ECONOMIC ISSUES IN AGRICULTURE
Agricultural & Applied Economics
July, 2000

Crude oil prices have more than tripled during the past year, the 4th time in 30 years oil prices suddenly shot upward -- without warning.
This price spike was apparently caused by a miscalculation by OPEC (the Organization of Petroleum Exporting Countries).
 
 

OPEC expanded production in late '97 with the expectation that world demand for petroleum would continue to rise. But demand fell, for several reasons:

1) The economies of most Far East countries went into recession. A devalued currency in these countries meant oil imports became more costly.

2) The winter of 1998-98 was unusually warm in North America, Europe and Japan.

3) Russia's financial distress caused a drop in oil demand and prompted the country to try to sell Russian oil abroad.

4) Iraq - which had been under a U.N. trade sanctions for years, negotiated a treaty that let them sell small amounts of oil to pay for necessary imports.

The result was a glut in the world oil market. Crude oil dropped in 1998 to $9.00 per barrel.

These prices prompted OPEC to agree to reduce oil output several times during 1998. Saudi Arabia, Kuwait and Venezuela all dropped production a bit - but Iraq and Iran raised theirs - and OPEC's total production was unchanged.

In early 1999 - with crude oil bouncing around $10 per barrel, the cartel again agreed to cut production. This time it worked.
 

About this time the Asian economies began growing faster than anticipated. In the last three months of 1999 and the first three months of 2000, world demand for crude oil was greater than supply by 2.5 million barrels per day -- due to less oil being pumped and the increase in demand. The shortfall (3.5% of world production) was filled by drawing down stocks. This was enough to propel the price of crude from $9 a barrel in early 1999 to more than $30 per barrel in early 2000.
 
 

There are two schools of thought among the 11 member OPEC governments about pricing policy.

Countries with large populations and urgent development requirements tend to favor the highest prices now.

But the countries with large reserves and small populations ( especially Saudi Arabia and Kuwait) take a longer term view and try to manage prices to maximize returns over a long period of decades.

This means holding prices down in a range that most consumers will regard as reasonable. Consumers continue to rely on oil rather than turning to other fuels - and so that non-OPEC producers will not be given incentives to develop high-cost oil sources to compete with OPEC.

It is the price, not volume which guides policy. One OPEC oil minister described the price range as $22 to $28 per barrel. Another, spoke of $20 to $23 per barrel. Prices are currently above these levels.

A point for blame is not that Saudi Arabia, the dominant force in the oil market should have done a better job of forecasting. The point is that a lot of genuinely unpredictable things happen in the world. The markets for oil are inherently unstable. The only reliable prediction is that oil markets are very difficult to stabilize - and, from time to time, there will be surprises.
 
 

Farmers, in the short run cannot change oil consumption. And most consumers have not altered oil consumption patterns. Farmers can use less tillage, but this often means added items of equipment. Georgia farmers spent $125 million for fuel and oil in 1998. This figure will likely exceed $200 million this year. As the major cash cost of applying irrigation water is fuel, those with irrigation systems are experiencing substantial cost increases.

No long term trend in oil prices exist. Since 1973 prices have fluctuated widely but without any sustained direction. But even at $30 per barrel, oil was slightly less expensive than the average adjusted for inflation in today's dollars, over the past quarter-of-a-century. The peak, in today's dollars, for crude oil would have been $67 a barrel in 1980, and for gasoline, $2.57 a gallon in 1981.

In effect, the impact of oil prices changes on the rest of the economy is significantly less than in the 1970's. In the 70's, the leap in oil prices caused public panic. Hoarding made the disruption worse. Further, price controls during this time period caused disruptive shortages and long lines of frantic motorists at service stations.

All we can say about crude oil prices is that "from time to time, unexpectedly; the world's oil market will swing the price dramatically up or down - for reasons that are not apparent until after it happens. The recent announcement that Saudi Arabia will increase its oil output by 500,000 barrels daily should affect the market. But it usually takes about two months for oil to get to the U.S., be refined, and get to the consumer.

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Editor's Note: Much of this article is from "The Surge in Oil Prices - Anatomy of a Non-Crisis", by J.W. Anderson, in Resources For The Future, Spring, 2000.
 

William Givan, Editor
Extension Economist

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