O X F O R D INSTlTUTE

E N E R G Y STUDIES

- FOR -

Who Makes the Oil Price?

An Analysis of Oil Price Movements I978 - 1982

Steve Roberts

Oxford Institute for Energy Studies

WPM 4

1984

The contents o f t h i s p a p e r are f o r t h e purposes of s t u d y and discussion and do n o t represent the v i e w s of t h e Oxford I n s t i t u t e for Energy S t u d i e s or any of i ts members.

Copyright 0 1984 Oxford I n s t i t u t e for Energy Studies

ISBN 0 948061 03 0

CONTENTS

I n t r o d u c t i o n

I Some T h e o r e t i c a l Cons ide ra t ions

I1 The Second Oil Price Explosion

111 The P r i c e U n i f i c a t i o n of 1981

IV The Slack Market of 1982

V Conclusions

Annex 1

Annex 2

Page

1

4

8

29

37

46

5 1

53

FIGURES

Page

F i g . 1 S p o t P r i c e s of Se lec t ed Crudes and Products ,

A p r i l 1978 - March 1979

2 Early 1979 Q f f i C i a l P r i ce Increases

3 Spot Crude and Product P r i c e s , 1979-1982

4 Egypt and Ecuador's O f f i c i a l Crude P r i c e s ,

1979-1 982

5 Ear ly 1981 O f f i c i a l Price Cuts

6 1982 O f f i c i a l P r i c e Changes

TABLES

10

1 4

17

23

31

41

T a b l e 1 Official P r i c e I n d i c e s for OPEC Producers ,

December 1978 - December 1980 2 0

2 O f f i c i a l Price Indices for non-OPEC Producers,

December 1978 - December 1980 21

3 O f f i c i a l P r i c e D i f f e r e n t i a l s : September 1978,

December 1981 and November 1982 3 4

1

Who Makes The Oil Pr ice? 1978-82

A s tudy of o i l developments du r ing '1978-82 may provide some

impor tan t i n s i g h t s i n t o the o p e r a t i o n of the p r i c i n g mechanism for

petroleum i n i n t e r n a t i o n a l t r ade . F i r s t of a l l , t h i s period enables us

t o s tudy the behaviour of oil producers i n both a r i s i n g and a f a l l i n g

market. I n 1979/80 excess demand pushed prices u p more than t h ree fo ld .

Two years l a te r the p o s i t i o n changed t o one of unprecedented excess

supply, with OPEC producing a t less than 55 per c e n t of capac i ty . As w e

s h a l l see the evidence sugges ts marked asymmetries i n behaviour

according to market cond i t ions .

Secondly, 1978-82 is a period during which s e v e r a l non4PEC

c o u n t r i e s emerged as s i g n i f i c a n t exporters and began to p l a y a major

r o l e i n the w o r l d market. W e would sugges t t h a t too o f t e n non-OPEC

producers have been given l i t t l e o r no a t t e n t i o n , be ing regarded merely

as pass ive agents i n a market i n which the p r i c i n g d e c i s i o n i s s a i d t o

be beyond t h e i r c o n t r o l . The evidence of the post-1978 pe r iod p a i n t s a

very d i f f e r e n t p i c t u r e .

Thirdly, a n d f o r the very reasons mentioned above, the pe r iod

1978-82 p rov ides a good t e s t i n g ground f o r t h e i s s u e of price

l eade r sh ip . Who l ed t h e o i l price rise of 1979-80? How w e r e prices

determined i n 1981 -82 when excess s u p p l i e s should normally have induced

a rap id price c o l l a p s e ? As we o u t l i n e i n Sec t ion I, a number of

c h a r a c t e r i z a t i o n s of the o i l p r i c i n g system c a n be developed, most of

which p o s t u l a t e some form of l e a d e r s h i p - e i t h e r by OPEC o r a subse t of

OPEC member c o u n t r i e s a c t i n g as a ' ca r te l ' , o r by a s i g n i f i c a n t

producer (Saudi Arabia) provid ing a f r e e b u f f e r s t o c k to an informal

commodity s t a b i l i z a t i o n scheme.

T h e o r i s t s have found it a t t rac t ive t o apply to the o i l market

a n equ i l ib r ium concept due to von S tacke lbe rg l I which d i s t i n g u i s h e s a

dominant producer (OPEC or Saudi Arabia) and a compe t i t i ve f r i n g e . The

former makes t h e price, t a k i n g i n t o account the e f f e c t of h i s a c t i o n s

1 H. von Stacke lberg , The Theory of the Market Economyl Oxford Univers i ty P r e s s , 1952.

2

on t h e supply dec i s ions of f r i n g e producers . The l a t t e r have no

in f luence on the market and j u s t t ake the price as given by t h e

dominant group.

Equi l ibr ium concepts may provide u s e f u l norms. B u t the o i l

market has ev iden t ly been i n a s ta te of d i s e q u i l i b r i u m i n the period

cons idered here . A no t ion , f i r s t developed by Kenneth Arrow2, and n o t

prev ious ly app l i ed to the o i l market, may be r e l e v a n t . The idea is that

i n d i sequ i l ib r ium every producer f a c e s a downwards s lop ing demand curve

and thus has some d i s c r e t i o n over h i s price. If everybody i s a price

maker h a t is then the r o l e of the leader?

O i l experts w i th in t h e i n d u s t r y have tended to look a t the

problem d i f f e r e n t l y . Their i n t e r e s t focuses on the r o l e played by Saudi

Arabia as the l inchpin of the p r i c i n g system, and on the i n t e r a c t i o n

between this country and o t h e r O P E producers. A convent ional wisdom

has developed i n the i n d u s t r y ; i t de f ines Saudi Arabia as the 'swing

s u p p l i e r I which s t a b i l i z e s prices by absorbing f l u c t u a t i o n s i n t h e

demand for OPEC o i l . Of course the 'swing s u p p l i e r ' cannot i n c r e a s e h i s

product ion beyond i n s t a l l e d c a p a c i t y ; and he is u n l i k e l y to remain

i n d i f f e r e n t i f ou tput d e c l i n e s below a c e r t a i n limit. On t h i s view

Saudi Arabia's a b i l i t y to s t a b i l i z e prices, though s i g n i f i c a n t , is

neve r the l e s s cons t ra ined .

We s h a l l see that the evidence supports the Arrow not ion as

w e l l as t h e idea of c o n s t r a i n e d Saudi l eade r sh ip . Again, whether this

corresponds to any view of price l eade r sh ip as def ined by the standard

economic l i t e r a t u r e i s ques t ionab le . W e a t tempt i n the concluding part

of the paper (Sec t ion V) t o sugges t d i f f e r e n t theoretical

c h a r a c t e r i z a t i o n s of the oil pricing mechanism accord ing t o

demand/supply condi t ions p r e v a i l i n g i n the market. But t h e r e is a

l i m i t to t h e e x t e n t to which the behaviour of the o i l producers can be

expla ined i n s t r i c t l y economic terms. P o l i t i c s are a f a c t o r of major

importance, and economists f o r g e t t h i s a t t h e i r peril.

Kenneth T. Arrow, ' T o w a r d s a Theory of P r i ce Adjustment ' , i n M. Abramowi t z (ed . ) , The A l l o c a t i o n of Economic Resources, Stanford Univers i ty Press , 1959.

3

This paper i s s t r u c t u r e d around three d i s t i n c t sub-periods:

( i ) The pe r iod of r i s i n g prices from September 1978 t o December

1980;

(ii 1 The price u n i f i c a t i o n of 1981 ;

Iiii) The slack market of 1982.

