OPEC and Adam Smith

Abstract

ABSTRACT Unless OPEC can discipline itself to production levels that will result in the spot price of crude being equal to or greater than the contract price of crude, the demand for OPEC crude, along with the price of crude, will continue to erode for the remainder of the decade. Because of the quantum jump in energy prices during the 1973-74 and 1979-80 periods, certain irreversible forces have been set in motion that have changed the structural demand for energy. These forces have resulted in a decline in energy demand per real GNP in the major industrialized nations of in excess of 24%, indicating price elasticities of between −0.3 and −0.5. This suggests that, regardless of the strength in the economies of the nations of the industrialized world, an "off oil" policy has been put into place through conservation, efficiencies, substitutions, and new technology. Moreover, superimposed on this major structural change in demand for petroleum has been the amount of nonOPEC oil and nonpetroleum supplies coming into the market at an annual rate of 1.0-2.0 million BD per year. The bottom line to these structural changes is pressure on OPEC to reduce production and/or prices in order to maintain its viability as an organization. Failure to exercise the discipline or proration suggests that Adam Smith's Economics 101 will continue to wind down oil prices for the remainder of the decade and possibly beyond.