a good year for the DJIA, with gains of 15% in the twelve months.

1973 had been expected to be even better, with Time magazine reporting,

just 3 days before the crash began, that it was 'shaping up as a gilt-edged

year'. In the two years from 1972 to 1974, the American economy slowed

from 7.2% real GDP growth to -2.1% contraction, while inflation (by CPI)

jumped from 3.4% in 1972 to 12.3% in 1974 (Davis, E. Philip (January

2003).

Worse was the effect in the United Kingdom, and particularly on the London

Stock Exchange's FT 30, which lost 73% of its value during the crash. From

a position of 5.1% real GDP growth in 1972, the UK went into recession in

1974, with GDP falling by 1.1%. At the time, the UK's property market was

going through a major crisis, and a secondary banking crisis forced the Bank

of England to bail out a number of lenders. In the United Kingdom, the crash

ended after the rent freeze was lifted on 19 December 1974, allowing a

readjustment of property prices; over the following year, stock prices rose by

150%.However, unlike in the United States, inflation continued to rise, to

25% in 1975, giving way to the era of stagflation. The Hong Kong Hang

Seng Index also fell from 1,800 in early 1973 to close to 300.

Macro economic effects: The 1973 oil crisis was a major factor in Japan’s

economy shifting from oil-intensive industries , and resulting huge Japanese

investment in industries such as electronics, the Japanese auto makers also

took advantage of this embargo after the realized what fuel cost were in

united states, they started producing small, more foul efficient models,

19

which began selling as an alternative to “gas-guzzling” American vehicles I

of the time .this trigged a drop in American auto sales that lasted into 1980’s

The western nations “central banks” r decided to sharply cut interest rates to

encourage growth, deciding that inflation was a secondary concern but this

was not so effective decision and it surprised the central banks and policy

makers.

1979 Iranian revolution:

The 1979 (or second) oil crisis in the united state

occurred in the wake of the Iranian revolution. Amid massive protests, the

shah of Iran, Muhammad reza Pahlavi, fled his country in early 1979,

allowing the Ayatollah Khomeini to gain control. The protests shattered the

Iranian oil sector. While the new regime resumed oil exports, it was

inconsistent and at a lower volume, forcing prices to go up. Saudi Arabia

and other OPEC nations, under the presidency of Dr .Mana Alotaiba

increased production to offset the decline, and the overall loss in production

was about 4 percent. However, a widespread panic resulted, driving the price

far higher than would be expected under normal circumstances. In 1980,

following the Iraqi invasion of Iran, oil production in Iran nearly stopped,

and Iraq's oil production was severely cut as well.

After 1980, oil prices began a six-year decline that culminated with a 46

percent price drop in 1986. This was due to reduced demand and over-

production, which caused OPEC to lose its unity. Oil exporters such as

Mexico, Nigeria, and Venezuela expanded production. Ending of price

controls allowed the US and Europe to get more oil from Prudhoe Bay and

the North Sea.

20

Iran:

In November 1978, a strike by 37,000 workers at Iran's nationalized oil

refineries initially reduced production from 6 million barrels (950,000 m3)

per day to about 1.5 million barrels (240,000 m3) .foreign workers (including

skilled oil workers) fled the country. On January 16, 1979,shah of Iran,

Muhammad reza Pahlavi and his wife left Iran at the behest of Prime

Minister shapour Bakhtiar (a long time opposition leader himself), who

sought to calm down the situation.

Effect on Other OPEC members

OPEC net oil export revenues for 1971 – 2007

FIGURE SURCE: www.eia.doe.gov/emeu/cabs/OPEC_Revenues/OPEC.html.

The rise in oil price benefited other OPEC members, which made record

profits.

21

Effect on the United States:

Richard Nixon had imposed price controls on domestic oil, which had

helped cause shortages that led to gasoline lines during the 1973 oil crisis.

Gasoline controls were repealed, but controls on domestic US oil remained.

The jimmy carter administration began a phased deregulation of oil prices on

April 5, 1979, when the average price of crude oil was US$ 15.85 per barrel

(42 US gallons). Over the next 12 months the price of crude oil rose to

$39.50 per barrel (its all time highest real price until March 7, 2008.)

Deregulating domestic oil price controls allowed domestic U.S. oil output to

rise sharply from the large Prudhoe Bay fields, while oil imports fell sharply.

Hence, long lines appeared at gas stations, as they had six years earlier

during the 1973 oil crisis. As the average vehicle of the time consumed

between two to three liters (about 0.5-0.8 gallons) of gasoline (petrol) an

hour while idling, it was estimated that Americans wasted up to

150,000 barrels (24,000 m3) of oil per day idling their engines in the lines at

gas stations .

During the period, many people believed the oil companies artificially

created oil shortages to drive up prices, rather than factors beyond human

control or the US' own price controls. The amount of oil sold in the United

States in 1979 was only 3.5 percent less than the record set for oil sold the

year previously.

