IB Economics IA Commentary. Title of Extract: OPEC will pump more oil, assures Saudi Arabia

''The only thing I am concerned about is the upward or downward pressure of speculators, analysts and future market investors on prices away from natural market fundamentals."

He said spare capacity would remain at 4 million barrels per day, and for OPEC as a whole at 6 million.

The oil price has risen strongly in the past fortnight, closing in on $US100 a barrel as optimism grows that a "double-dip" recession has been averted and worldwide growth is the most likely prospect. But there is concern that if prices rise much above $US100 there will be a risk of the same financial implosion that was triggered in 2008 when oil hit $US147.

Telegraph, London

This story was found at: http://www.smh.com.au/business/opec-will-pump-more-oil-assures-saudi-arabia-20110125-1a49h.html 

     According to the given extract, the Organization of Petroleum Exporting Countries (OPEC), an association representing the world’s largest oil exporting nations, has vowed to increase their petroleum production to feed the growing demand for petroleum-based products and maintain a reasonable equilibrium price (Equilibrium price – the ideal price at which the quantity demanded and quantity supplied are equal).  Only recently beginning to recover from the 2008 worldwide depression, this effort to preserve current prices (Price – “the amount of money needed to buy a particular good, service, or resource.”) comes from improving consumer optimism and worry among consuming nations that increasing global demand will force prices to skyrocket, bringing pressure on OPEC to maintain good relations with its importers by keeping prices stable and practical.  

     As basic economic theory suggests, an increase in the demand (Demand – the quantity of a product that consumers are willing and able to purchase at a specific price.) of a product will cause its price to increase.  Therefore, consumers are justified in their fear of climbing prices since only three years earlier, crude oil reached its peak of $147 per barrel that caused public determination to retain affordable prices afterward which brought strain on OPEC to further implement methods of price regulation in the future.    In order to combat the rise in price and return it to the original level, an increase in supply (Supply – the quantity of a product that a firm is willing and able to offer at a given price.) must be produced to sustain the demand.  

      In Figure 1, the original supply (S1) and demand (D1) meet equilibrium at Point A, which is established as the most efficient price.  However, when the demand curve increases and shifts outwards (D2), the ideal equilibrium price rises to P2 at Point B.  This is the correlation between the demand and price of oil; as the global population has steadily increased, the demand for petroleum-based products has similarly increased as a necessity to modern industry and has resulted in higher global prices.

     The OPEC reactionary policy of, “meeting any increase in demand with an increase in supply,” can be demonstrated in Figure 2, as a method of price stabilization.  Since a sizeable increase in demand has just occurred in Figure 1 (D2), OPEC then must increase its production to move the supply curve outward (S2) to curb the recent rise in demand.  By increasing the quantity supplied to Q3, the equilibrium price shifts downward from P2 at Point B and settles at P3, corresponding to the new point of equilibrium at Point C.  Since the increase in demand was met directly with an identical increase in supply, the new equilibrium price (P3) has been reestablished with the original price (P1), thus proving OPEC’s equilibrium policy effective in theory given that there are sufficient resources to produce an increased quality supplied.

     While this policy is ideal in economic theory, it fails to consider the prospective consumption of market opportunists who tend to stockpile valuable resources for future use when they speculate an upcoming increase in its price and withhold purchase when prices are likely to fall.  Just as al-Naimi comments, although the organization, “expects price stability to continue at last year’s rates,” by implementing the policy, they are, “concerned about … the upward or downward pressure of speculators … on prices away from natural market fundamentals.”  OPEC members are justified in their concern over the consequences of speculative buying because these purchases falsely drive demand and prices while not fueling an immediate need for the good, either upward or downward according to future predictions instead of current figures.  Since petroleum-based products are essential to industrial society and are among the most sought-after resources, this fallacy in the fragile equilibratory demand-supply relationship can often cause disruptions in price stability, undermining OPEC’s efforts to keep prices consistent.

     While OPEC can manage to keep prices stable in the present by feeding the rising demand with increased supply, the organization will face greater economic difficulties with price stability in the future as the global population constantly rises and oil becomes increasingly scarce.