Marketplace: Oil Is a Slippery Business

STUDENT'S VERSION

This lesson printed from:
http://www.econedlink.org/lessons/index.php?lid=865&type=student

INTRODUCTION

refineryMarketplace, a daily economics news program heard on National Public Radio, featured a story on December 28, 2001 about the Organization of Petroleum Exporting Countries (OPEC) and its decision to cut production of crude oil in the first half of 2002. Following the September 11, 2001 attacks on the United States, demand for fuel dropped significantly, causing a decrease in the price of oil and oil-related products. OPEC's decision to cut production of oil is intended to help stop that decrease in price by decreasing the supply. OPEC is generally seen as the primary institution that controls oil prices. Is that what OPEC really does? Use this lesson to get an overview of the history and function of this institution.

Some vocabulary terms that you should know before you begin the activities in this lesson are:

  • Oligopoly
  • Monopoly
  • Competition

To find the definitions to these three terms use Amosweb . Simply type the term into the search text box and click the search button to find the definition to the term.

TASK

You will be able to:

  • Describe relationships between industries in terms of their economic impact on one another.
  • Describe the role and function of OPEC (Organization of Petroleum Exporting Countries).
  • Analyze data trends and relationships in oil production and oil pricing over time.
  • Evaluate the relative success of OPEC in accomplishing its goals.

PROCESS

Activity 1

Become familiar with the concept of supply and demand and relationships between industries by naming some industries that were negatively affected in the aftermath of the September 11, 2001 terrorist attacks on the United States.

  • What primary industries do you think had the most drop-off in sales in the months following the attacks? Why?
  • What related industries could have been affected by decreases in these sales?
While you are discussing the chain of relationships, you should create an organizational chart showing the ways many businesses can be negatively affected by a slowdown in one industry. This activity allows you to look for relationships between industries. Click on the oil barrel to access the activity. The activity includes an option to write a summary on the topics discussed. This particular lesson focuses on supply and demand for crude oil in particular, so some of the discussion during this activity should be on the fuel industry
September 11 Activity oil

Other topics that can be used are:

Tourism

Government

Airlines

Insurance

Charitable Organizations

Restaurants

Pharmaceuticals

Real Estate

Retail

Postal

Manufacturing Online Commerce

Military

Fuel Hotel

Retail

Biohazard  
  • What happens when demand for a particular product or item decreases? Why?
  • What can industries do to protect themselves from complete collapse during times of economic downturn?

Activity 2

Now listen to the Marketplace audio segment on crude oil production cuts to be made by OPEC (Play from 1:10 through 3:08).

Transcript:

It's Friday, December 28, 2001. I'm David Brancaccio.
It's 94 cents a gallon at some gasoline pumps -- but how long can it last? The oil producers' cartel, OPEC, agreed to cut crude oil production to boost prices that collapsed when demand dried up after Sept.11th. But as Marketplace's Stephen Beard reports from London, OPEC may have trouble reaching its target price of $25 a barrel.

Beard:"OPEC members have decided to cut their combined output by 6 percent -- that's 1.5 million barrels a day. The cut will take effect Jan. 1st. It's intended to tighten supplies and boost the flagging price of crude -- which should mean higher prices at the pump. But don't panic, says Ray Holloway, head of a major UK gas retailing association."

Holloway:"If oil production is cut, then we are going to see an increase in price. But it depends how much -- how much of a cut, how much of it holds, and how much oil markets perceive the future availability of crude oil. I wouldn't be too pessimistic."

Beard:"Indeed, many analysts here say there is every reason for consumers to be optimistic about the price of crude. OPEC now controls only 40% of world oil production. The cartel has had to twist the arms of nonmember countries, like Russia, to cut their output too. The Russians, the Norwegians and the Mexicans have agreed to some cuts, but energy consultant Fergus Macloud is not impressed. He thinks the Russians will certainly renege on the deal. And if they do, he thinks some members of OPEC will too."

Macloud:"The chances of the full OPEC cutback of 1.5 million barrels being fully carried through are very low. Probably only two-thirds of that will take place. So the real issue is, 'Is this going to be enough to give OPEC their target price of $22 to $28 a barrel?' I doubt it, really."

Beard:"OPEC has succeeded in nudging oil prices back from post-Sept. 11th lows. But Analysts, like Macloud, do not expect a further substantial rise -- unless there is robust economic recovery in the United States, Japan and Germany.

In London, this is Stephen Beard for Marketplace."

After you have listened to the article segment answer these questions. You may refer back to the audio segment or transcript, or you may wish to use the provided links for more information. You will revisit these links in Activity 3 so it is a good idea to familiarize yourself with some of them here.

  • Who are the members of OPEC? Why does the organization exist, and how do members agree on cutting production rates? 
  • If OPEC controls 40% of crude oil production , who controls the rest?
  • Why would other countries cut or not cut their production in conjunction with OPEC's decision?
  • When OPEC has cut or increased production of oil in the past, has the price of petroleum responded the way it was intended? The WTRG Oil Price History and Analysis site provides a fairly reader-friendly analysis of the non-OPEC influences on pricing over the years.
  • Does OPEC control the price of oil and oil-related products?

Activity 3

Now work in with a partner and explore the following websites and articles. Each group should come up with a short summary on the structure and function of OPEC, a description of the oil-producing countries that are not members of the institution, and a basic analysis of whether OPEC has been successful in its mission to "stabilize the oil market."

Activity 4

After completing their your basic research, you should create a bar graph that shows the production rates of crude oil by OPEC members during a specified period of time (e.g. last 4 decades, or last 12 months) and overlay it with a line graph showing the price rates on oil over the same time period. You should analyze the graph and be able to say whether there is a correlation between the two data sets. Refer to the National Center for Educational Statistics graphing tool to create the first section of the graph. You can then complete the line graph portion by hand. You may research prices on your own, or use the tables below, reproduced from information found on the Energy Information Administration web site.

Things to look for when analyzing your data are similar trends in the supply line and the pricing overlay. There are many other factors that influence the price of oil, so use this research as a basis for further study. In your research in Activity 3 did you find other influences over the price of oil beyond supply? Refer back to the WTRG Oil Price History and Analysis and World Oil Market and Oil Price Chronologies: 1970-2000l to help bolster or refute your findings. Think back to the opening activity on industries affected by the September 11, 2001 terrorist attacks on the United States keeping in mind the relationship between supply, demand, and related market prices.

Table Reproduced from EIA site:

World Crude Oil Supply 1997-2001 (Million Barrels per Day)

 

1997

1998

1999

2000

OPEC

29.35

28.77

27.57

29.10

Non-OPEC

42.66

46.35

46.61

47.76

World

72.01

75.12

74.18

76.86

Source: Energy Information Administration, www.eia.doe.gov

 

World Crude Oil Prices 1997-2002

 

Jan.1, 1997

Jan.2, 1998

Jan. 1,1999

Jan.1, 2000

OPEC

23.07

14.97

9.96

23.19

Non-OPEC

23.96

15.91

9.90

24.11

World

23.46

15.36

9.93

23.60

Source: Energy Information Administration, www.eia.doe.gov
  • What correlation do you see between the production rates and the prices?
  • Has OPEC succeeded in its organizational mission to stabilize the market?

CONCLUSION

Now prepare a set of interview questions and talking points for a simulated meeting between an OPEC representative and a non-member country considering joining the organization. Discussions should reflect your understanding of the motivations of the member organizations and the relationship between controlling supply and its effect on pricing.

The OPEC representative would want to discern whether the interviewing organization would share the commitment to act in tandem with other members on production controls. The OPEC representative would also want to convince the non-member of the benefits of working together as an institution.