Many politicians proposed gas rationing; one such proponent was Harry

Hughes, Governor of Maryland, who proposed odd-even rationing (only

people with an odd-numbered license plate could purchase gas on an odd-

numbered day), as was used during the 1973 oil crisis. Several states

actually implemented odd-even gas rationing, including Pennsylvania, New

22

Jersey, and Texas. Coupons for gasoline rationing were printed but were

never actually used during the 1979 crisis. On July 15, 1979, President

Jimmy Carter outlined his plans to reduce oil imports and improve energy

efficiency in his "Crisis of Confidence" speech (sometimes known as the

"malaise" speech). It is often said that during the speech, Carter wore a

cardigan (he actually wore a blue suit). And encouraged citizens to do what

they could to reduce their use of energy. He had already installed solar

power panels on the roof of the White House and a wood-burning stove in

the living quarters. However, the panels were removed in 1986, reportedly

for roof maintenance, during the administration of his successor, Ronald

Reagan, and were never replaced. Carter's speech argued the oil crisis was

"the moral equivalent of war". Several months later, in January 1980, Carter

issued the Carter Doctrine, which declared that any interference with U.S.

oil interests in the Persian Gulf would be considered an attack on the vital

interests of the United States. Additionally, as part of his administration's

efforts at deregulation, Carter proposed removing price controls that had

been imposed in the administration of Richard Nixon before the 1973 crisis.

Carter agreed to remove price controls in phases; they were finally

dismantled in 1981 under Reagan. He also said he would impose a windfall

profit tax on oil companies. While the regulated price of domestic oil was

kept to $6 a barrel, the world market price was $30.In 1980, the U.S.

Government established the Synthetic Fuels Corporation to produce an

alternative to imported fossil fuels.

Automobile fuel economy OF USA:

At the same time, Detroit's then-Big Three automakers (Ford, Chrysler, GM)

were marketing downsized automobiles which met the CAFE fuel economy

23

mandates passed in 1978; by the mid-1980s, a majority of rear wheel drive

(RWD) family sedans and station wagons sold poorly despite government

mandates from CAFE; vehicles like the Ford Fairmont and Dodge St. Regis

were short-lived in response to the second energy crisis. GM’s Cadillac

division experimented with their V8-6-4power plant (the ancestor of the

modern-day Active Fuel Management and/or variable displacement), which

was a market failure. When RWD family sedans were marketed during this

era, this is where Japanese imports were building inroads; by the start of the

1980s, every automaker was making the transition to front-wheel drive.

24

Table1 world crude oil prices (U.S. dollar per barrel)

Year nominal prices in year 2004 dollars

1970 1.80 7.08

1971 2.24 8.39

1972 2.48 8.90

1973 3.29 11.18

1974 11.53 36.09

1975 11.53 32.84

1976 12.38 33.34

1977 13.30 33.67

1978 13.60 32.17

1979 30.03 65.60

Source: U.S. Energy Information Administration, U.S. Departments of Commerce and Labor.2004 For facility purposes we plot the above prices on the graph on

next page. the table contained nominal oil prices (the prices in dollar at a

25

particular year say oil prices in on the average in year 1970,or 1979).while

and in year 2004 19701$=4.78$2004

World oil prices graph 1, from 1973-1979:

Nominal, in year 2004 dollar:

0

20

40

60

80

100

120

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

Series3

Series2

Years

The graph shows that the price is increases before the imposition of

oil embargo but at a slow rate. When oil embargo imposed the price increase

suddenly in 1973-1974.and then it remains more or less up to 1978.but after

Iranian revaluation increases on again.

26

Price relatives:

Oil price are compared of different years from 1971-1979 using 1973

as a base year.

Years Nominal oil prices Price relatives

Pn/po *100

1970

1.80 15.54

1971 2.24 19.34

1972 2.48 21.34

1973 3.29 28.4

1974 11.58 100

1975 11.53 99.56

1976 12.38 106.91

1977 13.30 117.44

1978 13.60 117.46

1979 30.03 259.3

1973 oil prices is compared with oil prices before and after 1973’s oil prices

27

In 1973 the OAPEC imposed oil embargo on us and they starts fixing prices

and as a result the rise in can be seen in 1974 and its onward effect. For

comparing prices of different we take 1974 as a base year. The calculation

shows that before the imposition of oil embargo the prices were also raising

but at a very low rate. As from table 2 we can see that from year 1970 to

1971 on the average there is just only 4% rise in oil price using 974 as a

base. And from years 1971-1972 and from 1972-73 the rise in oil price is 3%

and 5% respectively. But from year 1973 to 1974 the price raises by 71.6%.

And after this years almost increasing throughout the 1970s decade. And

after Iranian revaluation there is 159.3% increase in oil prices as compare to

1973’s oil prices

28

Chapter 4

29

1980’s oil crisis:

