1

Chapter 1
 2

The Organization of Petroleum Exporting Countries (OPEC) is an

international Organization of eleven developing countries that influences
and maintains the price of oil through the control of production levels. The
Organization of the Petroleum Exporting Countries (OPEC) was created at
the Baghdad Conference in Iraq in September 1960. The founding members
of the organization were Iran, Iraq, Kuwait, and Saudi Arabia and
Venezuela. Current OPEC members are Algeria, Indonesia, Iran, Iraq,
Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and
Venezuela. Since oil revenues are so vital for the economic development of
these nations, they aim to bring stability and harmony to the oil market by
adjusting their oil output to help ensure a balance between supply and
demand. OPEC's eleven Members collectively supply about 40 per cent of
the world's oil output, and possess more than Three-quarters of the world's
total proven crude oil reserves. Therefore, people usually connect any oil
price change with the OPEC and there has been considerable curiosity and
concern about its behavior and role in the international oil market. The
principal aim of the OPEC is the coordination and unification of the
petroleum policies of member countries and determination of the best means
for safeguarding their interests, individually and collectively; ways and
means of ensuring the stabilization of prices in international oil markets with
a view to eliminating harmful and unnecessary fluctuations; secure a steady
income to the producing countries; an efficient, economic and regular supply
of petroleum to consuming nations, and a fair return on their capital to those
investing in the petroleum industry.
 3

Importance of the study:

Petroleum is the bloodline for the world economy

in this modern world, and it has important role to every aspect of our lives.
For heating our homes and running cars, and flying planes, this helps in
transportation and fulfilling all the requirements of global village. The
growth of economy is engaged to these means of transportation. These
sources help in the exports and imports of the commodities and earn
valuable foreign exchange for the country. It is clear that petroleum and its
resulting products have helped shape the way modern society works.
However over time, existing petroleum reserves have dwindled in volume
and yield. Thus, the overall supply of petroleum and oil has often been able
to keep up with overall demand. And beside this One of the most powerful
entities that Influences the supply and effective prices of petroleum and oil is
the Organization of Petroleum Exporting Countries (OPEC).opec countries
at the end of 1999 had about 78% of proven oil reserves, but only 41% of
out (oystein noregn, crude power political and oil). The expected life time of
OPEC is close to 80 years at present output, almost double of the world
Average of 41 years. It is said that Non-OPEC countries has no long life and
they will not survive for long time and their power to influence the oil
market will finish soon so the whole authority will be in the hands of OPEC
members. And if the same dependence on oil remains the same in the future
there is no doubt that the OPEC members will rule on the world economy.
Any conscious or non conscious decision by OPEC relating to the petrol
price can effect the economic growth of a country. As rightly pointed by
international Energy Agency in 2004 that $10 rise in price of oil from $25 to
$35 the OECD countries are facing 0.4% cuts in their GDP. Moreover the
 4

world needs for oil and rising prices can have significant inflationary effects
as higher cost of energy can show economic growth forcing consumers to
spend less on non-energy related goods and companies to reflect high energy
costs on their product. The importance of oil also Arises during Yom Kippur
war (october6, 1973) between Arab counties and Israel. The Arab members
of OPEC (known AOPEC) imposed embargo on America for the reason of
helping Israel. Which changed the shape of the war and war is suddenly
stopped. Because of the oil weapon. After the first price shock of 1973–
1974, OPEC was widely viewed by energy experts as a cartel with stability.
Its production of oil in 1973 was 30 629 (000) barrel per day (bpd), that
comprised 55% of the total world oil production (Harri Ramcharran, 2001).
Expectations of growing oil demand, rising prices and secured income from
oil revenues allowed OPEC members to spend and borrow freely. Elaborate
long-range structural, social and economic programs were implemented.

Objective of the study:

1) To study OPEC behavior under different historical oil crisis
2) To study impact of oil price shocks
3) And measure price relative for each oil shocks

Hypothesis:
The study will reveal that weather OPEC and its members has the power to
effect the oil prices

Methodology:
The data is secondary base. And the most helpful websites are
www.digitallibrary.edu
 5

www.docstoc.com
www.osun.org

Organization of the study:

The first chapter is consisting of introduction to
the topic and importance of the study, objective of the study and hypothesis.
Second chapter is literature review. Chapter three has the 1970s oil crises
and four have 1980’s and fifth has 1990’s oil crises. And at the end there is
conclusion from the study.
 6

Chapter 2
 7

Alhaji and huettener (2000) find that neither OPEC nor the OPEC core has
the properties of the dominate firms.

A; f A hajji and David huettener (2000) studied a comparison between opec

and other international commodity cartels to show weather OPEC is a cartel
or not but the analysis shows that difference between OPEC and other
cartels the results showed that theory of cartels as developed in the economic
literature does not fit open very well, particularly in comparison with other
commodity organization. And open is not a cartel because of the absence of
a dominate open market share, open’s overdependence on one commodity
for revenue and the fact that the elasticity of demand for OPEC oil is less
then one. And the oil companies cartel between the 1930 and 1960 fits the
cartels theory much better then OPEC the study showed that Saudi is more
Influential then other OPEC members’ .because Saudi Arabia meets al the
characteristics of a dominate producer by having relati8ely large market
share, excess capacity flexible behavior, the ability to move its prices by
increasing and decreasing production and operating on the elastic part of its
demand curve. And no other OPEC member has similar behavior.

Kohl (2002) argues that OPEC faces difficulties to stabilize oil prices with
Imperfect data and very limited instruments. He suggested the OPEC’s use
of production quotas as the only instrument to stabilize prices has not been
as effectible due to number f factors including geo-political unrest, changes
in demand, changes in Iraqi exports, and production o Non-opec countries

Santis (2003) the study attempted to explain why crude oil prices fluctuate,
the main cause being the quota regime which characterizes the OPEC
 8

agreements. Given that the Saudi oil supply is inelastic in the short term a
shock in the oil market is accommodated by an immediate price change. By
contrast a dominant firm behavior in the long term causes an output change
which is accompanied by a smaller price change. The results of a general
equilibrium model applied to Saudi Arabia supported this analysis. Result
also indicated that Saudi Arabia does not have any incentive for altering the
crude oil market equilibrium as its welfare declines. A second set of
simulations is designed to understand what kind of OECD policy might help
to bring down prices. A tax cut would worsen the situation whereas policies
that increase the price elasticity of demand seem to be very effective.

Deaves and krinsky (2003) studies the effect of OPEC announcement on the
market and what will be the react of the market after the announcement at
the end of meeting. And he finds evidence that traders are under react to
OPEC Conference and this announcement leading to abnormal profit for
certain investors. The behavior of oil futures returns

Internal Energy Agency (May 2004) analyzed the effect of raise of oil price
from $25 to $35 because of OPEC supply management policies in. Due to
which economies show downwards. The results showed that OECD as a
whole losing 0.4%of the GDP. Inflation and unemployment also roused. The
GDP of Euro-zone countries fall by 0.5% and inflation rising by 0.5%
OCED imported more then half of its oil need in 2003 at a cost of over 260
million 2%greater the 2001. The USA will suffer the least with GDP falling
by 0.3% japans FDP fallen by 0.4%.the high oil price also effect the
developing countries more then OECD countries.
 9

Pijush Paul (2005) analyzed that OPEC supply 40% of world’s oil supply
and hold 78% of resources and his analysis showed that OPEC fix oil price
in relations with non-opec courtiers and OPEC’s oil availability is enough
for next few decades and fast production decline in non-opec courtiers may
make OPEC as the key player to decide oil prices but OPEC as a group has a
limited success because of internal cheating it looks like OPEC is losing its
control to decide. The oil prices and market is deciding the price because of
growing demand.