I n each w e seek f i r s t ta describe t h e output and price changes which

occurred, h i g h l i g h t i n g the d i f f e r e n t i a l s i z e and t iming of changes i n

official prices by each producer , and comparing these i n t u r n w i t h

movements i n spot crude and product prices. W e seek throughout to draw

o u t the imp l i ca t ions of our f i n d i n g s for the oil p r i c i n g system, and

t h e s e are brought toge ther i n the concluding s e c t i o n .

4

I

Some T h e o r e t i c a l Cons idera t ions

As suggested above, this paper seeks not merely to p r e s e n t a

h i s t o r i c a l survey of the movements i n crude o i l prices s i n c e 1978, b u t

also to examine t h e e x t e n t t o which the f a c t s lend suppor t t o s o m e

widely he ld views on the ope ra t ion of the world petroleum market and i n

p a r t i c u l a r of t h e p r i c i n g system. It may be u s e f u l a t t h e outset t o

o u t l i n e some poss ib l e t h e o r e t i c a l c h a r a c t e r i z a t i o n s of the p r i c i n g

mechanism i n the o i l market. We s h a l l cons ide r s p e c i f i c a l l y t h r e e such

approaches: f i r s t that which views the market as comprising a dominant,

price-making cartel and a compet i t ive , p r i ce - t ak ing f r i n g e ; secondly

t h a t which concent ra tes on more s t anda rd p r i ce - l eade r sh ip models ; and

t h i r d l y that which views a l l p rduce r s , l a r g e and small, as

price-makers when the market is i n d i sequ i l ib r ium.

i. C a r t e l and Fr inge

Much r e c e n t work on t h e p r i c i n g mechanism i n the world petroleum market

has focused on the not ion of the ex i s t ence of a dominant producer group

OK cartel which f i x e s p r i c e s to clear the market, c u r r e n t l y and Over

all f u t u r e per iods , t a k i n g i n t o account the op t ima l supply responses of

a number of small, pr ice- tak ing producers . See , f o r example t h e work

of Sa lan t3 , Ulph4, and Dasgupta and H e a l 5 . Thus, Stephen S a l a n t has

developed a computerized Nashqourno t model of the world o i l market

which e x p l i c i t l y uses a p r i c e - f i x i n g producer and a compet i t ive

f r i n g e . The l a t t e r seeks to maximize i t s p r o f i t s a t the price l e v e l

d i c t a t e d t o it by the dominant s u p p l i e r . Such work has come to the f o r e

Stephen W. Sa lan t , Imperfec t Competit ion i n the World O i l Market, Lexington Books, 1982.

A - Ulph and G . F ~ l i e , 'Exhaus t ib le Resources and Cartels: A n I n t e r - temporal Hash-Cmrnot Model', Canadian Journa l of Economics, 1980.

P. Dasgupta and G. H e a l , Economic Theory and Exhaus t ib le Resources , ' Cambridge Handbook, Cambridge Univers i ty P r e s s , 1979.

5

i n the mid-1970s wi th t h e emergence of a number of l a r g e producers

o u t s i d e OPEC. The b a s i c no t ion and hence the explana t ion of the price

mechanism is very s t r a igh t fo rward . As suggested by Newbery6, this can

be construed as an equi l ibr ium concept or, fo l lowing Pindyck7 defended

as a f i r s t approximation to the o i l market. W e s h a l l seek i n this paper

t o examine the e x t e n t of the approximation - a n e x e r c i s e which

s u r p r i s i n g l y has not y e t been done.

ii . P r i c e Leadership

Close ly r e l a t e d to the c a r t e l / f r i n g e c h a r a c t e r i z a t i o n of t h e world

petroleum market, one may attempt to f i t the p r i c i n g system to the

textbook d e s c r i p t i o n s of price l eade r sh ip . The l i t e r a t u r e on o l igopo ly

g ives us , among o t h e r s , the fo l lowing two models. 'Dominant f i rm '

l e a d e r s h i p is perhaps the most f a m i l i a r . It envisages a l a r g e [ u s u a l l y

low c o s t ) producer which sets the i n d u s t r y price, t ak ing i n t o account

t h e r e a c t i o n of t h e smaller producers to t h a t price, so as to maximize

i t s p r o f i t s . Such a l e a d e r would ensure t h a t a l l o t h e r producers fo l low

h i s price dec i s ions by t h rea t en ing to use aggres s ive p r i c i n g and

product ion policies to d r i v e t h e m out of the market i f they do not

conf om.

The price leader i s n o t necessa r i ly the producer which changes

i t s price f i r s t ; i n the real world, any of the small producers may

a l ter its price ch rono log ica l ly before the others - perhaps d r iven by

short- term revenue requirements . A t r u e price-leader, i n t h i s model,

n o t only i n i t i a t e s the price change bu t is a b l e t o en fo rce it i n the

long run and have a d i r e c t i n f luence on t h e d e c i s i o n s of o t h e r

producers .

The second m o d e l of price l e a d e r s h i p (due to Markham8) is

'Barometric Leade r sh ip ' , i n which a l l firms agree [ fo rma l ly or

D.M.G. Mewbery, ' O i l P r i c e s , Cartels and the Problem of Dynamic Incons is t e ncy ' , The Economic Journa l , 97, September 1 9 8 1 . R.S. Pindyck, ' G a i n s to Producers from C a r t e l i z a t i o n of Exhaus t ib le

Resources ' , R e v i e w of Economics and S t a t i s t i c s , 60, 1978.

J.W. Markham, 'The Nature and Sign i f i cance of P r i c e Leadersh ip ' , American Economic Review, 41, 1951.

6

i n fo rma l ly ) t o follow the price changes of a f i rm which they cons ider

t o have a good knowledge of the p r e v a i l i n g market condi t ions , and which

has a good r epu ta t ion f o r f o r e c a s t i n g f u t u r e market developments. This

f i r m thus becomes the barometer of t h e indus t ry , and to quote S t i g l e r

' I . . . commands adherence of r i v a l s to his price only because, and t o the

e x t e n t t h a t , h i s price r e f l e c t s market cond i t ions with t o l e r a b l e

promptness .I1'

barometr ic l eade r sh ip which may be important . F i r s t of a l l , t h e l e a d e r

may change from t i m e t o t i m e - though only i f and when the r e p u t a t i o n

of a f i r m improves s u f f i c i e n t l y to win the confidence of the rest of

t h e i n d u s t r y . Changes are t h e r e f o r e u n l i k e l y to occur very

f r e q u e n t l y . Secondly, it i s recognized that whilst upward price

movements w i l l almost i n v a r i a b l y be l ed ch rono log ica l ly by the

barometr ic leader, price c u t s may be i n i t i a t e d by o t h e r f i rms i n the

form of u n o f f i c i a l d i scounts e tc , with the barometr ic f i rm u l t i m a t e l y

reducing o f f i c i a l prices i n l i n e .