The outbreak of the war between Iran and Iraq in 1980 shook the oil market

as well. In its initial stage, the Iran-Iraq war abruptly removed almost 4

million daily barrels of oil from the world market—15 percent of total

OPEC output and 8 percent of free world demand. In 1980 OPEC

representatives (with the exception of Saudi Arabia) agreed to set prices at

thirty-six dollar a barrel. However, the impact of the Second Oil Shock

turned out to be short-lived. The influence of OPEC appeared to be

diminishing as the production by Mexico, Britain, Norway, and other non-

OPEC countries and Alaska was continuing to increase. Anxious to increase

market share, they were making significant cuts in their official prices. As a

result, OPEC's share of world output quickly fell by 27 percent. Saudi

Arabia, the largest producer in OPEC, saw its oil revenues decreased from

$113.2 billion in 1981 to just $20.0 billion in 1986.Although the Second Oil

Shock sent the developed world into recession, the most serious long run

impact of the second shock was in the developing world. During the 1970s,

the oil producing states placed a significant portion of their revenue into

commercial banks because they simply could not spend the money as fast as

it came in. The commercial banks loaned this money to developing countries

which hoped to repay the loans with revenue from their rapidly growing

economies. However, the developed world responded to the Second Oil

Shock by rapidly raising interest rates which deepened the on-going

recessions. The developing countries saw exports fall, oil import prices rise,

and interest payments skyrocket. The result was the debt crisis which first

appeared in Mexico in 1982 and quickly spread throughout the developing

world. In the "lost decade" of the 1980's, years of hard fought economic

30

gains were wiped out. From 1980-88, the real income of median workers fell

by 40 percent.

Since early 1980s, the world petroleum market confronted the

OPEC with an unpalatable choice: cut prices to regain markets or cut

production to maintain price. However, the OPEC countries did not want to

reduce prices, for fear that they would undermine their whole pricing

structure, lose their great economic and political gains, and so diminish their

political influence. OPEC did not always organize a united front against this

pressure. For example, Saudi Arabia, whose oil production far surpassed

other member countries, had championed decisions for low pricing for larger

market-sharing and long-term gains.

The 1980s oil glut was a surplus of crude caused by falling demand

following the 1970’s oil crisis The world price of oil, which had peaked in

1980 at over US$35 per barrel ($91 per barrel in today's terms), fell in 1986

from $27 to below $10 ($52 to $19 today). The glut began in the early 1980s

as a result of slowed economic activity in industrial countries (due to the

crises of the 1970s, especially in 1973 and 1979) and the energy

conservation spurred by high fuel prices. The inflation adjusted real 2004

dollar of oil fell from an average of $78.2 in 1981 to an average of $26.8 per

barrel in 1986.

In June 1981, the New York time stated an "Oil glut! ... is here" and Time

magazine stated: "the world temporarily floats in a glut of oil,” though the

next week an article in The New York Times warned that the word "glut"

was misleading, and that in reality, while temporary surpluses had brought

down prices somewhat, prices were still well above pre-energy crisis levels.

This sentiment was echoed in November 1981, when the CEO of Exxon

31

crop also characterized the glut as a temporary surplus, and that the word

"glut" was an example of "our American penchant for exaggerated

language." He wrote that the main cause of the glut was declining

consumption. In the United States, Europe and Japan, oil consumption had

fallen 13% from 1979 to 1981, due to "in part, in reaction to the very large

increases in oil prices by the organization of petroleum exporting countries

and other oil exporters," continuing a trend begun during the 1973 price

increases. After 1980, reduced demand and overproduction produced a glut

on the world market, causing a six-year-long decline in oil prices

culminating with a 46 percent price drop in 1986.

Background:

The 1973 oil crisis and the 1979 oil crisis turned oil from a

cheap to a very expensive energy source. During the 1973 energy crisis, the

price of oil quadrupled. Oil never returned to pre-1973 levels, either in real

or nominal terms, even during the 1980s glut. The nominal price continued

its slow increase after the crisis ended. Six years later, the price more than

doubled during the 1979 energy crisis. OPEC and Saudi Arabia artificially

raised the price of oil several times in 1979 and 1980. Also during this time,

several OPEC members significantly lowered their production levels, the

Iran hostage crisis occurred, and the Iran Iraq war began.

There was fear that the world's oil market supply was tenuous, causing the

price of oil to escalate and that OPEC would dictate very high prices in a

shortage.

32

Production: here we will analyze THE OPEC Oil production and non-

OPEC oil PRODUCTION.

Non-OPEC

During the 1980s, non-OPEC production increased worldwide. It can be

shown from the below diagram.

Non-OPEC oil production

US:

In April 1979, jimmy carter signed an executive order which was to remove

market controls from petroleum products by October 1981, so that prices

would be wholly determined by the free market Ronald Rogan signed an

executive order on January 28, 1981 which enacted this reform immediately,

allowing the free market to adjust oil prices in the US This ended the

33

withdrawal of old oil from the market and artificial scarcity, encouraging

increased oil production. The US Oil windfall tax was lowered in August

1981 and removed in 1988, ending disincentives to US oil producers.

OPEC oil production:

From 1980 to 1986 OPEC decreased oil production several times and nearly

in half to maintain oil's high prices. However, it failed to hold on to its

preeminent position, and by 1981, its production was surpassed by Non-

OPEC countries. OPEC had seen its share of the world market drop to less

than a third in 1985, from nearly half during the 1970s. In Feb1982, the

Boston globe reported that OPEC's production, which had previously peaked

in 1977, was at its lowest level since 1969. Non-OPEC nations were at that

time supplying most of the West's imports.

OPEC's membership began to have divided opinions over what actions to

take. In September 1985, Saudi Arabia, tried to gain market share by

increasing production, creating a "huge surplus that angered many of their

colleagues in OPEC". High-cost oil production facilities became less or even

not profitable.