Riza Demier and Ali M.kutan (December 2006) studied empirically the
effect of OPEC’s announcement on crude oil supply from OPEC and non-
opec oil producers. They obtained results that OPEC and no-opec country’s
announcement has effect on crude oil price. The study revealed that non-
OPEC related announcement has significant effects where as OPEC d not
seem to affect the crude oil price more significantly

Guidi et al (2006) looks at the significance of OPEC meetings, but mainly

from the point of view of the impact they have on stock market rather then
on crude oil returns, he divides the data from 196 to 2004 in period of
conflict and non conflict. And then compare the reaction of the stock market
in the US and UK to OPEC quota decision between conflict and non-conflict

Ronond li (2007) has examined two major implication of the dominant firm
model for OPEC and empirically tested .the first implication related to the
production level of the OPEC and each OPEC member country. Pairwise co
integration results indicates that the majority of the opec members do not
move together with the rest of opec in their production level in regards to the
 10

role of opec global oil market. Secondly granger Causality results shows that
there is no statistically significant causality running from OPEC production
to non-Opec production and price level and dominant firm hypothesis is
more consistent with the non-opec producers then the OPEC.

Hamilton (2008) this paper examined the actors responsible of change in

crude oil prices. The paper reviewed the statistical behavior of oil prices and
relates these to the predictions of theory and looks in detail at key features of
petroleum demand and supply. He discussed the role of commodity
speculation, OPEC, and resource depletion. The paper concluded that
although scarcity rent made a negligible contribution to the price of oil in
1997,it could now begin to play a role. If demand growth resumes in china
and other courtiers at its previous rate , the scarcity rent will start to make an
Important contribution to the price, if not now cannot be far away.

Sharon xiaowen Lin, and Michael tamvakisa (24 April 2009) studied the
effect of OPEC announcement on the oil price. the study showed that such
announcement effect price returns but the magnitude of such effects varies
primarily according to the existing price regime quota cuts results in positive
price returns, except in weak market conditions, quota increase do not have a
Clear-cut-effect when prices are relatively high the quota increase are
relatively high. The quota increases do results in negative returns in weak
and normal market price that is neither too low nor too high. No changes in
quota seem to result in negative or insignificant result. The study showed
that there is no significant difference between OPEC and non OPEC crude in
relation to OPEC announcement and there is just a popular belief that OPEC
has superior information on oil price the analyzed showed that the
 11

importance of OPEC announcement is depending on the context in which

they are made. Both the type of decisions9 cut, increase or no change and
price environment (relatively low, average, or relative high) are important
and necessary if one is to evaluate the role and impact of OPEC
announcement on crude oil market.
 12

Chapter 3
 13

1970’s oil crisis:

The 1970’s oil crisis started in October when the “ARAB”

member’s of OPEC imposed oil embargo on the USA in response to sending
military help to the Israel. The “Arab” member’s of OPEC created a new
organization at time which is known as oapec. (Organization of Arab
petroleum exporting countries). OAPEC consisting Arab OPEC plus Egypt,
Syria, and Tunisia. The oapec declared it would limit or stop oil shipment to
the united state and other countries if they support Israel.
In order to understand the main cause of the 1973 oil crisis one must first
know the history of the region and the Arab- Israeli conflict. World War II a
Zionist state, known as Israel, was created on 56% of the land that was
formerly known as Palestine. This state served as a homeland for Jews. The
local Arabs were enraged by the fact that the Palestinian land had been taken
to create this state. They refused to acknowledge Israel as an independent
state. The Arabs began to launch
Efforts to recapture the land that they felt were rightfully theirs. This created
the Suez-Sinai War. The British and the French sided with the Israelis in
order to punish Nasser for nationalizing the Suez Canal. The Israeli military
forces quickly defeated the Arabs. The Arabs responded to this defeat by
uniting. In 1967 Israel launched the Six-Day War, claiming much land. In
1973 Arab forces retaliated. On Yom Kippur, the holiest Jewish holiday,
Arab forces attacked, backed by Soviet technology (The Mid-east Oil
Crisis). Saudi Arabia's King Faisal swayed other oil supporting countries
into placing an embargo on crude oil to Western nations, in late October.
This was meant to punish the Western states that had supplies weapons and
 14

aid to Israel (The Arab oil embargo of 1973-74). Arab oil-producing

countries wished to pressure the Western countries, specifically America
into demanding that Israel withdraw their troops from the Arab Territories
that they had occupied since 1967. This included the ones that the Israelis
had recently conquered. They used the embargo in this way as a political
tactic. They were also able to use the embargo for economic means. Once
they had placed the embargo on the west, the world's largest consumer of
oil, the Arabs realized the power that they had over the world through oil.
Once they had resumed shipments of oil they were able to keep the prices
high and make a larger profit. Panicking investors and oil companies added
to the surge in oil prices in the U.S. These causes plunged a nation where
everything seemed to revolve around cars into desolation and insecurity.
America found that it could no longer afford to thoughtlessly consume oil.
Philosopher E.F. Schumacher said of the crisis, "The party's over."

The imposition of embargo can result long run effect. Such as high
oil price, disturb supply, and can cause recession. With the expectation of
this effect European nations and Japan subsided from the US Middle East
policy.
On October 16, 1973, OPEC announced a decision to raise the
price of oil by 70% to 5.11%a barrel. Arab oil ministers’ agreed to the
embargo, a cut in production by 5% from September’s output. And to
continuous to cut over time in 5% until their economic and political
objective were met
 15

The effect of embargo:

The effects of embargo were immediate OPEC
forced oil companies to increase payments. The prices of oil raised in 1974
nearly to $12. These increases in oil prices has a dramatic effect on the oil
exporting countries, and especially for Middle East who had been dominated
by the industrial powers have controlled the important commodity. The
follow of capital is reserved and they become rich. Some income was given
to the underdeveloped countries that is much hit by high oil price and has
low price of their exporting commodities and raw material and western
demand for their product. And much money is spend n the purchase of
weapon
The control of a vital commodity become known as the “oil
weapon” which came in the form of an embargo and cut back in oil
production from the Arab states to select industrial government of the world
to preserver Israel during the fourth Arab Israeli war in October in October
1973.A few month later, the crises stopped . The embargo was lifted in
March 1974 after negotiations at the Washington oil summit, but the effect
of the energy crisis continued through 1970s. The prices of energy continued
increasing in the following year, aimed the weakling competitive position of
the dollar in world market.