The l i t e r a t u r e outlines two f u r t h e r f e a t u r e s of

The recent l i t e r a t u r e on petroleum economics o f t e n s i n g l e s o u t

Saudi Arabia as the price Leader w i t h i n OPEC. This r o l e has been

c h a r a c t e r i z e d i n many d i f f e r e n t ways. A p u r e l y 'economic' view,

(which, paradoxica l ly , i s o f t e n propounded i n the US for t r a n s p a r e n t

p o l i t i c a l reasons] is t h a t Saudi Arabia seeks to maximize its economic

i n t e r e s t s i n the long run by pursuing a moderate p r i c i n g p o l i c y . The

argument is t h a t Saudi Arabia has huge hydrocarbon reserves and a very

long t i m e hor izon for economic development. I ts main o b j e c t i v e i s to

p r o t e c t a sha re of the world energy market f o r its own oil by e r e c t i n g

moderate p r i c i n g barriers a g a i n s t e n t r y by s u b s t i t u t e f u e l s .

As Saudi Arabia i s unique i n i t s a b i l i t y to vary the rate of

e x t r a c t i o n with r e l a t i v e ease over a wide range, i t has the power t o

e x e r c i z e l eade r sh ip w i t h i n the counc i l s of OPEC. This p o w e r i s used t o

hold t h e agreed price l i n e when excess s u p p l i e s exert downward

p r e s s u r e s and t o dampen price rises when excess demand l e a d s t o pr ice

explos ion . I n one s i t u a t i o n Saudi Arabia defends a price which is

o f t e n c l o s e to i t s own p re fe rences even i f fo rma l ly def ined by OPEC.

I n the o t h e r s i t u a t i o n it seeks t o p r o t e c t t h e long-term o b j e c t i v e

mentioned above.

G.J. Stigler, 'The Kinky Demand Curve and Rig id P r i c e s ' , Jou rna l of P o l i t i c a l Economy, October 1947.

7

iii. Arrow's Model of Disequi l ibr ium P r i c i n g

Kenneth Arrow f i r s t developed the n o t i o n t h a t , i n any market i n

d i sequ i l ib r ium i n which there are a number of sel lers , each one f aces a

s lop ing demand curve . Indeed Arrow argued t h a t i n such a s i t u a t i o n ,

and even i n the case of p e r f e c t compet i t ion , each s m a l l producer would

price ' I . . . i n accordance with the prof i t -maximising tac t ics of a

monopolist . .'I * S a l a n t - t y p m o d e l which t akes price as given, i n d i s e q u i l i b r i u m t h e

Arrow approach sees every producer as a pr ice maker. Each producer

thus has t h e i n c e n t i v e to change its price u n i l a t e r a l l y . When t h e

d i sequ i l ib r ium i s one of excess supply, t h e demand curve f ac ing each

producer is less than p e r f e c t l y e l a s t i c and hence he can lower h i s

price and i n c r e a s e sales and revenues. When the re is excess demand i n

t h e market, t h e producer w i l l f a c e a demand curve which is s h i f t i n g t o

the r i g h t . He can thus e f f e c t i v e l y s e l l a t h i s supply price and

o p e r a t e a long his supply curve, r a i s i n g price u n t i l t h e excess demand

is e l imina ted .

Hence, un l ike the compet i t ive f r i n g e of t h e

Such an approach has not, as y e t , been app l i ed d i r e c t l y to the

o i l market, a l though it is our b e l i e f t h a t it may help to shed some

l i g h t on the p r i c i n g behaviour of producers f o r a t least some of the

post-1978 period. To d iscover the re levance of a l l three models to the

oil market, w e must t u r n t o examine the h i s t o r y of t h e 1978-1982

period.

l o K.T. A r r o w , o p . c i t . , p.46.

8

I1

The Second O i l P r i c e Explosion

We have chosen September 1978 as the s t a r t i n g p i n t f o r

a n a l y s i s as i t marks the end of a period of r e l a t i v e price s t a b i l i t y

(of some two years s i n c e the 4 th quarter of 1976) . W e s h a l l assume that

t h i s period of r e l a t i v e s t a b i l i t y i n prices and i n market sha res i n a

margina l ly s l a c k market produced, by September 1978, a s t r u c t u r e of

price d i f f e r e n t i a l s which w a s broadly i n equ i l ib r ium. This m e a n s that

t h e supply price of each crude i n the world market more-or-less

r e f l e c t e d t h e buyer ' s va lua t ion of the d i f f e r e n c e s i n t h e i r q u a l i t y ,

such t h a t he would be i n d i f f e r e n t between any two crudes of the same

price. (This assumption is explored i n more d e t a i l i n Annex 2 . )

We need f i r s t to o u t l i n e the main changes i n crude oil o u t p u t

over the whole per iod of September 1978 t o December 1980, as it is only

a g a i n s t such a backdrop t h a t price movements can be understood f u l l y .

Throughout the f i r s t t h r e e q u a r t e r s of 1978, world ou tpu t w a s

f a i r l y s t e a d y i n the 60 mbd range, of which OPEC accounted f o r 2 8 to 30

mbd. September s a w the usua l i n c r e a s e i n ou tput as Western i n v e n t o r i e s

were r ep len i shed before the win te r . The customary p a t t e r n over the

previous few years had been f o r ou tput to con t inue to rise over the

las t quarter - perhaps to a December peak some 2.5 mbd (World) o r 1 . 5

mbd ( O P E ) h ighe r than September. This p a t t e r n w a s d i s r u p t e d i n 1978 by

the anti-Shah s t r i k e s i n the I r a n i a n oil f i e l d s , which pushed I r a n i a n

output down from a peak of 6 mbd i n September t o 3.5 mbd i n November

and 2.4 mbd i n December. Despite a compensating i n c r e a s e i n Saudi

Arabian o u t p u t of 2 mbd over t h e th ree months, t o t a l OPEC product ion i n

December was some 4.7% lower than i t s September l e v e l .I

World output w a s s o m e 1 .1 % lower. 1977 had s e e n rises over these months of 4.2% (OPEC) and 3.8% (World).

9

The I r a n i a n p o s i t i o n worsened a t the s ta r t of 1979; ou tpu t

f e l l t o 500-700 thousand b/d i n January and February and expor t s w e r e

suspended. They were n o t resumed until e a r l y March, soon a f t e r

Ayatol lah Khomeini’s r e t u r n , when product ion picked up t o 2.3 mbd

(March) and 3.6 mbd ( A p r i l ) . It remained i n the 3 t o 4 mbd range f o r

t h e rest of 1979. T o t a l OPEC output followed very much this p a t t e r n ,

w i th low po in t s of around 28.5 mbd i n January and February, p ick ing up

t h e r e a f t e r t o 30 to 31 mbd f o r the rest of t h e year .

What, then, of t h e price movements which these output changes

invoked?

I n many ways, the most r evea l ing f e a t u r e s of the 1978-80 pr ice

i n c r e a s e s can be drawn from t h e i n i t i a l movements before t h e O P E

meet ings of December 1978 i n Abu Dhabi and March 1979 i n Geneva. W e

s h a l l cons ider s e p a r a t e l y , t he re fo re , t h r e e sub-periods: September 1978

t o December 1978; December 1978 t o March 1979; and the bulk of the

pe r iod from March 1979 t o December 1980.

(a) The Spot Price Movements t o December 1978

The f i r s t price i n c r e a s e s came i n the s p o t product market. Spot prices

of a number of l i g h t products were t h e f irst to show any marked

i n c r e a s e , beginning as e a r l y as August 1978. Naphtha, and Premium and

Regular Gasoline prices rose by 8-10% from J u l y to August on the

Rotterdam market a n d such inc reases w e r e mir rored i n the o t h e r main

world spot product markets . These e a r l y movements i n l i g h t products

sugges t some t i g h t e n i n g of the market be fo re t h e I r an ian supply

problems. They came three months before any s u b s t a n t i a l i n c r e a s e i n the

price of the l a r g e s t t r a d e d product - h igh su lphur (3.5%) f u e l oil - which began i n November 1978. The f i r s t i n c r e a s e s i n s p o t c rude prices

came between these two phases of product price rises, beginning i n

October 1978 a f t e r a prolonged per iod i n the $ 1 2 t o $14 range

(depending on the q u a l i t y of the crude) . As with spot product prices,

November 1978 wi tnessed a p a r t i c u l a r l y s h a r p spot crude price inc rease ,

as t h e e f f e c t s of t h e f i r s t product ion c u t s by I r a n began to be f e l t .