US imports:

The US imported 28 percent of its oil in 1982 and 1983, down from 46.5

percent in 1977, due to lower consumption. Reliance on Middle East sources

dwindled even further as Britain, Mexico, Nigeria and Norway joined

Canada in the forefront of American suppliers. Imported crude oil from

Libya was banned in the United States on March 10, 1982.

34

Reduced demand:

OPEC had relied on the price elasticity of demand of oil to maintain high

consumption, but underestimated the extent to which other sources of supply

would become profitable as prices increased. Electricity generation from

nuclear and natural gas; home heating from natural gas; and ethanol blended

gasoline all reduced the demand for oil. New passenger car fuel economy

rose from 17 mpg in 1978 to more than 22 mpg in 1982, an increase of more

than 30 percent.

Impact:

The 1986 oil price collapse benefited oil-consuming countries such as the

United States, Japan, Europe, and Third World nations, but represented a

serious loss in revenue for oil-producing countries in northern European,

Soviet Union, and OPEC.

In 1981, before the brunt of the glut, Time Magazine wrote that in general,

"A glut of crude causes tighter development budgets" in some oil-exporting

nations. In a handful of heavily populated impoverished countries whose

economies were largely dependent on oil production — including Mexico,

Nigeria, Algeria, and Libya — government and business leaders failed to

prepare for a market reversal.

With the drop in oil prices, OPEC lost its unity. Oil exporters such as

Mexico, Nigeria, and Venezuela, whose economies had expanded in the

1970s, were plunged into near-bankruptcy. Even Saudi Arabian economic

power was significantly weakened.

35

Iraq had fought a long and costly war against Iran, and had particularly weak

revenues it was upset by Kuwait contributing to the glut [and allegedly

pumping oil from the Rumaila field below their common border. Iraq

invaded Kuwait territory, planning to increase reserves and revenues and

cancel the debt, resulting in the first gulf war. The USSR had become a

major oil producer before the glut. The drop of oil prices contributed to the

nation's final collapse In the US, domestic exploration declined dramatically,

and the number of active drilling rigs was nearly halved in 1982. Oil

producers held back on the search for new oilfields for fear of losing on their

investments. In May 2007, companies like Exxon Mobil were not making

nearly the investment in finding new oil today that they did in 1981.oil

prices from 1980-1989 is given on the next page.

36

1980’s oil prices:

Years nominal oil prices in year 2004 dollars

1980 35.69 71.48

1981 34.28 62.76

1982 31.76 54.81

1983 28.77 47.76

1984 28.06 44.89

1985 27.53 42.47

1986 14.38 21.84

1987 18.42 27.24

1988 14.96 21.39

1989 18.20 25.08

Source: U.S. Energy Information Administration, U.S. Departments of Commerce and Labor.2004These prices are graphed here to easily understand changes in oil prices from

1980 to 1989.

37

Oil price graph 2

0

20

40

60

80

100

120

years

nominal oil prices in year 2004 dollars

Oil prices from 1980-1989:

38

Oil price are compared of different years from 1980-1989 using 1980 as a

BASE. Price relatives:

Year’s nominal oil prices

Pn /Po*1000

1980 35.69

100

1981 34.28 96.049

1982 31.76 88.99

1983 28.77 80.61

1984 28.06 78.62

1985 27.53 77.14

1986 14.38 40.29

1987 18.42 51.61

1988 14.96 41.92

1989 18.20 50.99

Price relatives of oil prices from year 1980 to 1989

39

THE prices were almost rising before 1980. in 1979 the price was 30.0

which is 159% greater then the prices in 1974.in 1980 the opec members

agreed to Fix prices at 36$ per barrel but the table shows that they fully

failed to maintains the prices according to their interest. and the success

were just remained to the year 1980.in the year 1991 the prices falls by

3.951%.and in year 1982 the prices falls by 11.01%.the falls continues

throughout 1980’s decade. And in 1986 the prices falls by 59.71. After the

year 1986 oil prices rises but still it a very slow rate. And at the end of this

decade that is from 1880 to 189 falls in oil prices on the bases of 1980 is

49.01%.

40

Chapter 5

41

1990’s oil crises:The cause of the Iraqi invasion of Kuwait on August 2, 1990--and hence of

the worldwide energy crisis that it precipitated--was economic, although the

issue was one that might not appear immediately relevant to consumers at

the pumps. For several months preceding the invasion, Iraqi President

Saddam Hussein had been asserting, with some justification, that Kuwait

was in effect engaged in economic war with Iraq, stealing oil from the

disputed Rumaila field and producing in excess of its OPEC quota. The

validity of Iraq's assertions has never been adjudicated by the international

community, before or since the invasion. Instead, on August 6 the United

Nations imposed an immediate and nearly total embargo on oil exports from

Iraq, as well as on Kuwait, which Iraq had by then absorbed This embargo

removed almost 5 million barrels a day of oil from the world market. Prices

of crude oil almost doubled in the wake of the invasion. Prices of jet fuel

tripled. But the officials of consuming nations did not act. As in 1973 and

1979, government representatives blamed 'speculators' for the rise in prices.

As in the past, this shortsighted market interference drove prices even

higher. This ill advised behavior on the part of high government officials of

several supposedly market-oriented nations leads to three very

uncomfortable conclusions. Third, to complement the strategic stocks,

consuming nations must promote the development of some strategic refining

capacity that could be used in a future crisis. This capacity should include

facilities capable of processing heavy crude oils and producing a high

percentage of light products.