Effect of embargo on USA efforts by government to handle the situation:

The immediate results of the Oil Crisis were dramatic.
Prices of gasoline quadrupled, rising from just 25 cents to over a dollar in
just a few months. The American Automobile Association recorded that up
to twenty percent of the country’s gas stations had no fuel one week during
the crisis. In some places drivers were forced to wait in line for two to three
 16

hours to get gas. The total consumption of oil in the U.S. dropped twenty
percent. This was due to the effort of the public to conserve oil and money.
There was an instant drop in the number of homes created with gas heat,
because other forms of energy were more affordable at this time (Arab Oil
Embargo of 1073-74). The U.S. government went to desperate measures to
improve the situation that America found itself in. Congress issued a 55mph
speed limit on highways. This was a good thing. Not only did oil
consumption go down, but fatalities decreased overnight. Today's fuel
economy stickers come from the effort to preserve oil in the 70's. Daylight
savings time was issued year round in an effort to reduce electrical use.
These changes were made in hopes of preserving oil. Tax credits were
offered to those who developed and used alternative sources for energy (The
Arab Oil Embargo of 1973-74). These included solar and wind power.
Nixon, who was president at that time, ordered the department of defense to
create a stockpile of oil in case the country needed the military to carry it
through a time of chaos. There was a large cutback in oil consumption.
Emergency rationing books were printed although they were never necessary
due to the end of the embargo. Nixon formed the Energy Department and it
became a cabinet office. It developed the national energy policy. They made
plans to make the U.S. energy independent (The Arab Oil Embargo of 1973-
74). Gasoline companies and stations also did all that they could to preserve
oil. Nixon had issued a voluntary cutback on the consumption of gasoline.
Gas stations would voluntarily close on Sundays. They refused to sell to
customers who weren’t regulars. Gas stations also wouldn't sell more than
ten gallons of gasoline to a customer at a time. They felt that these efforts
would help the public to become more fuel-efficient (The Arab Oil Embargo
of 1973-74). The public helped to retain energy as well. Families turned
 17

their thermostats down to sixty-five degrees. The rise in oil prices also
caused the public to be more fuel-efficient. Companies and industries
switched their energy source to coal (The Arab Oil Embargo of 1973-74).
People searched for alternative energy sources. People traded their
mammoth cars that had thoughtlessly been speeded down highways to over-
heated homes in the suburbs for smaller more fuel-efficient models.

The 1973oil crisis and recession in the united state:

1970’s was a period
of economic recession in much of the western countries. And putting and
end to the boom after world war two and it was different from any previous
recession. This was a periods of stagflation where there was high
unemployment and high inflation. The main causes of the stagflation were,
the Vietnam War, 1973, fall of Bretton wood system and 1973’s oil crisis.
According notational bearue of economic research, the recession in the
united state lasted from november1973tomarch 1975. During recession, the
GDP of US fell by 6% the unemployment was9 %.

1973 oil crisis and stock market crash:

The 1973 oil crisis affects all the
major stock market in world, including particularly UK. It was on of the
worst market downturns in modern history. The crash came after the
collapse of Breton wood system in the previous two year and it is
compounded by the outbreak of the 1973 oil crises of that year.

In the 694 days between 11 January 1973 and 6 December 1974, the New
York Stock Exchange's Dow Jones Industrial Average benchmark lost over
 18

45% of its value, making it the seventh-worst bear market in the history of
the index (Woodard, Dustin."1973-1974 Stock Market Crash). 1972 had
been a good year for the DJIA, with gains of 15% in the twelve months.
1973 had been expected to be even better, with Time magazine reporting,
just 3 days before the crash began, that it was 'shaping up as a gilt-edged
year'. In the two years from 1972 to 1974, the American economy slowed
from 7.2% real GDP growth to -2.1% contraction, while inflation (by CPI)
jumped from 3.4% in 1972 to 12.3% in 1974 (Davis, E. Philip (January
2003).

Worse was the effect in the United Kingdom, and particularly on the London
Stock Exchange's FT 30, which lost 73% of its value during the crash. From
a position of 5.1% real GDP growth in 1972, the UK went into recession in
1974, with GDP falling by 1.1%. At the time, the UK's property market was
going through a major crisis, and a secondary banking crisis forced the Bank
of England to bail out a number of lenders. In the United Kingdom, the crash
ended after the rent freeze was lifted on 19 December 1974, allowing a
readjustment of property prices; over the following year, stock prices rose by
150%.However, unlike in the United States, inflation continued to rise, to
25% in 1975, giving way to the era of stagflation. The Hong Kong Hang
Seng Index also fell from 1,800 in early 1973 to close to 300.

Macro economic effects:

The 1973 oil crisis was a major factor in Japan’s
economy shifting from oil-intensive industries , and resulting huge Japanese
investment in industries such as electronics, the Japanese auto makers also
took advantage of this embargo after the realized what fuel cost were in
united states, they started producing small, more foul efficient models,
 19

which began selling as an alternative to “gas-guzzling” American vehicles I

of the time .this trigged a drop in American auto sales that lasted into 1980’s
The western nations “central banks” r decided to sharply cut interest rates to
encourage growth, deciding that inflation was a secondary concern but this
was not so effective decision and it surprised the central banks and policy
makers.

1979 Iranian revolution:

The 1979 (or second) oil crisis in the united state

occurred in the wake of the Iranian revolution. Amid massive protests, the
shah of Iran, Muhammad reza Pahlavi, fled his country in early 1979,
allowing the Ayatollah Khomeini to gain control. The protests shattered the
Iranian oil sector. While the new regime resumed oil exports, it was
inconsistent and at a lower volume, forcing prices to go up. Saudi Arabia
and other OPEC nations, under the presidency of Dr .Mana Alotaiba
increased production to offset the decline, and the overall loss in production
was about 4 percent. However, a widespread panic resulted, driving the price
far higher than would be expected under normal circumstances. In 1980,
following the Iraqi invasion of Iran, oil production in Iran nearly stopped,
and Iraq's oil production was severely cut as well.

After 1980, oil prices began a six-year decline that culminated with a 46
percent price drop in 1986. This was due to reduced demand and over-
production, which caused OPEC to lose its unity. Oil exporters such as
Mexico, Nigeria, and Venezuela expanded production. Ending of price
controls allowed the US and Europe to get more oil from Prudhoe Bay and
the North Sea.
 20

Iran:

In November 1978, a strike by 37,000 workers at Iran's nationalized oil

refineries initially reduced production from 6 million barrels (950,000 m3)
per day to about 1.5 million barrels (240,000 m3) .foreign workers (including
skilled oil workers) fled the country. On January 16, 1979,shah of Iran,
Muhammad reza Pahlavi and his wife left Iran at the behest of Prime
Minister shapour Bakhtiar (a long time opposition leader himself), who
sought to calm down the situation.

Effect on Other OPEC members

OPEC net oil export revenues for 1971 – 2007

FIGURE SURCE: www.eia.doe.gov/emeu/cabs/OPEC_Revenues/OPEC.html.

The rise in oil price benefited other OPEC members, which made record
profits.
 21

Effect on the United States:

Richard Nixon had imposed price controls on domestic oil, which had
helped cause shortages that led to gasoline lines during the 1973 oil crisis.
Gasoline controls were repealed, but controls on domestic US oil remained.
The jimmy carter administration began a phased deregulation of oil prices on
April 5, 1979, when the average price of crude oil was US$ 15.85 per barrel
(42 US gallons). Over the next 12 months the price of crude oil rose to
$39.50 per barrel (its all time highest real price until March 7, 2008.)
Deregulating domestic oil price controls allowed domestic U.S. oil output to
rise sharply from the large Prudhoe Bay fields, while oil imports fell sharply.
Hence, long lines appeared at gas stations, as they had six years earlier
during the 1973 oil crisis. As the average vehicle of the time consumed
between two to three liters (about 0.5-0.8 gallons) of gasoline (petrol) an
hour while idling, it was estimated that Americans wasted up to
150,000 barrels (24,000 m3) of oil per day idling their engines in the lines at
gas stations .
During the period, many people believed the oil companies artificially
created oil shortages to drive up prices, rather than factors beyond human
control or the US' own price controls. The amount of oil sold in the United
States in 1979 was only 3.5 percent less than the record set for oil sold the
year previously.

