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3) Analyse the structure of the oil market and identify what kind of market structure it has.
Global oil producers can be separated into two distinct groups; OPEC (Organisation of Petroleum Exporting Countries) and non-OPEC countries. OPEC produces around 40% of global supply. OPEC was formed in 1960 by several oil producing countries which are substantial net exporters of oil in order to help co-ordinate oil producing policies of member states in order to stabilise the oil market and maintain a ‘reasonable’ profit. () OPEC is an example of a successful cartel as they have managed to successfully impact prices since they were created. Historically cartels have worked to restrain supply in order to maintain high prices. OPEC member states include Saudi Arabia, Libya, Kuwait, Algeria, Nigeria and Venezuela. The head of OPEC is Saudi Arabia. There are also many oil producing countries who are not part of OPEC such as the USA, Russia, Mexico, Canada, Norway/UK.
There are four common economic market structures that the oil market could fall into, they are:
Perfect competition: This is when a large number of firms and customers exist n a market and they sell homogeneous products. Normal profits are earned due to high competition and low barriers to entry.
Monopolistic competition: This is when there are a large number of firms in the market as well as customers. Normal profits are earned selling differentiated products which are similar in nature but to look different by changing some features or advertising it differently. Again there are low barriers to entry.
Monopoly: This is when a market is dominated by one company being the sole supplier of a type of good or service, usually the product they sell has very few or no substitutes so all customers are forced to buy from them, which means it has a ‘cross-elasticity of demand of zero (Press, Lowes and Davies. 2000 P354). Barriers to entry are very high making it impossible for firms to enter the market, this allows the monopoly firm to make abnormal profits, they are price makers not price takers.
Oligopoly: Oligopolistic market is when a few firms have most of the market share, they usually don’t compete on price, and their products are usually homogeneous or differentiated. By dominating the market together they have the ability to set prices. In an oligopolistic market firms sometimes have the ability to collude and set prices higher in order increase profit maximisation. High barriers to entry usually exist to put off new entrants such as high setup cost in high tech markets or high advertising costs such as in the UK soap powder market.
I think the oil market resembles a oligopoly as there a few suppliers and a very large market, OPEC members collude to control world price, although they only control 40% of supply due to price elasticity of demand for oil being very low they are able to influence the price. Barriers to entry are high as oil production is restricted to those countries that have reserves. I think there is a small difference to the traditional form of the oligopoly as OPEC although it represent many oil producing countries it functions as one entity in the oil market, due to the low price inelasticity of demand for oil OPEC enjoys to some extent powers similar to a monopoly structure in terms of pricing even though it has 40% market share.
4) Use demand and supply curves to show the impact of each of the following events on the prie of oil:
i) War in Iraq.
ii) Economic growth in China and India.
iii) Fuel protests which cause uncertainty in the mind of the public about the availability of petrol.
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- The war in Iraq affected both demand and supply, the major affect was on supply as oil exports from Iraq were stopped during the war, before the war began Iraq was producing many millions of barrels of oil each day which stopped. Demand was also affected due to panic buying, consumers feared a price hike due to the reduction in supply and increased uncertainty in the market, the impact on demand was a lot less than the impact on supply.
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- Economic growth in India and China has resulted in demand for oil to increase, as their industries grow their energy requirements have grown heavily, this will result in the demand curve shifting to the right resulting in the equilibrium price of oil increasing.
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- Fuel protests causing uncertainty affect demand as the price rises due to a ‘panic premium’, uncertainty results in panic buying and stock piling of more than is needed which results in the price rising and even more panic buying. This will result in the demand curve shifting to the right meaning a higher equilibrium price.
5) Why is demand for oil inelastic in the short run but not in the long run?
I would consider oil and it’s by-products in most cases a need rather than a luxury as the primary use for oil is for fuel and for producing electricity. In the short run there are fewer alternatives, power stations can not switch from using oil to produce electricity while in the long run they could either convert or close them down and make new power stations that are gas or nuclear powered. In the long run alternative options are available such as wind turbines, solar power or gas, renewable sources are the best solution for the future. In terms of the individual consumer they could switch to more fuel efficient cars in the long run. An increase in the price of oil will usually result in firms investing in developing more fuel efficient processes and equipment, this cant be done in the short run as it requires time, research and investment to develop and implement, if they think the price will increase temporarily they will not do it as the savings at the lower price may not outweigh the investment made to increase efficiency. It may be the case that when the price of oil rises suppliers such as OPEC may be willing to increase the amount they supply as they have spare capacity, this can only be done in the long run, also even if supply is increased, distribution systems will need to become bigger to cope with increase in supply, this again will require more investment and time. In the very long run new reserves can be found but will take a long time before production can begin.
6) What might be the long term consequences of oil becoming a scarce resource?
I think the long term consequences of oil becoming a scarce resource will be a negative impact on the global economy. The more scarce it becomes the higher the price will be as the supply line on the demand and supply graph will shift to the left, the price will rise at a rapid rate due to it high price elasticity of demand. This will affect the profitably of all industries that require oil or buy goods and services which require oil to produce, this covers nearly all industries. It will lead to a price rise in most goods to the consumer as the increase in price is passed on, in some industries this price rise can be passed on to the consumer more than others, goods that people need such as heating or fuel for their cars the suppliers will be able to pass on more of the increased cost, while other goods such as air conditioning units will suffer from lower sales because the cost of operating them will increase as well as the cost of production, people can live without them more easily rather than heating, in general the more of a luxury the product it is the less the increased cost will be passed as more people will make do it without it. Newly industrialised countries will suffer greatly as these industries will make up most of their economic output which will all suffer due to the increased of power, while developed countries like the UK will suffer proportionally less as the services sector is larger as a percentage of total economic output compared to third world countries. Developed countries produce more high tech goods which in terms of the cost of production the fuel required is proportionally a less significant amount compared to less high tech products being produced in nearly industrialised countries such as China where the cost of power is a much larger proportion of the cost of production.
In the long run new sources of fuels will have to be used such as other fossil fuels such as natural gas as well as nuclear power, investment in renewable energy sources will increase as all fossil will run out in the future and the main solution will be renewable energy sources such as solar and wind.
Word count: 2146
Bibliography:
Economist.co.uk and other resources recorded in the essay
Dictionary Economics , Pass, Lowes & Davies, 2000.
Economics, third edition, Elain Anderton
(sorry for length, just realised before handing in I missed out half a question)