42

Background:Iraq's invasion of Kuwait followed six months of extreme turbulence in

world oil markets. Crude oil prices had climbed to three-year peaks in

January 1990 and then plunged to levels comparable to their 1986 lows by

June. During this period, supplies of the benchmark crude known as West

Texas Intermediate (WTI) sold for as much as 23.40/bbl and as little as

$15.30/bbl on the market for immediate delivery (spot market). The primary

cause of the decline in prices was overproduction by Kuwait and the United

Arab Emirates (UAE). The attitude of these nations toward their OPEC

commitments naturally aroused the anger of the other oil-exporting

countries, particularly Iraq. By the end of June, President Hussein and his oil

minister Issam Abdul-Rahim al-Chalaby were making their feelings public.

The price of oil began to increase in spite of the oversupply. The decline and

later rise in crude oil prices were concentrated in prices quoted for prompt'

supplies for crude: crude to be delivered within the next 30 to 90 days. (1)

Prices for oil to be delivered 12 to 18 months in the future--so-called "far

forward" prices--actually increased while prices for prompt delivery were

falling This pattern can be observed by examining the term structure of oil

prices since the beginning of 1990. The term structure of oil prices compares

prices of crude oil for various delivery dates at a particular moment in time,

just as the term structure of interest rates compares short-, intermediate-, and

long-term rates at a moment in time. The term structure of crude oil prices

on January 19, June 20, and August 1, 1990. Reading from left to right, one

observes the price quoted for the first or immediately expiring contract

(equivalent to the spot price), then that of the second or next expiring

contract, and so on into the future. The decline in spot prices from January to

June was associated with an unusually large increase in inventories. In

43

effect, the oil market was sold into what is called co tango, in which spot

prices are less than forward prices-a -situation analogous to the standard

yield curve in finance (the opposite condition, in which forward oil prices

are lower than spot prices, is called backwardation). Economists have noted

that spreads between spot and forward prices are linked to the level of

stocks. This relationship could be observed in both the US and the world oil

market through 1989 up to August 1990 .spot supplies of crude would be

expected to trade at a premium of about $3.00/bbl to 12-month forward

crude if companies are holding only 325 million barrels in inventory. On the

other hand, spot supplies would be expected to trade at a discount of about

$2.00/bbl if companies are holding 385 million barrels. The decline in spot

prices from January to June coincided with such an increase in stocks.

Stocks were drawn down to 342 million barrels in January, and at that time

the premium for spot supplies to 12-month forward oil was $3.00/bbl.

Stocks then increased to 386 million barrels by the end of June, while spot

prices sank to a $3.35/bbl discount to 12-month forward supplies most of the

decline in prices during the first half of 1990 was concentrated in near-term

prices. Prices were far forward oil actually increased by $0.50/bbl. This

stability of forward prices was remarkable, particularly since a very active

trade in oil for far forward delivery has developed both on and off the

organized futures exchanges. The stability of forward prices may be

interpreted as an indication that participants in the market expected oil prices

of about $20.00/bbl over the longer run. This interpretation is confirmed by

the price movements of longer-term instruments such as the BP Royalty

Trust.(2) The entire price structure--prices at all points along the curve--rose

between mid-June and the end of July, in response first to Saddam Hussein's

saber rattling and then to the agreement among the oil-exporting nations at

44

the end of July to raise target prices to $21.00/bbl. The increase began in late

June when the Iraqi oil minister delivered a blistering attack on the UAE for

overproduction.(3) His attack was followed by a statement by the Iraqi

deputy prime minister Sa'adoun Hammadi that the depressed price of oil was

hurting the Iraqi economy badly. The blade has reached the bone after

cutting through the flesh."(4) The oil ministers of Saudi Arabia, Iraq,

Kuwait, the UAE, and Qatar met in Jeddah, Saudi Arabia, on July 11 to

attempt to defuse the situation. Worried that their overproduction had

angered the militarily stronger Iraq, ministers from Kuwait and the UAE

agreed to immediately adhere to OPEC production quotas until the price of

the so-called OPEC basket rose above $18.00/bbl (5) from its then-current

price, reported by Petroleum Intelligence Weekly to be $14.16/bbl. (6) Iraq

continued its verbal attacks on what it described as economic warfare by

Kuwait and the UAE despite the Saudis' attempt to patch matters up. In a

speech on July 17, Hussein threatened to use force against the other Arab

oil-exporting nations if they did not curb their overproduction. The New

York Times reported that Hussein had accused some unspecified nation

(widely assumed to be Kuwait) of colluding with the United States to lower

prices: "'The policies of some Arab rulers are American,' the Iraqi leader was

quoted as having said by news agencies from Baghdad.’They are inspired by

America to undermine Arab interests and security."'(7) Hussein went on,

according to the Times article, to state, "Iraqis will not forget the saying that

cutting necks is better than cutting means of living."(8) Hussein's speech

was also reported in the Wall Street Journal, the financial Times, and the

Washington Post. The Financial Times noted that oil markets seemed to

shrug off the Iraqi leader's remarks.(9) However, the government of Kuwait

was alarmed and sought the help of the Arab League to mediate the dispute.