Many politicians proposed gas rationing; one such proponent was Harry
Hughes, Governor of Maryland, who proposed odd-even rationing (only
people with an odd-numbered license plate could purchase gas on an odd-
numbered day), as was used during the 1973 oil crisis. Several states
actually implemented odd-even gas rationing, including Pennsylvania, New
 22

Jersey, and Texas. Coupons for gasoline rationing were printed but were
never actually used during the 1979 crisis. On July 15, 1979, President
Jimmy Carter outlined his plans to reduce oil imports and improve energy
efficiency in his "Crisis of Confidence" speech (sometimes known as the
"malaise" speech). It is often said that during the speech, Carter wore a
cardigan (he actually wore a blue suit). And encouraged citizens to do what
they could to reduce their use of energy. He had already installed solar
power panels on the roof of the White House and a wood-burning stove in
the living quarters. However, the panels were removed in 1986, reportedly
for roof maintenance, during the administration of his successor, Ronald
Reagan, and were never replaced. Carter's speech argued the oil crisis was
"the moral equivalent of war". Several months later, in January 1980, Carter
issued the Carter Doctrine, which declared that any interference with U.S.
oil interests in the Persian Gulf would be considered an attack on the vital
interests of the United States. Additionally, as part of his administration's
efforts at deregulation, Carter proposed removing price controls that had
been imposed in the administration of Richard Nixon before the 1973 crisis.
Carter agreed to remove price controls in phases; they were finally
dismantled in 1981 under Reagan. He also said he would impose a windfall
profit tax on oil companies. While the regulated price of domestic oil was
kept to $6 a barrel, the world market price was $30.In 1980, the U.S.
Government established the Synthetic Fuels Corporation to produce an
alternative to imported fossil fuels.

Automobile fuel economy OF USA:

At the same time, Detroit's then-Big Three automakers (Ford, Chrysler, GM)
were marketing downsized automobiles which met the CAFE fuel economy
 23

mandates passed in 1978; by the mid-1980s, a majority of rear wheel drive

(RWD) family sedans and station wagons sold poorly despite government
mandates from CAFE; vehicles like the Ford Fairmont and Dodge St. Regis
were short-lived in response to the second energy crisis. GM’s Cadillac
division experimented with their V8-6-4power plant (the ancestor of the
modern-day Active Fuel Management and/or variable displacement), which
was a market failure. When RWD family sedans were marketed during this
era, this is where Japanese imports were building inroads; by the start of the
1980s, every automaker was making the transition to front-wheel drive.
 24

Table1 world crude oil prices (U.S. dollar per barrel)

Year nominal prices in year 2004 dollars
1970 1.80 7.08

1971 2.24 8.39

1972 2.48 8.90

1973 3.29 11.18

1974 11.53 36.09

1975 11.53 32.84

1976 12.38 33.34

1977 13.30 33.67

1978 13.60 32.17

1979 30.03 65.60

Source: U.S. Energy Information Administration, U.S. Departments of Commerce and

Labor.2004
For facility purposes we plot the above prices on the graph on
next page. the table contained nominal oil prices (the prices in dollar at a
particular year say oil prices in on the average in year 1970,or 1979).while
and in year 2004 19701$=4.78$2004
World oil prices graph 1, from 1973-1979:
 25

Nominal, in year 2004 dollar:

120
100
80
S e rie s 3
60
S e rie s 2
40
20
0
1974
1970
1971
1972
1973

1975
1976
1977
1978
1979

Years
The graph shows that the price is increases before the imposition of
oil embargo but at a slow rate. When oil embargo imposed the price increase
suddenly in 1973-1974.and then it remains more or less up to 1978.but after
Iranian revaluation increases on again.
 26

Price relatives:
Oil price are compared of different years from 1971-1979 using 1973
as a base year.
Years Nominal oil prices Price relatives
Pn/po *100
1970
1.80 15.54

1971 2.24 19.34

1972 2.48 21.34

1973 3.29 28.4

1974 11.58 100

1975 11.53 99.56

1976 12.38 106.91

1977 13.30 117.44

1978 13.60 117.46

1979 30.03 259.3

1973 oil prices is compared with oil prices before and after 1973’s oil prices
In 1973 the OAPEC imposed oil embargo on us and they starts fixing prices
and as a result the rise in can be seen in 1974 and its onward effect. For
comparing prices of different we take 1974 as a base year. The calculation
 27

shows that before the imposition of oil embargo the prices were also raising
but at a very low rate. As from table 2 we can see that from year 1970 to
1971 on the average there is just only 4% rise in oil price using 974 as a
base. And from years 1971-1972 and from 1972-73 the rise in oil price is 3%
and 5% respectively. But from year 1973 to 1974 the price raises by 71.6%.
And after this years almost increasing throughout the 1970s decade. And
after Iranian revaluation there is 159.3% increase in oil prices as compare to
1973’s oil prices

Chapter 4
28
 29

1980’s oil crisis:

The outbreak of the war between Iran and Iraq in 1980 shook the oil market
as well. In its initial stage, the Iran-Iraq war abruptly removed almost 4
million daily barrels of oil from the world market—15 percent of total
OPEC output and 8 percent of free world demand. In 1980 OPEC
representatives (with the exception of Saudi Arabia) agreed to set prices at
thirty-six dollar a barrel. However, the impact of the Second Oil Shock
turned out to be short-lived. The influence of OPEC appeared to be
diminishing as the production by Mexico, Britain, Norway, and other non-
OPEC countries and Alaska was continuing to increase. Anxious to increase
market share, they were making significant cuts in their official prices. As a
result, OPEC's share of world output quickly fell by 27 percent. Saudi
Arabia, the largest producer in OPEC, saw its oil revenues decreased from
$113.2 billion in 1981 to just $20.0 billion in 1986.Although the Second Oil
Shock sent the developed world into recession, the most serious long run
impact of the second shock was in the developing world. During the 1970s,
the oil producing states placed a significant portion of their revenue into
commercial banks because they simply could not spend the money as fast as
it came in. The commercial banks loaned this money to developing countries
which hoped to repay the loans with revenue from their rapidly growing
economies. However, the developed world responded to the Second Oil
Shock by rapidly raising interest rates which deepened the on-going
recessions. The developing countries saw exports fall, oil import prices rise,
and interest payments skyrocket. The result was the debt crisis which first
appeared in Mexico in 1982 and quickly spread throughout the developing
world. In the "lost decade" of the 1980's, years of hard fought economic
 30

gains were wiped out. From 1980-88, the real income of median workers fell
by 40 percent.
Since early 1980s, the world petroleum market confronted the
OPEC with an unpalatable choice: cut prices to regain markets or cut
production to maintain price. However, the OPEC countries did not want to
reduce prices, for fear that they would undermine their whole pricing
structure, lose their great economic and political gains, and so diminish their
political influence. OPEC did not always organize a united front against this
pressure. For example, Saudi Arabia, whose oil production far surpassed
other member countries, had championed decisions for low pricing for larger
market-sharing and long-term gains.

The 1980s oil glut was a surplus of crude caused by falling demand
following the 1970’s oil crisis The world price of oil, which had peaked in
1980 at over US$35 per barrel ($91 per barrel in today's terms), fell in 1986
from $27 to below $10 ($52 to $19 today). The glut began in the early 1980s
as a result of slowed economic activity in industrial countries (due to the
crises of the 1970s, especially in 1973 and 1979) and the energy
conservation spurred by high fuel prices. The inflation adjusted real 2004
dollar of oil fell from an average of $78.2 in 1981 to an average of $26.8 per
barrel in 1986.

