Oil might soon be $25 a barrel or less

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From the archives: What Bluford H Putnam and Lee Thomas said about the falling oil price in 1983.

Oil_1983_illustration

by Bluford H Putnam and Lee Thomas
February 1983

Market forces have turned against Opec. Even an economic upswing will not make the industrial countries buy oil in the old lavish way. And some of the suppliers, already in trouble, are fiercely competing to sell.

An oil price of $25 per barrel or less – perhaps much less – seems likely. The cause of this sharp fall is not primarily the world recession, though the current slowdown may well have precipitated the crisis. We will probably not see an Opec price of any consequence until long after the economies of the world have shaken off their current malaise.

In the long run the real price of any commodity depends on underlying demand, and on the costs of satisfying that demand, using substitutes. In the oil market, the forces of conservation and substitution have developed slowly, but ultimately they must prove to be irresistible. The real question is not why the price of oil will fall, but rather why Opec was so successful for so long.

Further reading
 
Oil price lessons from 1983

Some researchers argue that the only successful cartel is one with only one member who controls 100% of the market. Others argue that even this is not enough. There must also be an absence of competing products.

Opec now controls well under half the world’s oil supply. And there are numerous alternative sources of energy.

Opec was able in 1974, and to some degree again in 1979, to influence the supply conditions in the oil market by a much greater proportion than its share of the market would suggest. It had the help of the US, Canada and the Soviet Union.

Political conditions in the US and Canada led to energy policies which strengthened Opec. Both countries attempted to shelter their domestic markets from the effects of Opec’s price rises. This destroyed incentives to conserve oil (demand side) or to increase domestic exploration and production (supply side).

The Soviet Union, an oil-producer, uses oil as a tool to subsidize and control the economies of Eastern Europe. Until recently, when everything turned sour economically in Eastern Europe, and the Soviet Union needed cash as well, it was controlling its oil production in support of the Opec price.

Oil_1983

Thus, major parts of the world oil market acted in support of Opec in 1974, and to a lesser extent in 1979. With this kind of assistance, the cartel appeared to work. Appeared is the right word, however, for as the US and Canada have shifted to more competitive oil pricing policies, and the Soviet Union has faced more difficult conditions in its backyard, Opec has been forced to operate in an increasingly competitive world. Energy policies in the US, and to a lesser extent in Canada, now promote incentives on both the demand and supply sides. These factors will keep Opec at bay long after the recession has ended.

The inflationary 1970s did much to distort relative prices among goods. The table compares the US consumer price index with the price of Saudi Arabian oil over the last 30 years. Between the 1952-55 and the 1981-82 periods, the relative price of oil has increased fivefold, compared to the prices of all goods in the consumer price index.

Restoring a reasonable relationship between oil and other prices

The trebling of the real oil price since 1975 is all the more remarkable because relative commodity prices were generally falling. In the long run, primary commodity production, including oil and metals extraction, probably represent mature industries which will claim a decreasing portion of future world GNP. The growth sectors in the developed economies, especially services, computers and communication technologies, are not commodity-intensive. The dramatic shift in the relative oil price is surprising. What is not surprising is the fact that it has set in motion supply and demand changes which will restore oil prices to a more reasonable relationship with other prices.

Some simple calculations indicate just how far oil prices could fall. If the relative price fell to the average for the 1952-60 period, with a complete collapse of Opec, the price of Saudi Arabian crude could be between $6 and $7 per barrel. But some long-term trend increase in the relative price of oil may have occurred. If the 1975 price of oil is taken as a benchmark – and this allows for the first Opec price shock – then a $20 per barrel price emerges.

All these calculations were pointing to sharply lower prices than the benchmark $34 per barrel prevailing early in 1983. The supply and demand adjustments resulting from recent prices reinforced this impression.

A look at the demand side shows how much economizing has taken place since energy prices began to soar. Oil consumption in the major industrialized countries fell from 39.2 million barrels a day in 1973 to 34.9 mb/d in the fourth quarter of 1981. World recession is one reason, but not the dominant one, as we can see by adjusting oil consumption figures for changes in industrialized countries’ output of goods and services. In fact, between 1973 and 1981, the last year for which statistics are available, the OECD ratio of oil consumption per dollar of GDP has fallen by a remarkable 25%. This trend seems to be accelerating, rather than levelling off.