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Marketplace: Oil Is a Slippery Business

Key Economic Concepts:

• Demand
• Market Economy
• Markets
• Production
• Supply

Description:

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.

Lesson Objectives:

Students will:

• 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.

Introduction:

Marketplace, 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 would be helpful for students to understand during this lesson are

Oligopoly- A market structure dominated by a small number of large firms, selling either identical or differentiated products, and significant barriers to entry into the industry. This is one of four basic market structures. The other three are perfect competition, monopoly, and monopolistic competition.

Monopoly- A market structure characterized by a single seller of a unique product with no close substitutes. This is one of four basic market structures. The other three are perfect competition, oligopoly, and monopolistic competition. As the single seller of a unique good with no close substitutes, a monopoly firm essentially has no competition. The demand for a monopoly firm's output is THE market demand. This gives the firm extensive market control--the ability to control the price and/or quantity of the good sold--making a monopoly firm a price maker. However, while a monopoly can control the market price, it can not charge more than the maximum demand price that buyers are willing to pay.

Competition- In general, the actions of two or more rivals in pursuit of the same objective. In the context of markets, the specific objective is either selling goods to buyers or alternatively buying goods from sellers. Competition tends to come in two varieties -- competition among the few, which is market with a small number of sellers (or buyers), such that each seller (or buyer) has some degree of market control, and competition among the many, which is a market with so many buyers and sellers that none is able to influence the market price or quantity exchanged.

Have your students define these words using research tools such as the dictionary or an internet search or an economics website like AmosWeb ^[1] . During the course of the lesson, ask the students to revisit the terms to see if they are getting better understanding of each term.

Resources:

[Note to teacher: The following link requires RealPlayer www.real.com/dmm/realplayer/search ^[12] .]
 

• AmosWeb: On online economics website students can use to look up economic terms.
  www.amosweb.com/cgi-bin/awb_nav.pl ^[13]
   
• Crude Oil Production Cuts December 28, 2001:  An article on the Marketplace website about OPEC trying to control oil production. Play from 1:10 through 3:08.
  marketplace.publicradio.org/shows/2001/12/28_mpp.html ^[14]
   
• OPEC Home Page: Students can use OPEC's website to learn more about the organization. Used to complete activity 3.
  www.opec.org/opec_web/en/ ^[3]
   
• EIA OPEC Fact Sheet: OPEC revenues students can use to learn more about OPEC and complete activity 3.
  www.eia.doe.gov/emeu/cabs/OPEC_Revenues/Factsheet.html ^[4]
   
• World Oil Market and Oil Price Chronologies: 1970-2000. A graphical representation of the history of oil prices. Used to complete activity 3.
  www.eia.doe.gov/emeu/cabs/chron.html ^[5]
   
• Oil Price History and Analysis: Another history of oil prices. This page also provides a good explanation of why prices have increased. Used to complete activity 3.
  www.wtrg.com/prices.htm ^[6]
   
• WTRG Economics Collection of Articles Written on OPEC: Articles written over several years analyzing the decisions faced by OPEC. Used to complete activity 3.
  www.wtrg.com/opec/index.html ^[7]
   
• American Petroleum Industry: Information on the average price of gasoline at the pump, the countries the U.S. imports of oil and product from, and state motor fuel tax rates.  Used to complete Activity 3.
  www.api.org/statistics/ ^[8]
   
• International Energy Outlook 2001: World Oil Markets and projection tables.  Used to complete Activity 3.
  www.eia.doe.gov/oiaf/ieo/oil.html ^[9]
   
• National Center for Educational Statistics graphing tool: A tool used in Activity 4 to help in creating a graph.
  http://nces.ed.gov/nceskids/createagraph/ ^[10]
• September 11 Activity: Used in Activity 1 to further provide evaluation and understanding on industries affected by 9/11.
  Flash Activity

Process:

Activity 1

Discuss the concept of supply and demand and relationships between industries by asking students to name 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? [Possible answers: Airlines, tourism, entertainment; Possible reasons: Fear of new attacks, fear of a failing economy, depression.]
• What related industries could have been affected by decreases in these sales? [Fuel Companies, restaurants and hotels, retailers.]

Other topics that can be used as prompts or starter topics are:

• What happens when demand for a particular product or item decreases? Why? [The price of the product goes down because consumers want less at all price levels, thus the prices associated with each quantity demanded fall.]
• What can industries do to protect themselves from complete collapse during times of economic downturn? [Some industries lose members (e.g. airlines declaring bankruptcy; restaurants going out of business.) Some cut expenditures by imposing layoffs or hiring freezes. Others work together to prevent bottoming out the price of a commodity and maintain a level of supply/demand that keeps the market stable. They do this by reducing the supply of the product, but this can be difficult to control when there are multiple producers of the commodity. In 1960, oil exporting countries formed an organization to control the production levels of crude oil. As of January 2001, this organization's membership controls This organization has grown over time into an institution. This lesson will focus on the structure and function of the Organization of Petroleum Exporting Countries [OPEC] and what it has done over the years to protect the interests of its membership. Students will discuss the implications of the size of the organization as well as its impact over time.]

Activity 2

Have the students

to the Marketplace audio segment on crude oil production cuts ^[2] 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."