45

At the same time, the Saturday, July 21, issue of the financial Times

reported that Kuwait had canceled a state of alert for its armed forces and

adopted a conciliatory tone. The same dispatch carried an unconfirmed

report that a small detachment of Iraqi troops had landed on the Kuwaiti

islands of Bubiyan and Warbah.(10) Three days later the Washington Post

reported that Iraq had massed nearly 30,000 troops on its border with

Kuwait, and noted that Kuwait had reactivated a fill military alert." John

Roberts reported that Iraq's troop move was part of its effort to permanently

settle its dispute with Iran. In a dispatch published on July 25 by the Oil

Daily Energy Compass, Roberts noted that Iraq is on the verge of making

peace with both Kuwait and Iran--and it will use concessions from Kuwait to

make up for concessions it plans to give to Iran.'12 According to Roberts,

the details would involve an agreement to reestablish the border between

Iraq and Iran along the middle of the Shatt al-Arab, precisely where it was

drawn in the 1975 Treaty of Algiers. In return, Kuwait would be required to

transfer to Iraq the full revenues from oil produced from the Rumaila oil

field from 1980 to 1990 (roughly $2.5 billion), cede the islands of Warbah

and Bubiyan to Iraq, and abandon any claim within OPEC for a higher

output quota. Peter Build noted in the same publication that Iraq wanted

OPEC to maintain its output quota at 22.5 million barrels a day for the rest

of the year and to agree that the target price for the OPEC basket should be

raised to $25.00/bbl. (13) In this environment the members of OPEC met at

the end of July in Geneva to discuss prices for the second half of the year.

Ultimately the members compromised by raising the target price to

$21.00/bbl. Prices rose during July, reflecting the view of market

participants that the underlying supply picture had changed. Both forward

and spot prices rose during the period, with spot prices continuing to sell at a

46

discount to forward prices. By the end of July, spot oil was quoted for

$20.04/bbb while far forward oil was selling for $21.40/bbl, an increase of

$2.13/bbl from January levels. By the end of July one could infer from the

term structure of oil prices that Iraq would be successful in its efforts to

boost the OPEC basket. My own analysis, released on July 31, indicated that

the basket would rise to $21.00/bbl by the end of December.14 the analysis

also suggested that the price of WTI would raise to $26.00 by December.

This projection of the December price of WTI derived from an examination

of the term structure of prices and the supply of inventories. Adherence to a

production quota of 22.5 million barrel's per day from August 1 through the

end of December would have required that free world crude oil inventories

be reduced by 200 million barrels by the end of the year to meet projected

consumption; US stocks would have had to be reduced to perhaps 312

million barrels. This reduction in stocks would have caused the oil market to

revert to backwardation. The of the relationship between stocks and spreads

led to conclude that, by December, WTI for January 1991 delivery would

sell for a premium of $4.00/bbl to forward contracts for January 1992 oil.

This would put prompt WTI at $27.00/bbl in December if far forward oil

remained at its end-of-July level of $23.00/bbl.

Impact of invasion:Iraq's invasion and the ensuing embargo totally changed conditions in the oil

market. The initial concern of consuming-country government and oil

company officials was the loss of crude oil supplies. However, these worries

were eased as other oil-exporting nations agreed to increase output to

replace the lost crude oil. First, the replacement crude oil was heavier than

the lost Kuwaiti and Iraqi oil. Finally, the uncertainties associated with the

47

problems in the Middle East caused demand for precautionary stocks to

increase. The world lost roughly 1 million barrel's per day of light end-

products--naphtha’s, gas oil (heating oil and diesel fuel), and aromatics--

while gaining approximately 1 million barrels per day of fuel oil. Lost

Refining Capacity The problem of balancing the supply and demand for

products was complicated by the loss of refining capacity in Kuwait. Prior to

the invasion Kuwaiti refineries had the capacity to process 800,000 barrels

of crude oil per day. Cranfield reports that the largest of these units produced

a mix of 23.6 percent naphtha (devoted mostly to petrochemical feeds), 23.6

percent aviation fuel and 47.3 percent gas oil and diesel oil." (16) Increased

Jet Fuel Consumption the precarious balance in the market was further

exacerbated by the increased demand for jet fuel associated with the military

buildup that followed the invasion. Greater military use of jet fuel has

apparently increased this demand by 200,000 to 300,000 barrels (5 percent

to 7 percent). In Europe, the price of jet fuel on spot markets increased by

149 percent, from 59cts/gallon to 147cts/gallon. The rise in jet fuel prices

tended to pull up the prices of crude’s that yield a high percentage of middle

distillates. Increased Demand for Stocks Market conditions were also

exacerbated by an increased demand for inventories following the invasion.

(8) Light crude oils that had high yields of gasoline and gas oil were

particularly popular. Williams draws an analogy between the transactions

demand for commodity stocks and the transactions demand for money

balances. In a similar fashion, oil companies will prefer to increase stocks if

the cost of acquiring incremental stocks rises. In turn, the rise in spot prices

during August and September resulted as firms drew down stocks, working

their way down the new supply-of-storage function.