Supp l i e s to the s p o t market f e l l as most oil companies withdrew,

keeping t h e i r oil f o r c o n t r a c t customers. This, coupled with the

Figure 1

I: $ I b

38

36

34

32

30

28

26

24

22

20

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I6

14

SPOT P R I C E S O F SELECTED C R U D E S AND PRODUCTS

- April 1978 to March 1979 -

F I'

I \ I ' ', Premium Gasoline

I / I

I I

I I

I I

I I

I 1

I I

I I

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f

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. .

12 - 10 -

A I M J n ' J I ' A u ' S ' O h 1 D J ' F I M '

1978 1979

Heauv Fuel Oil 3.596s

Official Marker Price

11

i nc reas ing

s i t u a t i o n ,

unease i n t h e oil market a s a whole over t h e I r a n i a n

pushed a l l spot p r i c e s up markedly i n mid-Novemeber 1978.

F igure 1 graphs t h e i n i t i a l movements i n two s p o t crude p r i c e s

a long with t h e two product p r i c e s d i s c u s s e d , - a n d h i g h l i g h t s t h e very

sharp and s u b s t a n t i a l na tu re of t h e i n c r e a s e s .

These s p o t p r i c e rises provide u s w i t h a backdrop a g a i n s t which

t o a s s e s s t h e very f i r s t o f f i c i a l p r i c e i n c r e a s e s , which were announced

by OPEC a t t h e end of December 1978 a t i ts Abu Dhabi meeting. By

December, spot l i g h t product p r i c e s had r i s e n by some 40%, s p o t crude

p r i c e s by 18% and spo t heavy product p r i c e s by some 9%. The o f f i c i a l

crude p r i c e s agreed a t t h e OPEC meeting e f f e c t e d i n c r e a s e s of between

2% and 6%, wi th t h e major i ty of c rudes , inc luding t h e Marker, r i s i n g by

5% (i .e. some 60-70 cen t s /b ) I T h i s w a s very much less than requi red t o

match t h e s p o t p r i c e i n c r e a s e s , and indeed it i s n o t c l e a r t h e e x t e n t

t o which t h e movements on t h e s p o t market a f f e c t e d t h e OPEC dec i s ion .

All j u s t i € i c a t i o n s of t h e p r i c e rise a t t h e t i m e were made i n terms of

t h e e f f e c t of i n f l a t i o n on r e a l p r i c e s and t h e impact of d o l l a r

exchange r a t e movements on OPEC revenue, and it was even repor ted t h a t

Saudi O i l Min i s t e r Y a m m i was "no t happy" w i t h t h e outcome. To quote

Petroleum I n t e l l i g e n c e Weekly 12

by t h e I r a n i a n supply s h o r t f a l l , made it d i f f i c u l t t o hold o u t €or a

smal le r r i s e . " Some evidence, t hen , of t h e movements i n spo t p r i c e s

a f f e c t i n g t h e o f f i c i a l p r i c e d e c i s i o n , b u t l i t t l e evidence of OPEC

achiev ing , o r even at tempting an o f f i c i a l p r i c e r i s e of anything l i k e

t h e s i z e needed t o match spot price movements.

I 1 .... market f o r c e s , appa ren t ly headed

l2 Petroleum I n t e l l i g e n c e Weekly , December 25 , 1978 , p- 2.

1 2

(b) December 1978 t o March 1979

This period between the OPEC meetings of Abu Dhabi and Geneva witnessed

very dramatic rises i n both s p o t and o f f i c i a l prices, and is also a

pe r iod which r evea l s some i n t e r e s t i n g f a c t o r s r e l e v a n t to t h e

p r i ce - l eade r sh ip ques t ion . In o rde r to understand the price movements

over those four months it is worth reviewing, b r i e f l y , the sequence of

e f f e c t s which the I r a n i a n product ion cuts had on t h e world market.

As w e have seen, October 1978 to March 1979 s a w some

s u b s t a n t i a l c u t s i n output by I r an , which had a f f e c t e d t o t a l world and

OPEC ou tpu t . The I r a n i a n loss amounted t o some 5 mbd, compensated i n

part by a 2 mbd i nc rease by Saudi Arabia. Whilst a n e t p roduct ion c u t

of 3 mbd is s u b s t a n t i a l , it i s a t f i r s t s i g h t s u r p r i s i n g that a 5% f a l l

i n world ou tpu t could cause, u l t ima te ly , a t h r e e f o l d price inc rease . To

understand this we must examine e x a c t l y how the I r a n i a n c u t s a f f e c t e d

the o i l market.

The fall i n I r a n i a n product ion had a p a r t i c u l a r l y l a r g e e f f e c t

on BP (an es t imated loss of 1.4 mbd), Exxon (loss of 400,000 bd) , and

Socal (loss of 300,000 bd) , a l l of whom had to d e c l a r e "force majeure"

c u t s on a number of t h e i r c o n t r a c t customers. BP, the most heavily

a f f e c t e d , began t h e c u t s as e a r l y as t h e second week of January 1979

wi th a huge 35% reduct ion . This w a s increased t o 45% (1.4 mbd) i n mid-

February, a t which t i m e t h e r e w e r e a spate of o t h e r force-majeure

o f f i c i a l supply c u t s announced - Exxon's 10% (400,000 bd) being the

second l a r g e s t . This t i g h t e n i n g of s u p p l i e s t o a few major companies

caused a f u r t h e r shr inkage of supply t o the spot market, and a s h a r p

reduct ion i n t h e f l o w of crude t o t h e Third Party Market, of which BP

and Exxon had been the ch ief suppl iers . The 'Third P a r t y Market ' w a s

the means by which major o i l co rpora t ions f ed crude o i l t o t hose

companies which d id n o t deal d i r e c t l y w i t h an OPEC o r a non-OPEC

producer. Japan was by f a r the largest such country, and indeed i t w a s

Japan who was m o s t h i t by BP and EXxon's c u t s .

The Japanese n a t u r a l l y responded to this new s i t u a t i o n by

t u rn ing d i r e c t l y to the producing na t ions , which, i n t u r n , prompted

producers both to i n c r e a s e t h e i r prices i n the l i g h t of the perceived

inc reased demand for t h e i r crude and f u r t h e r to restrict supp l i e s t o

t h e majors, thus accen tua t ing t h e problem. Indeed by the middle of

13

1979, many of t h e " fo rce majeure" c u t s had turned i n t o long term

reduc t ions i n t h e o f f i c i a l commitments of most majors on t h e Th i rd

Pa r ty Market.

T h i s cha in of even t s r e s u l t i n g from t h e I r an inan supply c u t s ,

in f luenced both spot and o f f i c i a l p r i c e movements i n t h e e a r l y months

of 1979.