In June 1981, the New York time stated an "Oil glut! ... is here" and Time
magazine stated: "the world temporarily floats in a glut of oil,” though the
next week an article in The New York Times warned that the word "glut"
was misleading, and that in reality, while temporary surpluses had brought
down prices somewhat, prices were still well above pre-energy crisis levels.
This sentiment was echoed in November 1981, when the CEO of Exxon
 31

crop also characterized the glut as a temporary surplus, and that the word
"glut" was an example of "our American penchant for exaggerated
language." He wrote that the main cause of the glut was declining
consumption. In the United States, Europe and Japan, oil consumption had
fallen 13% from 1979 to 1981, due to "in part, in reaction to the very large
increases in oil prices by the organization of petroleum exporting countries
and other oil exporters," continuing a trend begun during the 1973 price
increases. After 1980, reduced demand and overproduction produced a glut
on the world market, causing a six-year-long decline in oil prices
culminating with a 46 percent price drop in 1986.

Background:
The 1973 oil crisis and the 1979 oil crisis turned oil from a
cheap to a very expensive energy source. During the 1973 energy crisis, the
price of oil quadrupled. Oil never returned to pre-1973 levels, either in real
or nominal terms, even during the 1980s glut. The nominal price continued
its slow increase after the crisis ended. Six years later, the price more than
doubled during the 1979 energy crisis. OPEC and Saudi Arabia artificially
raised the price of oil several times in 1979 and 1980. Also during this time,
several OPEC members significantly lowered their production levels, the
Iran hostage crisis occurred, and the Iran Iraq war began.

There was fear that the world's oil market supply was tenuous, causing the
price of oil to escalate and that OPEC would dictate very high prices in a
shortage.
 32

Production: here we will analyze THE OPEC Oil production and non-
OPEC oil PRODUCTION.

Non-OPEC

During the 1980s, non-OPEC production increased worldwide. It can be

shown from the below diagram.

Non-OPEC oil production

US:

In April 1979, jimmy carter signed an executive order which was to remove
market controls from petroleum products by October 1981, so that prices
would be wholly determined by the free market Ronald Rogan signed an
executive order on January 28, 1981 which enacted this reform immediately,
allowing the free market to adjust oil prices in the US This ended the
 33

withdrawal of old oil from the market and artificial scarcity, encouraging
increased oil production. The US Oil windfall tax was lowered in August
1981 and removed in 1988, ending disincentives to US oil producers.

OPEC oil production:

From 1980 to 1986 OPEC decreased oil production several times and nearly
in half to maintain oil's high prices. However, it failed to hold on to its
preeminent position, and by 1981, its production was surpassed by Non-
OPEC countries. OPEC had seen its share of the world market drop to less
than a third in 1985, from nearly half during the 1970s. In Feb1982, the
Boston globe reported that OPEC's production, which had previously peaked
in 1977, was at its lowest level since 1969. Non-OPEC nations were at that
time supplying most of the West's imports.

OPEC's membership began to have divided opinions over what actions to

take. In September 1985, Saudi Arabia, tried to gain market share by
increasing production, creating a "huge surplus that angered many of their
colleagues in OPEC". High-cost oil production facilities became less or even
not profitable.

US imports:

The US imported 28 percent of its oil in 1982 and 1983, down from 46.5
percent in 1977, due to lower consumption. Reliance on Middle East sources
dwindled even further as Britain, Mexico, Nigeria and Norway joined
Canada in the forefront of American suppliers. Imported crude oil from
Libya was banned in the United States on March 10, 1982.
 34

Reduced demand:

OPEC had relied on the price elasticity of demand of oil to maintain high
consumption, but underestimated the extent to which other sources of supply
would become profitable as prices increased. Electricity generation from
nuclear and natural gas; home heating from natural gas; and ethanol blended
gasoline all reduced the demand for oil. New passenger car fuel economy
rose from 17 mpg in 1978 to more than 22 mpg in 1982, an increase of more
than 30 percent.

Impact:
The 1986 oil price collapse benefited oil-consuming countries such as the
United States, Japan, Europe, and Third World nations, but represented a
serious loss in revenue for oil-producing countries in northern European,
Soviet Union, and OPEC.

In 1981, before the brunt of the glut, Time Magazine wrote that in general,
"A glut of crude causes tighter development budgets" in some oil-exporting
nations. In a handful of heavily populated impoverished countries whose
economies were largely dependent on oil production — including Mexico,
Nigeria, Algeria, and Libya — government and business leaders failed to
prepare for a market reversal.

With the drop in oil prices, OPEC lost its unity. Oil exporters such as
Mexico, Nigeria, and Venezuela, whose economies had expanded in the
1970s, were plunged into near-bankruptcy. Even Saudi Arabian economic
power was significantly weakened.
 35

Iraq had fought a long and costly war against Iran, and had particularly weak
revenues it was upset by Kuwait contributing to the glut [and allegedly
pumping oil from the Rumaila field below their common border. Iraq
invaded Kuwait territory, planning to increase reserves and revenues and
cancel the debt, resulting in the first gulf war. The USSR had become a
major oil producer before the glut. The drop of oil prices contributed to the
nation's final collapse In the US, domestic exploration declined dramatically,
and the number of active drilling rigs was nearly halved in 1982. Oil
producers held back on the search for new oilfields for fear of losing on their
investments. In May 2007, companies like Exxon Mobil were not making
nearly the investment in finding new oil today that they did in 1981.oil
prices from 1980-1989 is given on the next page.
 36

1980’s oil prices:

Years nominal oil prices in year 2004 dollars

1980 35.69 71.48

1981 34.28 62.76

1982 31.76 54.81

1983 28.77 47.76

1984 28.06 44.89

1985 27.53 42.47

1986 14.38 21.84

1987 18.42 27.24

1988 14.96 21.39

1989 18.20 25.08

Source: U.S. Energy Information Administration, U.S. Departments of Commerce and
Labor.2004
These prices are graphed here to easily understand changes in oil prices from
1980 to 1989.

Oil price graph 2

 37

nominal oil prices in year 2004 dollars

120
100
80
60
40
20
0
80

81

82

83

84

85

86

87

88

89
19

19

19

19

19

19

19
19

19

19
years

Oil prices from 1980-1989:

Oil price are compared of different years from 1980-1989 using 1980 as a
BASE. Price relatives:
Year’s nominal oil prices
 38

Pn /Po*1000
100
1980 35.69

1981 34.28 96.049

1982 31.76 88.99

1983 28.77 80.61

1984 28.06 78.62

1985 27.53 77.14

1986 14.38 40.29

1987 18.42 51.61

1988 14.96 41.92

1989 18.20 50.99

Price relatives of oil prices from year 1980 to 1989
THE prices were almost rising before 1980. in 1979 the price was 30.0
which is 159% greater then the prices in 1974.in 1980 the opec members
agreed to Fix prices at 36$ per barrel but the table shows that they fully
failed to maintains the prices according to their interest. and the success
were just remained to the year 1980.in the year 1991 the prices falls by
3.951%.and in year 1982 the prices falls by 11.01%.the falls continues
throughout 1980’s decade. And in 1986 the prices falls by 59.71. After the
 39

year 1986 oil prices rises but still it a very slow rate. And at the end of this
decade that is from 1880 to 189 falls in oil prices on the bases of 1980 is
49.01%.
 40

