Question

Saudi Arabia steps up oil price war with big production increase
Saudi Arabia has intensified the oil price war by ordering its state-owned producer, Saudi Aramco, to raise the maximum production rate to record highs of 13m barrels a day.
The world’s most profitable company told the Saudi stock exchange on Wednesday that it would increase how much oil it can comfortably pump per day by 1m barrels to its highest rate ever.
The state order to raise Aramco’s “maximum sustainable capacity” comes after the kingdom launched a price war on rival petro-nations by vowing to raise its production by a quarter from last month despite an oil demand slowdown because of the coronavirus outbreak.
The Saudi government plans to raise its national oil production to an average of 12.3m barrels a day from next month, up sharply from less than 10m barrels in recent months, in an attempt to corner the global market.

(source:oilprice.com)
Saudi Arabia, the world’s biggest oil exporter, is understood to be anxious to defend its market dominance against a rising tide of oil production in the US and Russia after talks to agree new limits on global production fell apart over the weekend.
Moscow refused to cooperate with an OPEC plan to curtail oil production in line with a global demand slowdown, which is expected to wipe out forecasts for demand growth in 2020.
In response, the Saudis have offered discount rates to key buyers, in direct competition with Russia, which plans to raise its own production by 300,000 barrels a day.
The collapse of Opec’s talks with major producers outside the cartel, known as Opec+, marks an end to an almost four-year alliance established in the wake of the 2016 oil price crash to shore up market prices by limiting new supply into the market.
Russia’s energy minister, Alexander Novak, has not ruled out further talks with Opec to help stabilise the oil market. But both sides of the price standoff are adamant that they are prepared to weather a prolonged price rout.
Saudi Arabia has some of the lowest production costs in the world, meaning Aramco could withstand low prices far better than other big oil companies. However, the Saudi economy relies more heavily on oil revenues than most countries and reportedly requires prices of about $50-$60 (£38-£46) a barrel to support its state coffers.
In Russia, production costs are higher but its economy is more diverse and arguably more resilient to another oil market downturn.
The oil price war was ignited this week by the steepest price crash since 1991, which drove prices down to four-year lows of about $35 a barrel on Monday and sparked fears of an extended oil market downturn in 2020.
The price shock has wiped billions from the market value of oil companies this week, forcing down the share price of big firms including Shell and BP by about 20%, and raising concern over their dividends.
Analysts at Rystad Energy have warned that oil prices in the $30 territory could spell trouble for oilfield service companies too as big producers cut their spending on new projects. This spending could fall by $100bn in 2020 and a further $150bn next year, Rystad said.
The geopolitical spat has also compounded fears of a global economic slowdown, which accelerated this year after the outbreak of the Covid-19 virus
(Adapted from the Guardian Wed 11 Mar 2020)

Questions
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1) What has happened to the price of oil since the beginning of January 2020? According to the article which country, Russia or Saudi Arabia, is in a better position to sustain prices at this low level for the longest period of time? Justify your answer.


2) According to the article why has Saudi Arabia decided to increase oil production to record levels at this time?

3) Using demand and supply diagrams examine the most likely causes for the fall in the price of oil since the beginning of January 2020.   
4) What is a cartel and how does it influence the price and output of oil. In your answer you should refer to the type of market structure normally associated with a cartel and the features which help or hinder collusion.

5) Why are some of the members of OPEC and other oil producers increasing production even though the price elasticity of oil is relatively inelastic?

Answer 1

Answer 1: The oil price war was ignited by the steepest price crash since 1991, which drove prices down to four-year lows of about $35 a barrel on Monday and sparked fears of an extended oil market downturn in 2020.In Russia, production costs are higher but its economy is more diverse and arguably more resilient to another oil market downturn. So, Russia is in a better position to sustain prices at this low level for the longest period of time. On the other hand, the Saudi economy relies more heavily on oil revenues than most countries and reportedly requires prices of about $50-$60 (£38-£46) a barrel to support its state coffers.

Answer2: Moscow refused to cooperate with an OPEC plan to curtail oil production in line with a global demand slowdown leading Saudi Arabia deciding to increase oil production to record levels at this time.

Answer3:

The demand for oil was low this year meaning a negative demand shock and demand curve shift leftward to AD2. With price war supply was increased and Supply was increased to AS2. This lead to a new equilibrium at point A which reduced prices for oil.

Answer4: A cartel is a grouping of producers that work together to protect their interests. Cartels are created when a few large producers decide to co-operate with respect to aspects of their market. Once formed, cartels can fix prices for members, so that competition on price is avoided. In this case cartels are also called price rings. They can also restrict output released onto the market, such as with OPEC and oil production quotas, and set rules governing other aspects of the behaviour of members.

Oligopolistic firms join a cartel to increase their market power, and members work together to determine jointly the level of output that each member will produce and/or the price that each member will charge. By working together, the cartel members are able to behave like a monopolist.

Once established, cartels are difficult to maintain. The problem is that cartel members will be tempted to cheat on their agreement to limit production. By producing more output than it has agreed to produce, a cartel member can increase its share of the cartel's profits. Hence, there is a built‐in incentive for each cartel member to cheat.

Answer2: They are doing this to drive away the competition. The cost of oil production is more in US than Suadi Arabia or Russia. With low oil prices they will be able to capture US oil market.