(i) All spo t p r i c e s - crude and products a l i k e - i nc reased very

sha rp ly i n February 1979, as t h e majors and t h e o i l producers c u r t a i l e d

s u p p l i e s of crude t o t h e s p o t markets. Light product p r i c e s r o s e t o

over $38/b, heavy products t o over $17/b and t h e Marker crude spot

p r i c e to $22.5/b (monthly average f i g u r e s ) , r e f l e c t i n g i n c r e a s e s of

over 40% between t h e monthly averages of January and February 1979 ( s e e

Figure 1) .

(ii) Following t h e s e e a r l y movements i n s p o t p r i c e s , i n both

1978 and e a r l y 1979, t h e r e began a s e r i e s of o f f i c i a l p r i c e i n c r e a s e s ,

encouraged by t h e perce ived inc rease i n demand from Thi rd Pa r ty Market

customers. F igu re 2 graphs t h e chronology of t h e e a r l y o f f i c i a l p r i c e

i n c r e a s e s and s e v e r a l important p o i n t s emerge:

- The first c o u n t r i e s t o r a i s e o f f i c i a l p r i c e s s u b s t a n t i a l l y

were t h e UK ($1,50/b o r 11%) and Norway ($1.65/b or 12%) on 15th

January 1979. This was a f t e r t h e OPEC meeting of l a t e December 1978

which had agreed s l i g h t upward adjustments t o OPEC p r i c e s ( i n t h e

reg ion of 50-80 c e n t s o r 5 % ) , b u t f u l l y t e n weeks before t h e meeting of

l a t e March which introduced t h e f i r s t l a r g e g e n e r a l p r i c e rise. Thus

t h e f i r s t p r i c e inc rease was i n i t i a t e d by two non-OPEC producers - indeed two OECD c o u n t r i e s .

- There then followed a number of s l i g h t l y sma l l e r o f f i c i a l

p r i c e i n c r e a s e s by i n d i v i d u a l OPEC members. Ecuador was f i r s t t o movs

in e a r l y February, followed s o m e t w o weeks l a t e r by both Abu Dhabi and

Qatar, with i n c r e a s e s of 7 .2% and 6.8% r e s p e c t i v e l y . Th i s e a r l y move by

two c o u n t r i e s commonly regarded a s 'moderates ' came on 15th February,

two weeks be fo re s i m i l a r i n c r e a s e s by Kuwait and I r a q , and nea r ly s i x

weeks be fo re t h e March OPEC meeting. Further moves i n February/March by

I C .-

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al 01 Q

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L

ae v)

ae m hl

ae m

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F

15

Libya (a long w i t h Shar jah and Dubai) l 3 add t o t h e list of u n i l a t e r a l

a c t i o n s which toge the r b e l i e any d e s c r i p t i o n of OPEC as a u n i f i e d

p r i c i n g c a r t e l over t h i s p e r i o d .

- Much the l a r g e s t i n c r e a s e s i n t h e f i r s t t h r e e months of 1979

came f r o m t w o non-OPEC produce r s , S y r i a ($3.11/b i n c r e a s e s on 2 1 s t

February, g iv ing a cumulat ive i n c r e a s e t o t h a t d a t e of over 31%) and

Egypt ($3.05/b inc rease on 25th March); and from t h e s m a l l e s t OPEC

producer, Ecuador ($4.60/b on 1 s t March). N o . s ign here of t h e l a r g e

producers d i c t a t i n g p r i c i n g p o l i c y t o t h e s m a l l p roducers .

- Whilst t h e ma jo r i ty of t h e non-OPEC producers lagged t h e OPEC

' l e a d e r s ' (Qatar, UAE, Iraq, Kuwait, Ecuador) i n t h e i r f i r s t l a r g e

p r i c e i n c r e a s e , they had a l l ( w i t h t h e except ion of USSR, China and

Mexico) in t roduced a s u b s t a n t i a l p r i c e rise (i.e. of $1.50 o r m o r e )

before t h e March OPEC meeting. They a l l , t h e r e f o r e , preceded a c t i o n by

t h e ma jo r i ty of OPEC.

OPEC members e n t e r e d t h e i r March 1979 Geneva conference w i t h

widely d i f f e r i n g v i eus on p r i c e s , and a r e c o n c i l i a t i o n of those views

w a s t o prove impossible. Saudi Arabia's a t t empt s t o urge moderation

were l a r g e l y ignored, and it u l t i m a t e l y agreed t o a Marker crude p r i c e

i n c r e a s e of j u s t over $ l / b t o $14.456/b. Other members, however, were

l e f t to add whatever premia or surcharges they wished t o t h i s 'minimum'

marker p r i c e - t h e r e s u l t be ing a wide range of price i n c r e a s e s from

Saud i ' s $ l / b t o up t o $3.75/b by t h e Afr ican producers (Alger ia , Libya

and N i g e r i a ) . Even Gulf producers such as Abu Dhabi, Qatar, I r a n and

K u w a i t set t h e surcharge a t $1.80/b. The f i r s t OPEC conference a t which

l a r g e p r i c e r i s e s were in t roduced , t h e r e f o r e , w a s one of d i s u n i t y of

a i m s and outcomes. Its e f f e c t w a s simply t o keep pace w i t h t h e l a r g e

i n c r e a s e s i n spot and non-OPEC o f f i c i a l p r i c e s which had a l r eady

occured.

F i n a l l y , note t h a t a l l t h e s e p r i c e i n c r e a s e s s t i l l l e f t

o f f i c i a l p r i c e s s u b s t a n t i a l l y below s p o t c rude p r i c e s - by an average

of about $6/b a t t h e end of March 1979.

l 3 Sharjah and D u b a i a r e both members of OPEC through t h e i r membership of t h e United Arab Emirates, a l though they do not act i n unison w i t h Abu Dhabi, t h e ch ie f o i l -p roduce r and OPEC member i n t h e UAE.

16

( c ) March 1979 t o December 1980

The bulk of 1979 and 1980 w a s a confused pe r iod of rap id , a d g e n e r a l l y

uncoordinated, price increases, from which it is d i f f i c u l t t o d i s c e r n

any clear p a t t e r n o r any evidence of p r i ce - l eade r sh ip on t h e part of a

s i n g l e group of producers . !The main developments were as fol lows:

Spot c rude prices (see Figure 3 ) increased very r a p i d l y i n 1979,

p a r t i c u l a r l y i n April-June (Arabian Light spot price increased from

$28/b t o $ 3 S / b ) and i n September-November (from $35 to a peak of $41 1.

This was both a much f a s t e r and g r e a t e r abso lu t e increase than was

disp layed i n any o f f i c i a l c o n t r a c t price i n 1979. A t the peak of

November 1979, t h e Arabian L igh t s p o t price was f u l l y $23/b above i t s

o f f i c i a l price. The f a c t o r s behind these two s p u r t s are a g a i n both of

i n t e r e s t and importance. As noted above, March 1979 s a w the resumption

of I r a n i a n expor t s , and by April s p o t prices began to weaken. Saudi

Arabia t h e r e f o r e decided t h a t it w a s aga in s a f e t o r e t u r n t o i t s

t r a d i t i o n a l ou tput of 8.5 mbd, which it had raised t o 9.5 mbd to

counter t h e I r a n i a n c u t s . The e f f e c t of this c u t , exaggerated f u r t h e r

by Niger ian c u t s of up t o 100,OO bd t o BP who i n a d v e r t e n t l y broke

N i g e r i a ' s boycot t of South Afr i ca i n May 1979, w a s to send crude-hungry

majors h e a v i l y i n t o the s p o t market, d r i v i n g prices up towards $35/b by

mid-May .