48

2. OPEC and the oil price collapse of 1998–99:When OPEC oil ministers met in Jakarta, November 26-December 1, 1997,

with the Brent oil price at $20/barrel, they decided to increase their oil

output ceiling from 25 to 27.5 million barrels/day (Middle East Economic

Survey [MEES], December 8, 1997). Two years later the Jakarta meeting

was termed “one of the biggest mistakes in OPEC history” by Venezuelan

Energy Minister Ali Rodriguez (MEES, April 3, 2000). By not foreseeing

the decline in Asian oil demand precipitated by the currency and banking

crises in the fall of 1997, as compounded by other factors, OPEC had

contributed to an oversupply in the oil market in 1998 and a collapse in oil

prices which caused major damage to OPEC economies The Brent oil price,

already falling in January 1998, reached about $13/barrel in March and

declined to below $10/barrel in December.1 Several factors outside of

OPEC’s control converged to reduce demand and increase supply in 1998:

1) Asian oil demand, which had become extremely important in global

incremental oil demand growth, reversed and went negative, reducing

anticipated oil demand by almost one million barrels/day. Russian oil

exports were increased 600–800,000 barrels in the fourth quarter to produce

needed dollars.

2) An exceptionally warm winter in North America, Europe, and Japan

further suppressed demand by about one million barrels/day and turned what

is normally a seasonal stock draw into a period of stock build during the first

quarter.

3) In China, oil imports were reduced toward the end of the year in an effort

to preserve hard currency, reaching a peak decline of nearly one million

barrels/day. (Petroleum Industry Research Foundation, 1999).

49

The collapse of oil prices in 1998 and into early 1999 led to a major

reduction in OPEC oil export revenues which undermined member

countries’ fiscal stability and caused sharp cuts in state budgets. In 1998

OPEC revenues were estimated at just under $100 billion, down 35% from

the $154 billion earned in 1997. In real dollars OPEC revenues peaked in

1980 following the second oil shock. 1998 represented OPEC’s worst

revenue year since then, slightly lower than the previous low point brought

about by the oil price collapse of 1986. Saudi Arabia, for example, saw its

oil revenues fall 28% between 1997 and 1998 to around $29.7 billion.

Between January 1998 and March 1999, Saudi oil prices averaged between

$9 and $13/barrel. As is the case in many OPEC producer

Stocks remained high throughout 1998 and exerted a downward pressure on

the world oil price, which greatly complicated OPEC management efforts.

There has always been a strong inverse relationship between oil stock levels

and oil prices,. The collapse of oil prices in 1998 and into early 1999 led to a

major reduction in OPEC oil export revenues which undermined member

countries’ fiscal stability and caused sharp cuts in state budgets. In real

dollars OPEC revenues peaked in 1980 following the second oil shock.

Between January 1998 and March 1999, Saudi oil prices averaged between

$9 and $13/barrel.

3. OPEC regroups and prices recover, and then overshoot, 1999–2000:

In February 1999, the oil price of the OPEC basket was at

$10/barrel, and OPEC output had risen to almost 28 million barrels/day

driven by noncompliance with the agreements of the previous year. Oil

prices began to climb back upward. In May, Saudi Oil Minister Ali Naimi

commented that for him a “reasonable price” of crude would be in the range

50

of $18–20/ barrel. By September, MEES estimated OPEC compliance at

94%, but noted that OPEC needed to reduce still more to attain full

compliance with the March quotas (September 20, 1999). By September, the

Brent oil price surpassed $23/barrel. Venezuela began to press for some kind

of OPEC price band mechanism. OPEC might at this point have taken some

action to increase oil supply to head off further price escalation, but it did

not. By the end of February 2000, WTI crude oil prices had risen above

$30/barrel. Reduced heating oil stocks and escalating prices in the United

States in early 2000 led US Energy Secretary Bill Richardson to visit several

OPEC countries to argue for oil production increases. Realizing that oil

prices may have gone too high, OPEC increased its oil output target four

times during 2000, adding ostensibly 3.7 million barrels/day to supply. Oil

prices remained high at over $30/barrel for much of the year, although they

dropped briefly following OPEC decisions (Fig. 4). Nigeria and Venezuela

favored 1.5 million barrels/day. Saudi Oil Minister Ali al-Naimi expressed

his personal preference to maintain oil prices between $20 and $25/barrel

Brent, and he did not mention the price- band (, April 3, 2000). While oil

prices dropped slightly following the March meeting, by mid-June prices

surged to over $31/barrel. Saudi Oil Minister Ali al-Naimi and OPEC

Secretary General Rilwanu Lukman both proclaimed that OPEC’s long run

price target was $25/barrel for the OPEC basket of crude’s (the midpoint of

the price band) (, June 26, 2000). When oil prices did not decline after the

June meeting, Saudi Arabia said in early July that it would add another

500,000 barrels/day to the market to move prices downward toward

$25/barrel. OPEC was overshooting its mark. On September 10, OPEC met

again and announced a production increase of 800,000 barrels/day effective

October 1. This raised the production ceiling to 26.2 million barrels/day

51

excluding Iraq. Oil prices did not respond much to this announced increase

in supply because of market concerns about OPEC’s lack of spare capacity.