As the students listen to the segment, have them generate a list of questions they'll need to answer to better understand the story. Examples of these questions are:

• Who are the members of OPEC? Why does the organization exist, and how do members agree on cutting production rates? [OPEC was created in 1960, and is a coalition of oil producing countries including Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. The stated goals of the organization are to "stabilize the oil market" by controlling or influencing production rates on a global level. Members act independently, but come together in conference to agree on production rates as a group. These agreements are not binding, and students may discover in their research that many times the member countries have not held to their agreements. Still, OPEC has had an influence on the oil market and is seen in the industry as a powerful controlling agent on prices.]
• If OPEC controls 40% of crude oil production, who controls the rest? [Other countries who produce and export large amounts of crude oil are Russia, Norway, Mexico, Oman, and Angola, among others.]
• Why would other countries cut or not cut their production in conjunction with OPEC's decision? [If OPEC cuts production, and other countries do not, those countries could see an increase in market share. There is, though, the danger of a price war resulting from that situation as each country cut prices in order to shore up their own share. It is in the best interest of non-OPEC countries to cooperate with OPEC in an effort to maintain a stable distribution of market share.]
• When OPEC has cut or increased production of oil in the past, has the price of petroleum responded as intended? [While there is a correlation between OPEC production rates and the price of petroleum, it is argued that OPEC has not been successful as a consortium. This is largely due to the non-binding nature of OPEC member agreements on production as well as the outside influences that contribute to any change in market value of a product [war, global economic indicators, political issues like price control policies or embargoes]. The WTRG Oil Price History and Analysis site below 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? [No. OPEC members control their own countries' production rates and influence other non-OPEC production rates. Pricing is determined by the market.]

Activity 3

Have the students work in small groups to 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."

• OPEC Home Page ^[3]
• EIA OPEC Fact Sheet ^[4]
• World Oil Market and Oil Price Chronologies: 1970-2000 ^[5]
• Oil Price History and Analysis ^[6]
• WTRG Economics Collection of Articles Written on OPEC ^[7]
• American Petroleum Industry: Industry Statistics ^[8]
• International Energy Outlook 2001: World Oil Markets ^[9]

Activity 4

After completing their basic research, the students 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. The students should analyze the graph and be able to say whether there is a correlation between the two data sets. Refer the students to the National Center for Educational Statistics graphing tool ^[10] to create the first section of the graph. They can then complete the line graph portion by hand. The students may research prices on their own, or use the tables below, reproduced from information found on the Energy Information Administration web site.

Table Reproduced from EIA site:

What correlation do you see between the production rates and the prices?

[Students should see that there is a relationship between OPEC Supply and world oil prices that does not exist between non-OPEC supply and oil prices. Graphs students draw should be similar in nature to the images provided here. Remind students, however, that supply is not the only factor influencing pricing. In their research on the WTRG Oil Price History and Analysis [6] and World Oil Market and Oil Price Chronologies: 1970-2000 [5] sites, students should examine other factors such as war and global politics as factors influencing pricing. This allows students to think back through the opening activity to this lesson which asked what industries were affected by the September 11, 2001 terrorist attacks on the United States. Remind students that supply and demand are both factors that affect pricing. OPEC and other oil producing countries alter supply in response to demand, and it is the relationship between these two factors that ultimately determine prices. The important concept to get here is that reducing or increasing supplies of a product can affect the price positively or negatively. OPEC has attempted to keep pricing stable by adjusting its production as the market shifts. . Use this discussion to stimulate debate on whether OPEC has been successful in its mission.]

Has OPEC succeeded in its organizational mission to stabilize the market? [Open-ended question; this is a debatable question.]

Conclusion:

Have the students 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 students' 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.

Links Used:

1. ^{^} "AmosWeb" - (www.amosweb.com) This is a searchable database of over 2000 economic terms and concepts.
2. ^{^} "Crude Oil Production Cuts December 28, 2001" - (marketplace.org) An article/video on the Marketplace website about OPEC trying to control oil production.
3. ^{^ ^} "OPEC Home Page" - (www.opec.org) Students can use OPEC's website to learn more about the organization.
4. ^{^ ^} "EIA OPEC Fact Sheet" - (www.eia.doe.gov) Provides information about OPEC.
5. ^{^ ^ ^} "World Oil Market and Oil Price Chronologies: 1970-2000" - (www.eia.doe.gov) A graphical representation of the history of oil prices.
6. ^{^ ^ ^} "Oil Price History and Analysis" - (www.wtrg.com) Provides a history of oil prices. This page also provides a good explanation of why prices have increased.
7. ^{^ ^} "Collection of Articles Written on OPEC" - (www.wtrg.com) Articles written over several years analyzing the decisions faced by OPEC. Provided by WTRG Economics.
8. ^{^ ^} "American Petroleum Industry" - (www.api.org) Information on the average price of gasoline at the pump, the countries the U.S. imports of oil and product from, and state motor fuel tax rates can be found at this site.
9. ^{^ ^} "International Energy Outlook 2001" - (www.eia.doe.gov) World Oil Markets and projection tables.
10. ^{^ ^} "Create a Graph" - (nces.ed.gov) This NCES page allows students to create their own graphs.
11. ^{^ ^} "Energy Information Administration (EIA)" - (www.eia.doe.gov) The homepage for the EIA.
12. ^{^} "Real Player" - (www.real.com) Get real player at this website.
13. ^{^} "AmosWeb" - (www.amosweb.com) On online economics website students can use to look up economic terms.
14. ^{^} "Crude Oil Production Cuts December 28, 2001" - (marketplace.publicradio.org) An article/video clip on the Marketplace website about OPEC trying to control oil production.

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