Question

 

Question 2: The following information is extracted from several articles2 about oil market.

An intensifying oil price war between Saudi Arabia and Russia has created “very painful” market conditions for the world’s largest crude oil producers. International benchmark Brent crude traded at $32.97 Thursday, down almost 8%, while U.S. West Texas Intermediate (WTI) stood at $30.40, around 7.8% lower. Oil prices have almost halved since the start of the year.

Last week, Saudi Arabia failed to secure Moscow’s support for deeper output cuts at a meeting of the Organization of the Petroleum Exporting Countries and its allies, known as OPEC plus. OPEC had proposed to deepen cuts by 1.5 million barrels per day and Russia was asked to cut an extra 300,000 bpd.

“There was no point in cutting until after everyone understood how sharply demand could fall. We cannot fight a falling demand situation when there is no clarity about where the bottom (of demand) is,” Pavel Sorokin, the Russia’s deputy energy minister, said.

“It is very easy to get caught in a circle when, by cutting once, you get into an even worse situation: oil prices would shortly bounce back before falling again as demand continued to fall.”

Cooperation between two (Saudi Arabia and Russia) of the world’s three largest oil producers — the third is the United States — appears to be at an end.

2How a Saudi-Russian Standoff Sent Oil Markets Into a Frenzy. 9th March 2020. New York Times Russia to OPEC - deeper oil cuts won't work. 12th March 2020. Reuter The losers — and even bigger losers — of an oil price war between Saudi Arabia and Russia. 12th March 2020. CNBC

a) With aid of diagram, explain how the fall in crude oil demand affect the output of OPEC plus members.

b) Discuss why Russia refuse to follow Saudi Arabia’s proposal to cut crude oil production with aid of diagram.

Answer 1

Fall in crude oil demand amidst lower buyers or practically negligible buyers due to pandemics causes prices to drop extremely low as supply exceeds demand as storage tankers are overflown causing prices to go even zero and negative for first time. To bring prices back to stability, OPEC members agree to cut output production and thus aggregate supply reduces in market leading to slightly better demand and thus price stability through an artificial supply glut or supply shock in short run.

Since Russia thinks cutting production amidst lack of clarity of bottom of demand is useless and is vicious circle which will put oil prices significantly higher and thus cause lower demand and lower market share. Consequently Russia failed to agree to production cuts.