The real production increase was probably about 300,000 barrels/day. Much

lesser amounts were held by Kuwait— 260,000 barrels/day; Nigeria—

200,000 barrels/day; UAE—120,000 barrels/day. Mexico, a non-OPEC

member, which had been cooperating with OPEC, had 300,000 barrels/day

in spare capacity. Other OPEC countries with little or no spare capacity had

little to gain by further OPEC output increases since they were not able to

raise their production sufficiently (International Energy Agency [IEA],

Monthly Oil Market Report, September 2000 as excerpted in MEES,

September 18, 2000). The price of crude oil dropped following this

announcement to around $30/barrel, but then increased again in October One

of the reasons for the persisting high oil prices was the continuing low level

of oil stocks in OECD countries, especially the United States (see Fig. 2). As

oil prices continued to hover well over $30/barrel, OPEC invoked its price

band mechanism for the first time and announced at the end of October an

increase in quotas of 500,000 barrels/day. In December 2000, oil prices

suddenly dropped—WTI by almost $8/barrel and dated Brent by more than

$10/barrel the price fall began in Asia, where oil supplies were abundant,

then moved westward. The 1990’s oil prices nominal and adjusted in year

2004 are given on the next page.

52

1990’s oil prices:

Year’s nominal prices in year 2004 dollars

1990 23.81 31.59

1991 20.05 25.70

1992 19.37 24.27

1993 17.07 20.91

1994 15.98 19.16

1995 17.18 20.19

1996 20.81 24

1997 19.30 21.89

1998 13.11 14.71

1999 18.25 20.18

2000 36.20 36.20

Source: U.S. Energy Information Administration, U.S. Departments of Commerce and Labor.2004

53

The prices are graphed on next page there are huge Fluctuation in oil prices from year 1990 to 2000. The oil price line starts from peak and then falling again it again it is rising when OPEC regroups.

Oil prices graph 3, from 1990 to 2000

0

10

20

30

40

50

60

70

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

years

nominal prices in year 2004 dollars

In 1990-190 the prices are high but later on the prices start falling as the non

OPEC production increases. And prices increases when OPEC regrouped in

1999-200.

54

Price relatives:

For measuring price relatives we will take 1990 as a base year.

Year Nominal oil prices Price relative

Pn/Po*100

1990 23.81 100

1991 20.05 84.20

1992 19.37 81.35

1993 17.07 71.69

1994 15.98 67.11

1995 17.18 72.15

1996 20.81 84.75

1997 19.30 81.05

1998 13.11 55.06

1999 18.25 76.64

2000 36.20 152.03

55

The 1990’s decade of the oil prices fluctuation. After the Iraqis invasion on

Kuwait the oil prices rises from 18 to 23 and remains the same in 1990. But

after this year from table we can see that the oil prices start falling. And this

fall in oil prices is 15.8%. And there is continuous falling in prices up to

1994. And a price starts increasing up to 1997. Then in 1998 the oil a price

again falls because of OPEC false decision. And fall in the oil prices is

4.49% and compare to the prices of year 1990.but in February when

regrouped they get good result and oil prices rises. The increase in oil prices

from year 1998 to year 1999 is 21.58%. And year 2000 there is 52% rise in

prices as compare to year 1990 after the OPEC regrouping.

56

Chapter 6

57

6. Conclusion:

From the study we come to know that the 1973, 1979 and 1990 oil

crises were driven by political or military events. In these year the oil prices

shows different fluctuation with the OPEC decision. In 1973 OPEC was

successful in raising oil prices. the 1979 oil prices also rises because of the

Iranian revaluation and the 1990 oil crises was The cause of the Iraqi

invasion of Kuwait Unlike previous oil crises (1973, 1979, 1990) which

were driven by political or military events, the oil prices collapse of 1998

and the price shock of 2000 were caused by fundamental economic forces—

an imbalance of supply and demand. After its initial misjudgments of the oil

market in late 1997 and in 1998, and further weakened by its lack of

discipline, OPEC did demonstrate in 1999 and 2000 that it has market power

and the ability to turn the market around, first by cutting production in 1999,

then by expanding production in 2000. However, it miscalculated again in

2000 as to the amount of additional supply that would be needed to hold

prices at or under $30/barrel, and as a result prices soared above $30 for

much of the year. This had damaging effects on the world economy and was

not in OPEC’S long-term interest, as the organization itself recognized.

Political factors that were important in enhancing OPEC discipline during

this period include the election of the Chavez government in Venezuela (in

late 1998), which adopted a much more pro-OPEC oil policy, and the

establishment of a Saudi-Iranian rapprochement at the highest levels to

maintain more stable oil prices and manage Iraq. Changes of government in

Nigeria and Algeria have also apparently contributed to cooperation. OPEC

itself has increased the frequency of its meetings to four or more each year,

58

which puts it in a better position to fine-tune the market and react to changes

in supply and demand. Saudi Arabia has become more proactive in leading

OPEC decisions. The oil ministers in several countries are now technocrats,

not political figures, which makes cooperation easier; for example, Ali al-

Naimi in Saudi Arabia and Chakib Khelil in Algeria, who recently served as

OPEC’s president. Cooperation by several non OPEC countries, especially

Mexico and Norway, was very important in assisting the market turn-around

in 1999.

Recommendation:

The oil prices should not let to be set by some organization. It is to be set the

market forces. The private organization always looks to make profit and not

to the welfare of the people. And as we know that the oil has important role

in the life of people so it is not in favor of the ordinary people to raise the oil

prices.

59

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