It is d i f f i c u l t t o know the motives behind t h e Saudi cut. Some,

no tab ly Adelman14 have i n t e r p r e t e d i t as a d e l i b e r a t e attempt t o push

prices s t i l l h igher , wh i l s t o t h e r s 1 5 have seen it as a non-aggressive

response to the r e t u r n of I r a n i a n exports t o t h e world market. As we

s h a l l see, Saudi attempts to hold down the price throughout the rest of

1979 and 1980 would appear a t odds wi th Adelman's i n t e r p r e t a t i o n .

Indeed, t h e 1 mbd c u t corresponded to an i n c r e a s e i n I r a n i a n ou tpu t of

some 3 mbd by A p r i l , l e av ing t o t a l OPEC ou tpu t 2 mbd h ighe r than i n

March. With spot prices weakening by March, it is perhaps not

unreasonable €or Saudi Arabia t o have f e l t j u s t i f i e d i n r e t u r n i n g to

l 4 Morris Adelman, 'OPEC as a Cartel I , i n James M. Griffin and David J. Teece (eds .) , OPEC Behaviour and World O i l Prices, George Allen Ei

Unwin, 1982, pp. 47-49.

l 5 I a n Seymour, OPEC - Ins t rument of Change, Macmillan P res s , 1980, pp. 183-184.

0 cv

18

i t s lower ou tpu t l e v e l t o make way f o r I r a n ' s resumption of expor t s .

Whatever the motives of the Saudi c u t , and despite the aggrega te

i n c r e a s e i n OPEC ou tpu t , the e f f e c t w a s aga in t o cause unease i n the

world market and a f u r t h e r dramatic s p u r t i n t h e crude s p o t price.

The second spot price spurt of November 1979 is, a t f i r s t

s i g h t , something of a paradox, with seemingly adequate output t o meet

c u r r e n t demand. There was, however, s u b s t a n t i a l s tockbui ld ing i n t h e

l as t t w o quarters of 1979 as t h e majors sought both to r e p l e n i s h

deple ted s t o c k s and t o guard a g a i n s t p o s s i b l e f u t u r e p o l i t i c a l problems

in I r a n . T b quote Seymourt6, "Fear rather than shor t age was , t h e r e f o r e ,

t h e dominant f o r c e behind the buoyant market i n t h e second half of

1 9 79 . " Following the peak a t the end of 1979, spot crude prices

proceeded to f a l l du r ing the f i r s t e i g h t months of 1980 (Arabian L igh t

f e l l from $41/b to $32/b by August 1980) before t h e o n s e t of the

I r an / I r aq War pushed them to a second peak (Arabian Light $41/b a g a i n )

in November 1980. This second peak w a s above the l e v e l

achieved by any official prices i n 1980, bu t s e v e r a l producers had

increased their o f f i c i a l prices s u f f i c i e n t l y by mid-1 980 t o have

regained p a r i t y with s p o t crude prices before t h e second s p o t price

jump-

Some understanding of t h e output movements behind t h e s p o t

price s p u r t of l a te 1980 would aga in be u s e f u l . I r a n i a n product ion,

having recovered to 4 rnbd i n September 1979, f e l l s t e a d i l y over the

next year to just over 1.1 mbd i n September 1980 a t the outbreak of the

I r a n / I r a q War. &spi te t h i s , t h e year had seen no major aggrega te

supply s h o r t a g e s - indeed t h e r e was t h e usua l p a t t e r n of inventory

run-down i n the f i r s t quarter of 1980 (less than usua l i f anyth ing) and

s u b s t a n t i a l build-up i n the third q u a r t e r . This r e f l e c t e d s h a r p l y

f a l l i n g demand worldwide, as w e l l as compensating i n c r e a s e s i n ou tpu t

by Saudi Arabia (back a t around 10 mbd) and non4PEC product ion some

1.5 mbd above 1978 l e v e l s . Iraq's output was s t e a d y a t around 3 . 4 t o

3.5 mbd. The w a r saw the combined output of I r a n and Iraq f a l l from 4.5

mbd to under 1 mbd i n October and November 1980. Saudi Arabia

l 6 I . Seymour, op . c i t . , p.189.

19

immediately sought t o s o f t e n the impact of t h i s cutback by inc reas ing

ou tpu t t o over 10.5 mbd bu t t o t a l OPEC output s t i l l f e l l by some 2 mbd.

Whils t t h i s c u t fo rced spot crude p r i c e s back up t o $41/b, it

d i d no t have t h e same effect as t h e s i m i l a r c u t i n 1978/9, which was

followed by a t h r e e f o l d r i s e i n s p o t p r i c e s i n j u s t e leven months.

reasons f o r t h i s a r e wel l documented by Badger and Belgrave17 and need

n o t concern us unduly here . W e would perh:aps p l a c e less emphasis than

do Badger and Belgrave on the speedy and a p p r o p r i a t e a c t i o n by the IEA

and Saudi Arabia , and p o i n t m o r e t o t h e fundamental ly d i f f e r e n t market

cond i t ions i n which t h e two product ion c u t s occurred. I n September 1980

t h e i n d u s t r y knew t h a t world o i l consumption had been on a d e c l i n i n g

t r e n d f o r almost two y e a r s - a pe rcep t ion which, n a t u r a l l y , nobody had

i n 1979. Moreover inventory l e v e l s were very h igh , p rov id ing a secu re

cushion t o bo th companies and governments.

The

O f f i c i a l P r i c e s . A s suggested above, t h e pe r iod s a w a gene ra l melee of

o f f i c i a l p r i c e i n c r e a s e s , wi th producers leapf rogging ove r each o t h e r s '

p r i c e rises. OPEC members, wi thout except ion, r e g u l a r l y inc reased

p r i c e s o u t s i d e OPEC meetings, and indeed a c t e d i n no d i f f e r e n t manner

t o t h e non-OPEC producers (wi th t h e s o l e except ion of Saudi Arabia, as

d i scussed below). A t t h e extreme, Ecuador appeared t o abandon any

concept of a f i x e d o f f i c i a l p r i c e f o r i t s crude, and v a r i e d its pkiee

wi th 'market c o n d i t i o n s ' a lmost on a cargo-by-cargo b a s i s . N o s i n g l e

count ry took a c o n s i s t e n t ' l e a d ' i n t h e pe r iod - i n terms of

c o n s i s t e n t l y i n c r e a s i n g p r i c e s e a r l i e r t han and/or by a g r e a t e r margin

than t h e r e s t . Tables 1 and 2 show a v a r i e t y of c o u n t r i e s t o have

inc reased p r i c e s more r a p i d l y than t h e r e s t a t one t ime or another .

Seve ra l c o u n t r i e s d i d emerge towards t h e t o p of the p r i c e league - notably I r a n , Libya and Ecuador w i t h i n OPEC, and Egypt and S y r i a

o u t s i d e OPEC - b u t t h e r e i s no c l e a r evidence of producers fo l lowing

any one c o u n t r y ' s p r i c e movements c l o s e l y throughout t h e pe r iod .

17Daniel Badger and Robert Belgrave, O i l Supply and P r i c e : Right i n 1980, B r i t i s h I n s t i t u t e ' s J o i n t Energy Programme, Energy Paper No. 2 , 1982.

