This question is in view of the Saudis recent claim that they’re now going to increase oil production to reduce the price of crude oil. Looking backwards, why does production even matter? I don’t understand why the Saudis (who are #1 in oil production, right?) feels it must cut production to raise the price of a barrel of crude oil. Huh?
If the Saudis own so much of the world’s oil supply, then can’t it name any price it wants WITHOUT cutting production? As I ask this question, please put down your Economics text of standard dogma and listen to common sense. Of course, you are always welcomed to point out the flaw to my thinking, but don’t just give me the “supply and demand” routine.
If I owned almost all the peanuts in the world, and you couldn’t function without it, couldn’t I force you to pay any price I wanted - regardless of production? Maybe I am missing a basic concept? Or, has economic theory missed the fundamentals of life - he who has the gold (er, um, oil) rules the world?
a) The Title of this thread should have, more correctly, been geared towards the Saudi’s control over world oil prices, vs. “OPEC”, as originally posted.
b) The last line should have, more correctly, read: "he who owns the gold (er, um, oil) makes the rules.
#1 - Saudi Arabia is a member of OPEC. Unless they want to go it alone, they have to hew to OPEC’s production limits and demands.
#2 - If they go it alone, the other members of OPEC will have oil for sale cheaper, so the Saudis make no money.
#3 - Raise the price high enough, and the Saudis make it worthwhile for other countries to exploit their own oil supplies. The US has plenty of oil…it just isn’t cost-effective to get it out. Raise the price, and it becomes cost-effective.
#4 - Oil is like taxes…the trick is to get the maximum milk for the minimum moo.
#5 - Push the price high enough, and even the French will want US Marines storming Riyahd.
#6 - There is plenty of oil produced by non-Opec countries. OPEC too high? Shop elsewhere.
If it were true that I absolutely needed some peanuts, and you were the only supplier, then I guess I’d have to pay whatever price you wanted to charge.
However, it pretty much never works this way. There are always substitutions people can make instead. If it suddenly costs $1000 for a gallon of gas, everybody would just stop driving. It would be bad for us, but bad for the oil supplier as well.
Short answer: there are multiple sellers who are each interested in making the most money they can, and the best way to do that is not to sell a few barrels at a high price, but to sell many many barrels at a slightly lower price. The sellers compete to offer oil at the lowest price; it is a “buyer’s market.” I’ll go into a long and tortured analogy to demonstrate:
Let’s say you and, ummm… Tim. Tim and you own all the peanut producing land, together. You own sixty percent of the peanut-producing land in the world, and he owns the other forty percent. You each realize the gains to be made by keeping prices high, but you’ve also got a family to feed. Your peanuts are sold at auction at the end of each week (let’s say that your peanuts are VERY fast-growing).
There is a population of people who need to buy peanuts, but they need to buy them as cheaply as possible, because it’s not their money – it’s the money that belongs to their taxpayers and shareholders. These are savage capitalists. They will do anything to get the cheapest peanuts they can. And they have reserves of peanuts, too, because they know you will occasionally try to hike up the prices.
You need to pay your peanut farmers at the end of each week – let’s say this costs $100. And you need your family to eat, which will cost another $100. And you also need to give each of your sons, the Princes, their $100 allowance, because you’re a lazy socialist welfare state… sorry, let’s keep your expenditures to $200 and ignore Saudi politics.
Tim also needs to pay his farmers (but his only cost $80) and his family needs to eat (also only $80, because he has all daughters, who think it’s fashionable to be skinny).
So you need to raise $200, and Tim needs to raise $160. You each figure your peanuts will sell at auction for $10.00 a bushel, so you put 20-some bushels on sale and Tim puts exactly 20 on sale (each of you allowing for a little profit and hedging your bets on the price).
By noon, the buyers are only up to $5.00 a bushel (these capitalists are vicious). You and Tim are getting worried. The buyers have reserves of peanuts at home saved up for just such an occasion, and they would rather go home empty-handed and say “let’s use some of our reserve” than come home and explain to their bosses that they paid double the market value of a bushel for these peanuts. Tim realizes he’s got a lot at stake, and cracks first. He decides to double the amount of bushels he has on sale (up to 40 bushels) and take the $5.00 price, because if he doesn’t bring home the money and shower his country with welfare and perks, his people will overthrow him in a bloody coup–I mean, his wife will not speak to him. Yeah, that’s it.
Suddenly, 80% of the buyers have been satisfied. They’ve taken Tim’s peanuts at the bargain price, and gone home. You are now left standing in a market where the last buyers must deal with you and only you. You manage to convince these guys that you’re the only game in town. Four of them buy it, and pay you $10.00 a bushel, but because the price is high, they just buy what they need. You only move 10 bushels, and you’re still short $100. You’re getting desperate (and so are the other buyers) when there’s a commotion at the other end of the agora.
It’s Tim, that utter bastard, selling more of his peanuts for $7.50 a bushel (apparently he is also a vicious capitalist)!! The rest of the buyers flock to him (realizing they’re not going to get you to budge on price) and buy only what they need. They buy 20 more bushels, and he makes $150 on top of his $200. He’s way ahead of the game! Sure, you’re angry at him, but what are you going to do, invade his country and seize his peanut assets? Hardly! By the time you lower your price, nobody is interested, and you fail to sell any peanuts. Tim has not only fed his wife & kids and paid for his farm, but his farm’s GDP is way up. The unemployed adolescent men in his country are given welfare checks and stay busy instead of fomenting revolution and terrorism (actually, Tim is Russia - his unemployed youth have tuberculosis and AIDS, and spend the rest of their short lives making fast money in the Russian mob).
You, on the other hand, because you tried to demand a price, got locked out, did not meet your sales goals, and when you came home, your wife did not talk to you. In fact, she kicked you out and found a man who would sell the peanuts for a reasonable price and give her all the bling her heart desired. You have been overthrown in a bloody coup, and instead of being a sheikh, surrounded by all the luxury peanuts provide, you are dead. The unemployed peanut farmers in your country descend into terrorism, religious extremism, and… oh yeah, I promised I’d leave Saudi politics out of this.
Bummer, eh?
So that’s the crux: it’s a buyer’s market. There exists more supply than demand; the only way to ensure that you get the price you want is to cut the supply to a volume that is less than the demand. Since no single seller controls the supply, each seller is incentivized to be “greedy”, break the monopoly/cartel, and sell peanuts at a cut price to the buyers who got “shut out”. Since each seller is incentivized to try to make a little extra in this way, it is not long before supply exceeds demand… and it’s a buyer’s market again.
Here’s a couple of quotes from the CIA World Factbook of all things. “The petroleum sector accounts for roughly 75% of budget revenues, 45% of GDP, and 90% of export earnings…The government is supporting private sector growth to lessen the kingdom’s dependence on oil and increase employment opportunities for the swelling Saudi population.” Figures are based on 2003.
Or we’d convert all our cars to run on kitchen grease.
Seriously, we could provide our entire nation’s demand for diesel, at least, through biofuels – but it would require planting about three-quarters of our arable land with rapeseed. Rapeseed produces 115 gallons of biodiesel per acre, and would require about 350 million acres under till to produce the 40 billion gallons a year of diesel we use. The United States has 464 million acres of arable land. (There are plants that are capable of producing even more biodiesel per acre than rapeseed, like the oil palm and the pecan, but they have narrower growth zones than rapeseed.) This would have a major impact on our agricultural and fuel markets, but it’s not impossible.
