Chapter 38 Energy Prices

1. Chapter 38Energy Prices

2. Chapter Outline • Historical View • OPEC • Why Prices Change So Fast? • What Will The Future Hold? • Kick It Up A Notch

3. Real Oil and Gas Prices2005 dollars Per gallon (1 barrel=42 gallons)

4. Historical Events Relating to Oil and Gas Prices • 1972 Arab-Israeli War • US support for Israel prompted an embargo by Arab oil producers against the US and Europe. This led to a significant increase in crude oil prices. • 1979 Iranian Revolution • Iran’s Islamic revolution led to instability in the Persian Gulf. This led to a significant increase in crude oil prices. • 1980’s • Rapid increases in profits led to significant discoveries of oil in Mexico and the North Sea • 1980-1988 Iran-Iraq War • The war led to increased production by both parties as each needed to fund their war effort. This caused a precipitous fall in crude oil prices.

5. World Oil Reserves

6. OPEC • The Organization of Petroleum Exporting Countries (OPEC) • Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela • OPEC began as a cartel. • A cartel is an organization of individual competitors that join to form as a single monopolist.

7. Was OPEC a Cartel? OPEC production has always been a significant part of the oil market but it has never reached the level of monopoly. The cartel model is still useful because it has been a dominant player.

8. Market for Oil One Country’s Oil P P MC S=MC Profit Profit ATC MR’ Pcartel PPC MR D QPC Qcheat Qquota Qcartel QPC Q Q MR The Cartel Model

9. Why Oil and Gas Prices Change So Fast • Because expected price is a determinant of supply and demand a world event that causes people to expect a price increase will • Increase current demand (as middlemen and consumers try to buy as much as possible) • Decrease current supply (as middlemen and gas stations try to hold onto their current stocks) • This causes an immediate increase in prices.

10. Historical Events Relating to Oil and Gas Prices • 1990 Iraq Invasion of Kuwait • 1992-1998 OPEC massive overproduction • 1999 OPEC discipline • 2003 US invasion of Iraq • 2004-2005 Hurricanes in the Gulf of Mexico • 2007 Iran-US tensions; Commodity Speculation • 2008 Global Financial Crisis

11. From $1 to $4 in Ten Years • OPEC production cuts; Low stocks of oil; bad weather • Release of oil from the Strategic Petroleum Reserve; recession • Political unrest in oil producing Venezuela and Nigeria; War in Iraq • Hurricanes Damage Platforms in the Gulf of Mexico • Threatened Conflict b/w U.S. Iran • Global Commodity Speculation • Global Financial Crisis

12. Gasoline Prices 1998-2008

13. Gasoline Prices and Hurricanes A significant portion of refining capacity in the US is in the Gulf of Mexico

14. Electricity • Residential electric power tends to be sold by a regulated monopoly. • It has been a monopoly because of significant barriers to entry. • It has been regulated because prices would be much higher than is socially optimal.

15. Types of Monopolies • Simple Monopoly: a monopoly in which marginal costs of production are rising. • Natural Monopoly: a monopoly in which marginal costs of production are falling.

16. Monopoly in the Market for Residential Electricity • The market for residential electricity is likely to be a natural monopoly for nuclear power because of the very high fixed costs (transmission lines and the power plant and diminishing marginal costs.) • The market may be characterized as a simple monopoly or natural monopoly for coal or gas generated electricity.

17. An Unregulated Simple Monopoly MCMonopoly P Pmonopoly D MR Qmonopoly Q

18. An Unregulated Natural Monopoly P Pmonopoly D ATC MR MCMonopoly Qmonopoly Q

19. An Regulated Simple Monopoly MCMonopoly P Pmonopoly Pregulated D MR Qregulated Qmonopoly Q

20. An Regulated Natural Monopoly P Pmonopoly D Pregulated ATC MR MCMonopoly Qmonopoly Qregulated Q