What Went

20

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22

The manner i n which o f f i c i a l prices followed spot crude prices

v a r i e d f o m country t o country. A t one extreme, Ecuador (wi th in OPEC)

and Egypt (non-OPEC 1 followed s p o t movements quite c l o s e l y - p a r t i c u l a r l y i n the rap id rise of t h e f i r s t half of 1979 ( s e e Figure

4 ) . A t the o t h e r extreme, Saudi Arabia lagged behind a l l o t h e r

official price rises throughout the period and i ts o f f i c i a l prices bore

l i t t l e o r no r e l a t i o n s h i p to movements i n the s p o t price throughout

1979 and 1980.

The very v o l a t i l e p r i c i n g of Ecuador and Egypt, among o t h e r s ,

and t h e i r rapid response t o s p o t price movements are

i n t e r e s t i n g f e a t u r e s of t h e 1979/80 price explosion. One may ask whether

t h e i r p o l i c i e s provided some kind of leadersh ip? W e would sugges t no t .

Ecuador and Egypt most c e r t a i n l y were not dominant producers , ab l e t o

d i c t a t e p r i c i n g p o l i c y to the rest of t h e wor ld ' s p roducers . Nor indeed

were they always able t o s u s t a i n price changes i n the f a c e of a

r e l u c t a n c e by o t h e r s to fol low. (This was p a r t i c u l a r l y so f o r Ecuador,

whose p r i c i n g w a s e s p e c i a l l y v o l a t i l e . 1 Equally, they w e r e n o t t h e

wel l - respected producers of the 'barometr ic l eade r sh ip ' model,

i n s p i r i n g the confidence of o t h e r s i n t h e i r judgements and f o r e c a s t s . Such was the c loseness of t h e i r p r i c i n g t o the spot price t h a t they

gave o t h e r producers no more informat ion than they werealready

r ece iv ing from the spot market. The p r i c i n g a c t i v i t y of such s m a l l

coun t r i e s is perhaps more simply expla ined by t h e i r r e l a t i v e lack of

commitment to long-term supply c o n t r a c t s , al lowing t h e m e f f e c t i v e l y t o

t r ade on the spot.

Whilst t h e a c t i o n of Ecuador and Egypt does n o t g ive evidence

of p r i c e - l e a d e r s h i p on t h e i r part , however, i t is impor t an t i n c a s t i n g

doubt on the notion of the re having been any l e a d e r over the per iod .

J u s t as ECuador, Egypt and t h e l i k e w e r e no t ' l e a d e r s ' , nor were they

fo l lowers of some more dominant producer .

The r o l e of Saudi Arabia, much t h e l a r g e s t producer i n OPEC, is

worthy of p a r t i c u l a r a t t e n t i o n . As the i n d i c e s of l k b l e s 1 and 2 show,

Saudi Arabian prices lagged w e l l behind those of a l l o t h e r O P E and

non-OPEC producers , such that by the end of April 1981 t h e Saudi Marker

price of $26/b w a s up t o $9 below those of comparable l i g h t crudes. It

appears t o have been a price fo l lower throughout the two years of price

i n c r e a s e s , with much smaller price rises than o t h e r s up to A p r i l 1980.

0 m a! C W

Y

.- L

0

I d c1 Q c a! - m N

------!:

24

The h i s t o r y book shows Saudi Arabia to have been a voice of

moderation throughout much of 1979 and 1980. As w e have seen, it w a s

uneasy about the March 1979 i n c r e a s e s when it only raised the marker

price by $ l /b ! This w a s t h e beginning of two years of ' m u l t i - t i e r e d '

p r i c i n g wi th in OPEC, with the Saudis keeping Arabian L igh t price

inc reases to a minimum, and much of the rest of OPEC o p e r a t i n g to a

much h igher de f a c t o 'marker ' p r ice .18

Indeed the Saudi motivat ion throughout the per iod appears

tohave been to p reven t wide divergence of prices wi th in OPEC - i t s

price inc reases , when they came, a t t empt ing always to r e e s t a b l i s h

p a r i t y r a t h e r t han push t h e whole system f u r t h e r up. The chronology of

December 1979/January 1980 i l l u s t r a t e s this p o i n t :

14 December 1979 - Saudi Arabia (along with the UAE, @ t a r and

Venezuela) i n c r e a s e s i t s marker price by $6/b, i n o rde r t o close the

$5.5/b gap which has appeared between i t and I r a n i a n l i g h t , and t o

attempt to "c l ip t h e wings of the price hawks"19.

16 D e c e m b e r 1979 - I r an r e -e s t ab l i shes the d i f f e r e n t i a l w i t h a $5/b

i n c r e a s e .

3 January 1980 - I r a n f u r t h e r i n c r e a s e s t h e d i f f e r e n t i a l by $2/b.

28 January 1980 - Saudi Arabia aga in tries to c l o s e the gap wi th its

own $2/b inc rease .

1 February 1980 - I r a n aga in r e -e s t ab l i shes the d i f f e r e n t i a l with a

f u r t h e r $2/b i n c r e a s e .

l 8 As e a r l y a s the June 1979 Geneva meeting this p a t t e r n became clear - with t h e Saudi marker price a t $18/b, b u t with the rest of t h e Gulf working to an e f f e c t i v e marker of $20/b, and I r a n employing i t s own $ 2 2 marker. P r i ces w e r e no t to regroup around the o f f i c i a l marker u n t i l October 1981, d e s p i t e f r equen t attempts by the Saudis to achieve such u n i t y .

D r . H u m b e r t o Calderon-Berti , Venezuelan O i l Min i s t e r .

I

25

Saudi Arabia's attempts to r e u n i f y OPEC prices throughout the

p e r i d served only to allow f u r t h e r i n c r e a s e s by the res t of OPEC.

There would appear t o be no evidence of convent ional p r i ce - l eade r sh ip

by t he dominant producer i n the t w o yea r s of r i s i n g prices.

None-the-less, a number of OPEC members d i d s t i c k c l o s e l y t o

t h e p r i c i n g p a t t e r n of Saudi Arabia. Indonesia and Venezuela increased

o f f i c i a l prices only s l i g h t l y f a s t e r i n 7979 and then remained i n step,

as d id the UAE, Iraq, Qatar and K u w a i t a f t e r t h e i r i n i t i a l l a r g e

i n c r e a s e s i n e a r l y 1979. D i f f e r e n t i a l s had n o t been restored i n any of

t h e s e cases by the end of 1980, however. The motives of t h i s group of

r e l a t ive 'moderates' are f a r from clear. They w e r e r e l u c t a n t to make

f u l l use of the headroom i n prices created by the s p o t market and the

more aggres ive producers a n l y e t t h e i r p e r i o d i c l a rge price i n c r e a s e s ,

no tab ly in early 1979, do n o t sugges t any over - r id ing l o y a l t y to the

O P I E p r i ce - f ix ing machinery. There is, indeed, much evidence t h a t these

c o u n t r i e s i n p a r t i c u l a r added l a r g e u n o f f i c i a l premia on top of

o f f i c i a l prices for long-term c o n t r a c t s with companies who were

d e s p e r a t e f o r o i l . This e f f e c t i v e l y inc reased prices to n e a r e r t h e s p o t

price without a f f e c t i n g the " o f f i c i a l " price.

The e f f e c t of producers ' widely d i f f e r i n g p r i c i n g p o l i c i e s w a s

t o widen price d i f f e r e n t i a l s s u b s t a n t i a l l y (both with in and o u t s i d e

O P E ) . Table 1 p r e s e n t s simple Standard Deviat ions f o r t h e index

numbers a t each date shown, They show a very clear and marked widening

of d i f f e r e n t i a l s w i t h i n OPEC t o a peak i n A p r i l 1980. The remainder of

1980 s a w some l i m i t e d narrowing of d i f f e r e n t i a l s , but the two year

pe r iod of r i s i n g prices s t i l l ended wi th very s u b s t a n t i a l d ivergences

of o f f i c i a l prices from the d i f f e r e n t i a l s t r u c t u r e of September 1978.

