Question

Much has been made over the past few years of drops and rises in the price of oil, with drops and rises often blamed on OPEC (drops because they are trying to drive out US frackers and rises because they have succeeded in driving them out. Two questions:

1) How can OPEC manipulate the oil market?

2) If you are reducing price to wipe out your competitors, you need a credible strategy to get the money back. Is OPEC able to do this with the frackers?

Answer 1

1) OPEC — which includes Saudi Arabia, Nigeria, Libya, Venezuela, Iran, Iraq and six other countries — has 81.89% of total world oil proven reserves according to 2017 numbers. This means they have the upper hand when it comes to oil production. As of September 2018, The group produced around 44% of total world production of crude oil.

OPEC can manipulate the prices of crude oil in the international market by increasing or decreasing the amount of production.

In an attempt to put US frackers out of business, OPEC can decide to maintain record-high levels of oil production. This will lead to low prices for oil in the international market. Since the shale oil fracking process is much more expensive than the OPEC production method this will drive the US frackers out of business.

Once the frackers are out of business, OPEC retains its dominance on the market and is able to charge what it sees fit for a barrel of oil. If OPEC’s plan is successful.

2) The data shows that production of US oil went down when OPEC was pumping in large quantities during early 2016, and since then the gradual production cuts from OPEC has led to an increase in prices. Rising prices and due to improvement in technology in US oil extraction, the amount of US oil production has also gone up significantly and is highest ever as of today. Not only the supply side but the demand side of the equation also play an important role, an increase in demand leads to higher prices which gives room for US producers to produce more.

Hence we can say that although OPEC is the dominant group in the oil market, it has not been as successful in the long term in the manipulation of prices as it has been in the short term.