Chapter 5
 41

1990’s oil crises:

The cause of the Iraqi invasion of Kuwait on August 2, 1990--and hence of
the worldwide energy crisis that it precipitated--was economic, although the
issue was one that might not appear immediately relevant to consumers at
the pumps. For several months preceding the invasion, Iraqi President
Saddam Hussein had been asserting, with some justification, that Kuwait
was in effect engaged in economic war with Iraq, stealing oil from the
disputed Rumaila field and producing in excess of its OPEC quota. The
validity of Iraq's assertions has never been adjudicated by the international
community, before or since the invasion. Instead, on August 6 the United
Nations imposed an immediate and nearly total embargo on oil exports from
Iraq, as well as on Kuwait, which Iraq had by then absorbed This embargo
removed almost 5 million barrels a day of oil from the world market. Prices
of crude oil almost doubled in the wake of the invasion. Prices of jet fuel
tripled. But the officials of consuming nations did not act. As in 1973 and
1979, government representatives blamed 'speculators' for the rise in prices.
As in the past, this shortsighted market interference drove prices even
higher. This ill advised behavior on the part of high government officials of
several supposedly market-oriented nations leads to three very
uncomfortable conclusions. Third, to complement the strategic stocks,
consuming nations must promote the development of some strategic refining
capacity that could be used in a future crisis. This capacity should include
facilities capable of processing heavy crude oils and producing a high
percentage of light products.
 42

Background:
Iraq's invasion of Kuwait followed six months of extreme turbulence in
world oil markets. Crude oil prices had climbed to three-year peaks in
January 1990 and then plunged to levels comparable to their 1986 lows by
June. During this period, supplies of the benchmark crude known as West
Texas Intermediate (WTI) sold for as much as 23.40/bbl and as little as
$15.30/bbl on the market for immediate delivery (spot market). The primary
cause of the decline in prices was overproduction by Kuwait and the United
Arab Emirates (UAE). The attitude of these nations toward their OPEC
commitments naturally aroused the anger of the other oil-exporting
countries, particularly Iraq. By the end of June, President Hussein and his oil
minister Issam Abdul-Rahim al-Chalaby were making their feelings public.
The price of oil began to increase in spite of the oversupply. The decline and
later rise in crude oil prices were concentrated in prices quoted for prompt'
supplies for crude: crude to be delivered within the next 30 to 90 days. (1)
Prices for oil to be delivered 12 to 18 months in the future--so-called "far
forward" prices--actually increased while prices for prompt delivery were
falling This pattern can be observed by examining the term structure of oil
prices since the beginning of 1990. The term structure of oil prices compares
prices of crude oil for various delivery dates at a particular moment in time,
just as the term structure of interest rates compares short-, intermediate-, and
long-term rates at a moment in time. The term structure of crude oil prices
on January 19, June 20, and August 1, 1990. Reading from left to right, one
observes the price quoted for the first or immediately expiring contract
(equivalent to the spot price), then that of the second or next expiring
contract, and so on into the future. The decline in spot prices from January to
June was associated with an unusually large increase in inventories. In
 43

effect, the oil market was sold into what is called co tango, in which spot
prices are less than forward prices-a -situation analogous to the standard
yield curve in finance (the opposite condition, in which forward oil prices
are lower than spot prices, is called backwardation). Economists have noted
that spreads between spot and forward prices are linked to the level of
stocks. This relationship could be observed in both the US and the world oil
market through 1989 up to August 1990 .spot supplies of crude would be
expected to trade at a premium of about $3.00/bbl to 12-month forward
crude if companies are holding only 325 million barrels in inventory. On the
other hand, spot supplies would be expected to trade at a discount of about
$2.00/bbl if companies are holding 385 million barrels. The decline in spot
prices from January to June coincided with such an increase in stocks.
Stocks were drawn down to 342 million barrels in January, and at that time
the premium for spot supplies to 12-month forward oil was $3.00/bbl.
Stocks then increased to 386 million barrels by the end of June, while spot
prices sank to a $3.35/bbl discount to 12-month forward supplies most of the
decline in prices during the first half of 1990 was concentrated in near-term
prices. Prices were far forward oil actually increased by $0.50/bbl. This
stability of forward prices was remarkable, particularly since a very active
trade in oil for far forward delivery has developed both on and off the
organized futures exchanges. The stability of forward prices may be
interpreted as an indication that participants in the market expected oil prices
of about $20.00/bbl over the longer run. This interpretation is confirmed by
the price movements of longer-term instruments such as the BP Royalty
Trust.(2) The entire price structure--prices at all points along the curve--rose
between mid-June and the end of July, in response first to Saddam Hussein's
saber rattling and then to the agreement among the oil-exporting nations at
 44

the end of July to raise target prices to $21.00/bbl. The increase began in late
June when the Iraqi oil minister delivered a blistering attack on the UAE for
overproduction.(3) His attack was followed by a statement by the Iraqi
deputy prime minister Sa'adoun Hammadi that the depressed price of oil was
hurting the Iraqi economy badly. The blade has reached the bone after
cutting through the flesh."(4) The oil ministers of Saudi Arabia, Iraq,
Kuwait, the UAE, and Qatar met in Jeddah, Saudi Arabia, on July 11 to
attempt to defuse the situation. Worried that their overproduction had
angered the militarily stronger Iraq, ministers from Kuwait and the UAE
agreed to immediately adhere to OPEC production quotas until the price of
the so-called OPEC basket rose above $18.00/bbl (5) from its then-current
price, reported by Petroleum Intelligence Weekly to be $14.16/bbl. (6) Iraq
continued its verbal attacks on what it described as economic warfare by
Kuwait and the UAE despite the Saudis' attempt to patch matters up. In a
speech on July 17, Hussein threatened to use force against the other Arab
oil-exporting nations if they did not curb their overproduction. The New
York Times reported that Hussein had accused some unspecified nation
(widely assumed to be Kuwait) of colluding with the United States to lower
prices: "'The policies of some Arab rulers are American,' the Iraqi leader was
quoted as having said by news agencies from Baghdad.’They are inspired by
America to undermine Arab interests and security."'(7) Hussein went on,
according to the Times article, to state, "Iraqis will not forget the saying that
cutting necks is better than cutting means of living."(8) Hussein's speech
was also reported in the Wall Street Journal, the financial Times, and the
Washington Post. The Financial Times noted that oil markets seemed to
shrug off the Iraqi leader's remarks.(9) However, the government of Kuwait
was alarmed and sought the help of the Arab League to mediate the dispute.
 45

At the same time, the Saturday, July 21, issue of the financial Times
reported that Kuwait had canceled a state of alert for its armed forces and
adopted a conciliatory tone. The same dispatch carried an unconfirmed
report that a small detachment of Iraqi troops had landed on the Kuwaiti
islands of Bubiyan and Warbah.(10) Three days later the Washington Post
reported that Iraq had massed nearly 30,000 troops on its border with
Kuwait, and noted that Kuwait had reactivated a fill military alert." John
Roberts reported that Iraq's troop move was part of its effort to permanently
settle its dispute with Iran. In a dispatch published on July 25 by the Oil
Daily Energy Compass, Roberts noted that Iraq is on the verge of making
peace with both Kuwait and Iran--and it will use concessions from Kuwait to
make up for concessions it plans to give to Iran.'12 According to Roberts,
the details would involve an agreement to reestablish the border between
Iraq and Iran along the middle of the Shatt al-Arab, precisely where it was
drawn in the 1975 Treaty of Algiers. In return, Kuwait would be required to
transfer to Iraq the full revenues from oil produced from the Rumaila oil
field from 1980 to 1990 (roughly $2.5 billion), cede the islands of Warbah
and Bubiyan to Iraq, and abandon any claim within OPEC for a higher
output quota. Peter Build noted in the same publication that Iraq wanted
OPEC to maintain its output quota at 22.5 million barrels a day for the rest
of the year and to agree that the target price for the OPEC basket should be
raised to $25.00/bbl. (13) In this environment the members of OPEC met at
the end of July in Geneva to discuss prices for the second half of the year.
Ultimately the members compromised by raising the target price to
$21.00/bbl. Prices rose during July, reflecting the view of market
participants that the underlying supply picture had changed. Both forward
and spot prices rose during the period, with spot prices continuing to sell at a
 46

discount to forward prices. By the end of July, spot oil was quoted for
$20.04/bbb while far forward oil was selling for $21.40/bbl, an increase of
$2.13/bbl from January levels. By the end of July one could infer from the
term structure of oil prices that Iraq would be successful in its efforts to
boost the OPEC basket. My own analysis, released on July 31, indicated that
the basket would rise to $21.00/bbl by the end of December.14 the analysis
also suggested that the price of WTI would raise to $26.00 by December.
This projection of the December price of WTI derived from an examination
of the term structure of prices and the supply of inventories. Adherence to a
production quota of 22.5 million barrel's per day from August 1 through the
end of December would have required that free world crude oil inventories
be reduced by 200 million barrels by the end of the year to meet projected
consumption; US stocks would have had to be reduced to perhaps 312
million barrels. This reduction in stocks would have caused the oil market to
revert to backwardation. The of the relationship between stocks and spreads
led to conclude that, by December, WTI for January 1991 delivery would
sell for a premium of $4.00/bbl to forward contracts for January 1992 oil.
This would put prompt WTI at $27.00/bbl in December if far forward oil
remained at its end-of-July level of $23.00/bbl.

Impact of invasion:
Iraq's invasion and the ensuing embargo totally changed conditions in the oil
market. The initial concern of consuming-country government and oil
company officials was the loss of crude oil supplies. However, these worries
were eased as other oil-exporting nations agreed to increase output to
replace the lost crude oil. First, the replacement crude oil was heavier than
the lost Kuwaiti and Iraqi oil. Finally, the uncertainties associated with the
 47

problems in the Middle East caused demand for precautionary stocks to

increase. The world lost roughly 1 million barrel's per day of light end-
products--naphtha’s, gas oil (heating oil and diesel fuel), and aromatics--
while gaining approximately 1 million barrels per day of fuel oil. Lost
Refining Capacity The problem of balancing the supply and demand for
products was complicated by the loss of refining capacity in Kuwait. Prior to
the invasion Kuwaiti refineries had the capacity to process 800,000 barrels
of crude oil per day. Cranfield reports that the largest of these units produced
a mix of 23.6 percent naphtha (devoted mostly to petrochemical feeds), 23.6
percent aviation fuel and 47.3 percent gas oil and diesel oil." (16) Increased
Jet Fuel Consumption the precarious balance in the market was further
exacerbated by the increased demand for jet fuel associated with the military
buildup that followed the invasion. Greater military use of jet fuel has
apparently increased this demand by 200,000 to 300,000 barrels (5 percent
to 7 percent). In Europe, the price of jet fuel on spot markets increased by
149 percent, from 59cts/gallon to 147cts/gallon. The rise in jet fuel prices
tended to pull up the prices of crude’s that yield a high percentage of middle
distillates. Increased Demand for Stocks Market conditions were also
exacerbated by an increased demand for inventories following the invasion.
(8) Light crude oils that had high yields of gasoline and gas oil were
particularly popular. Williams draws an analogy between the transactions
demand for commodity stocks and the transactions demand for money
balances. In a similar fashion, oil companies will prefer to increase stocks if
the cost of acquiring incremental stocks rises. In turn, the rise in spot prices
during August and September resulted as firms drew down stocks, working
their way down the new supply-of-storage function.
 48

2. OPEC and the oil price collapse of 1998–99:

When OPEC oil ministers met in Jakarta, November 26-December 1, 1997,
with the Brent oil price at $20/barrel, they decided to increase their oil
output ceiling from 25 to 27.5 million barrels/day (Middle East Economic
Survey [MEES], December 8, 1997). Two years later the Jakarta meeting
was termed “one of the biggest mistakes in OPEC history” by Venezuelan
Energy Minister Ali Rodriguez (MEES, April 3, 2000). By not foreseeing
the decline in Asian oil demand precipitated by the currency and banking
crises in the fall of 1997, as compounded by other factors, OPEC had
contributed to an oversupply in the oil market in 1998 and a collapse in oil
prices which caused major damage to OPEC economies The Brent oil price,
already falling in January 1998, reached about $13/barrel in March and
declined to below $10/barrel in December.1 Several factors outside of
OPEC’s control converged to reduce demand and increase supply in 1998:
1) Asian oil demand, which had become extremely important in global
incremental oil demand growth, reversed and went negative, reducing
anticipated oil demand by almost one million barrels/day. Russian oil
exports were increased 600–800,000 barrels in the fourth quarter to produce
needed dollars.
2) An exceptionally warm winter in North America, Europe, and Japan
further suppressed demand by about one million barrels/day and turned what
is normally a seasonal stock draw into a period of stock build during the first
quarter.
3) In China, oil imports were reduced toward the end of the year in an effort
to preserve hard currency, reaching a peak decline of nearly one million
barrels/day. (Petroleum Industry Research Foundation, 1999).
 49

The collapse of oil prices in 1998 and into early 1999 led to a major
reduction in OPEC oil export revenues which undermined member
countries’ fiscal stability and caused sharp cuts in state budgets. In 1998
OPEC revenues were estimated at just under $100 billion, down 35% from
the $154 billion earned in 1997. In real dollars OPEC revenues peaked in
1980 following the second oil shock. 1998 represented OPEC’s worst
revenue year since then, slightly lower than the previous low point brought
about by the oil price collapse of 1986. Saudi Arabia, for example, saw its
oil revenues fall 28% between 1997 and 1998 to around $29.7 billion.
Between January 1998 and March 1999, Saudi oil prices averaged between
$9 and $13/barrel. As is the case in many OPEC producer
Stocks remained high throughout 1998 and exerted a downward pressure on
the world oil price, which greatly complicated OPEC management efforts.
There has always been a strong inverse relationship between oil stock levels
and oil prices,. The collapse of oil prices in 1998 and into early 1999 led to a
major reduction in OPEC oil export revenues which undermined member
countries’ fiscal stability and caused sharp cuts in state budgets. In real
dollars OPEC revenues peaked in 1980 following the second oil shock.
Between January 1998 and March 1999, Saudi oil prices averaged between
$9 and $13/barrel.

3. OPEC regroups and prices recover, and then overshoot, 1999–2000:

In February 1999, the oil price of the OPEC basket was at

$10/barrel, and OPEC output had risen to almost 28 million barrels/day
driven by noncompliance with the agreements of the previous year. Oil
prices began to climb back upward. In May, Saudi Oil Minister Ali Naimi
commented that for him a “reasonable price” of crude would be in the range
 50

of $18–20/ barrel. By September, MEES estimated OPEC compliance at

94%, but noted that OPEC needed to reduce still more to attain full
compliance with the March quotas (September 20, 1999). By September, the
Brent oil price surpassed $23/barrel. Venezuela began to press for some kind
of OPEC price band mechanism. OPEC might at this point have taken some
action to increase oil supply to head off further price escalation, but it did
not. By the end of February 2000, WTI crude oil prices had risen above
$30/barrel. Reduced heating oil stocks and escalating prices in the United
States in early 2000 led US Energy Secretary Bill Richardson to visit several
OPEC countries to argue for oil production increases. Realizing that oil
prices may have gone too high, OPEC increased its oil output target four
times during 2000, adding ostensibly 3.7 million barrels/day to supply. Oil
prices remained high at over $30/barrel for much of the year, although they
dropped briefly following OPEC decisions (Fig. 4). Nigeria and Venezuela
favored 1.5 million barrels/day. Saudi Oil Minister Ali al-Naimi expressed
his personal preference to maintain oil prices between $20 and $25/barrel
Brent, and he did not mention the price- band (, April 3, 2000). While oil
prices dropped slightly following the March meeting, by mid-June prices
surged to over $31/barrel. Saudi Oil Minister Ali al-Naimi and OPEC
Secretary General Rilwanu Lukman both proclaimed that OPEC’s long run
price target was $25/barrel for the OPEC basket of crude’s (the midpoint of
the price band) (, June 26, 2000). When oil prices did not decline after the
June meeting, Saudi Arabia said in early July that it would add another
500,000 barrels/day to the market to move prices downward toward
$25/barrel. OPEC was overshooting its mark. On September 10, OPEC met
again and announced a production increase of 800,000 barrels/day effective
October 1. This raised the production ceiling to 26.2 million barrels/day
 51

excluding Iraq. Oil prices did not respond much to this announced increase
in supply because of market concerns about OPEC’s lack of spare capacity.
The real production increase was probably about 300,000 barrels/day. Much
lesser amounts were held by Kuwait— 260,000 barrels/day; Nigeria—
200,000 barrels/day; UAE—120,000 barrels/day. Mexico, a non-OPEC
member, which had been cooperating with OPEC, had 300,000 barrels/day
in spare capacity. Other OPEC countries with little or no spare capacity had
little to gain by further OPEC output increases since they were not able to
raise their production sufficiently (International Energy Agency [IEA],
Monthly Oil Market Report, September 2000 as excerpted in MEES,
September 18, 2000). The price of crude oil dropped following this
announcement to around $30/barrel, but then increased again in October One
of the reasons for the persisting high oil prices was the continuing low level
of oil stocks in OECD countries, especially the United States (see Fig. 2). As
oil prices continued to hover well over $30/barrel, OPEC invoked its price
band mechanism for the first time and announced at the end of October an
increase in quotas of 500,000 barrels/day. In December 2000, oil prices
suddenly dropped—WTI by almost $8/barrel and dated Brent by more than
$10/barrel the price fall began in Asia, where oil supplies were abundant,
then moved westward. The 1990’s oil prices nominal and adjusted in year
2004 are given on the next page.
 52

1990’s oil prices:

Year’s nominal prices in year 2004 dollars

1990 23.81 31.59

1991 20.05 25.70

1992 19.37 24.27

1993 17.07 20.91

1994 15.98 19.16

1995 17.18 20.19

1996 20.81 24

1997 19.30 21.89

1998 13.11 14.71

1999 18.25 20.18

2000 36.20 36.20

Source: U.S. Energy Information Administration, U.S. Departments of Commerce and
Labor.2004
The prices are graphed on next page there are huge Fluctuation in oil prices
from year 1990 to 2000. The oil price line starts from peak and then falling
again it again it is rising when OPEC regroups.
 53

Oil prices graph 3, from 1990 to 2000

nominal prices in year 2004 dollars
70
60
50
40
30
20
10
0
90

91

92

93

94

95

96

97

98

99

00
19

19

19

19

19

19

19

19

19

19

20
years

In 1990-190 the prices are high but later on the prices start falling as the non
OPEC production increases. And prices increases when OPEC regrouped in
1999-200.
 54

Price relatives:
For measuring price relatives we will take 1990 as a base year.
Year Nominal oil prices Price relative
Pn/Po*100
1990 23.81 100

1991 20.05 84.20

1992 19.37 81.35

1993 17.07 71.69

1994 15.98 67.11

1995 17.18 72.15

1996 20.81 84.75

1997 19.30 81.05

1998 13.11 55.06

1999 18.25 76.64

2000 36.20 152.03

The 1990’s decade of the oil prices fluctuation. After the Iraqis invasion on
Kuwait the oil prices rises from 18 to 23 and remains the same in 1990. But
after this year from table we can see that the oil prices start falling. And this
 55

fall in oil prices is 15.8%. And there is continuous falling in prices up to

1994. And a price starts increasing up to 1997. Then in 1998 the oil a price
again falls because of OPEC false decision. And fall in the oil prices is
4.49% and compare to the prices of year 1990.but in February when
regrouped they get good result and oil prices rises. The increase in oil prices
from year 1998 to year 1999 is 21.58%. And year 2000 there is 52% rise in
prices as compare to year 1990 after the OPEC regrouping.

Chapter 6
56
 57

6. Conclusion:

From the study we come to know that the 1973, 1979 and 1990 oil
crises were driven by political or military events. In these year the oil prices
shows different fluctuation with the OPEC decision. In 1973 OPEC was
successful in raising oil prices. the 1979 oil prices also rises because of the
Iranian revaluation and the 1990 oil crises was The cause of the Iraqi
invasion of Kuwait Unlike previous oil crises (1973, 1979, 1990) which
were driven by political or military events, the oil prices collapse of 1998
and the price shock of 2000 were caused by fundamental economic forces—
an imbalance of supply and demand. After its initial misjudgments of the oil
market in late 1997 and in 1998, and further weakened by its lack of
discipline, OPEC did demonstrate in 1999 and 2000 that it has market power
and the ability to turn the market around, first by cutting production in 1999,
then by expanding production in 2000. However, it miscalculated again in
2000 as to the amount of additional supply that would be needed to hold
prices at or under $30/barrel, and as a result prices soared above $30 for
much of the year. This had damaging effects on the world economy and was
not in OPEC’S long-term interest, as the organization itself recognized.

Political factors that were important in enhancing OPEC discipline during

this period include the election of the Chavez government in Venezuela (in
late 1998), which adopted a much more pro-OPEC oil policy, and the
establishment of a Saudi-Iranian rapprochement at the highest levels to
maintain more stable oil prices and manage Iraq. Changes of government in
Nigeria and Algeria have also apparently contributed to cooperation. OPEC
itself has increased the frequency of its meetings to four or more each year,
 58

which puts it in a better position to fine-tune the market and react to changes
in supply and demand. Saudi Arabia has become more proactive in leading
OPEC decisions. The oil ministers in several countries are now technocrats,
not political figures, which makes cooperation easier; for example, Ali al-
Naimi in Saudi Arabia and Chakib Khelil in Algeria, who recently served as
OPEC’s president. Cooperation by several non OPEC countries, especially
Mexico and Norway, was very important in assisting the market turn-around
in 1999.

Recommendation:

The oil prices should not let to be set by some organization. It is to be set the
market forces. The private organization always looks to make profit and not
to the welfare of the people. And as we know that the oil has important role
in the life of people so it is not in favor of the ordinary people to raise the oil
prices.
 59

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