( d ) T h e o r e t i c a l Impl i ca t ions of t h e 1979/80 P r i c e R i s e s

What impl i ca t ions , then , does the evidence of the 1979-80 pr ice

i n c r e a s e s have f o r t h e t h e o r e t i c a l c h a r a c t e r i z a t i o n of the world o i l

i n d u s t r y i n a t i g h t market? F i r s t of all, we would s u g g e s t that there

is l i t t l e or no evidence of OPEC act ing as a u n i f i e d cartel. W e have

described t w o yea r s of widespread u n i l a t e r a l price s e t t i n g by OPEC

members, with the ma jo r i ty of p r i c i n g d e c i s i o n s being taken o u t s i d e

o f f i c i a l OPEC meet ings . The pe r iod was also one i n which there w a s no

26

agreement on product ion wi th in the Organisa t ion . W e would sugges t that

a group of producers who i n d i v i d u a l l y decide on both t h e i r ou tpu t and

prices do not c o n s t i t u t e a c a r t e l i n any economically meaningful s e n s e .

Secondly, we do n o t be l i eve t h a t t h e evidence of the

tightdemand/supply cond i t ions of 1979/80 lends suppor t to the n o t i o n

that the o i l market comprises a dominant producer group which sets

prices and a competitive f r i n g e of pr i ce - t ake r s . As we have seen, t h e r e

h a s been no group of producers which has c o n s i s t e n t l y dictated prices

to t h e rest of the i n d u s t r y , o r indeed one which has c o n s i s t e n t l y

adopted t h e prices s e t by the o t h e r s . P r i c e changes have been i n i t i a t e d

by almost every producer a t some ,point over the t w o yea r s - the smaller

producers o f t e n r e a c t i n g more s w i f t l y to spot price movements. There

has c e r t a i n l y been no l a r g e producer which has enforced i t s price

changes - as i n the "dominant-firm price l eade r sh ip" model. me one

count ry which could conceivably do so, Saudi Arabia, has lagged behind

a l l o t h e r price movements throughout, and i t s attempts to se t OPEC

prices were unsuccesful . Q u a l l y , t h e r e has been no s i n g l e

"wel l - respec ted" producer which has acted a s d "barometer" to the

i d u s t r y . The ch rono log ica l leader changed too f r equen t ly f o r any

c redence t o be placed on such a not ion, and e q u a l l y , e a r l y price moves

w e r e no t always followed by the rest of t h e indus t ry .

It has been suggested t h a t , w h i l s t the dominant price se t t e r

m a y n o t d i c t a t e a l l price movements, it does dec ide broadly the l e v e l

a round which prices w i l l f l u c t u a t e . Hence, the dominant p r d u c e r sets

its price a t , say, $30/b and al lows the rest of t h e i n d u s t r y to compete

a round t h a t l e v e l . Again, we would sugges t t h a t t h i s does n o t

c o n s i s t e n t l y f i t the f a c t s i n a t i g h t market. There i s no evidence of

any country/group of c o u n t r i e s determining the l e v e l to which the price

was t o rise over the two years .

The p a t t e r n of price movements i n 1979/80 does n o t t h e r e f o r e

conform to the no t ion of a p r i ce - t ak ing f r i n g e i n t h e o i l market.

R a t h e r , the p r i c i n g a c t i v i t y of the per iod sugges t s t h a t even the

s m a l l e s t producer i n t h e market had a n i n c e n t i v e to change prices - i .e. every producer i n the market, i n t i m e s of excess demand, appears

to f a c e a s lop inq demand curve and not t h e h o r i z o n t a l demand curve

P o s t u l a t e d i n models w i th a p r i ce - t ak ing f r i n g e . Every producer, i n

this case, is a price-maker. In a s i t u a t i o n of excess demand, t o q u o t e

27

Arrow: 'I... any i n d i v i d u a l en t r ep reneur knows t h a t he can raise the

price, even i f h i s competi tors do not raise t h e i r s , because they cannot

s a t i s f y any more of the demand than they do a l r e a d y . The ent repreneur

is faced with a s lop ing demand curve and r a i s e s h i s price i n accordance

with the profit-maximizing tactics of a monopolist . . .'I and indeed

'I.. .it is equa l ly to the p r o f i t of a l l o t h e r en t r ep reneur s t o raise

t h e i r prices also. . . I ' 2o

I n fact, i n such a s i t u a t i o n of excess demand, each producer

f i n d s the demand curve to be s h i f t i n g to the r i g h t , such t h a t he can

e f f e c t i v e l y opera te a long h i s own supply curve . Such an explana t ion

would appear t o f i t c l o s e l y t h e pricing behaviour i n the o i l market of

1979/80. Small producers , both wi th in and o u t s i d e OPEC, had d r a t i o n a l

economic i n c e n t i v e to raise t h e i r prices.

But producers d i d not always (and some never d i d ) raise t h e i r

prices as h igh as demand might have allowed. A v a r i e t y of i n h i b i t i o n s

were probably a t work - f e a r of l o s i n g customers ' goodwil l should

circumstances change, poli t ical cau t ion , etc. It a l s o seems t h a t Saudi

Arabia exe rc i sed an in f luence on p r i c i n g behaviour .

The r o l e of Saudi Arabia dur ing this period is d i f f i c u l t t o

de f ine i n terms of usua l l e a d e r s h i p m o d e l s . As mentioned ear l ier ,

attempts by Saudi Arabia to s e t the price a t i t s p r e f e r r e d l e v e l w e r e

n o t s u c c e s s f u l . I n this sense , it w a s n o t a convent iona l price

l eade r . Its c o n t r i b u t i o n w a s rather d i f f e r e n t . Saudi A r a b i a ' s

behaviour helped OPEC r e t a i n an i d e n t i t y and sense of purpose. By

holding i t s prices down, w e l l below market levels and i n def iance of

a l l market i n d i c a t o r s , i t defended the not ion that the r e fe rence price

of o i l should remain an adminis te red price. By so doing it helped

p r e v e n t OPEC from abd ica t ing i t s func t ions e n t i r e l y to the market.

During this per iod , OPEC member c o u n t r i e s found themselves

moving between two poles : t h e s p o t market a t one extreme and Saudi

Arabia a t the o t h e r . Their i n d i v i d u a l p r i c i n g behaviours r e f l e c t the

r e l a t i v e a t t r a c t i o n of t hese two poles , a t d i f f e r e n t po in t s i n t i m e , t o

each member country. A s we have s e e n , Ecuador moved towards one pole

20 K.T. A r r o w , o p - c i t . , p.46.

28

and allowed i t s prices to fo l low the market, i n i ts ups and i n i t s

i n e v i t a b l e downs. Others, though s t r o n g l y tempted t o fol low such a n

extreme course , found themselves more or less r e s t r a i n e d by a

commitment to price admin i s t r a t ion . They were not prepared to give up

OPEC ( t h e i n s t i t u t i o n a l form of this commitment) e n t i r e l y . Saudi

A r a b i a ' s p r i c i n g behaviour was a cons t an t reminder of the need t o

admin i s t e r prices. It also provided a n anchorage to prices, a n

anchorage which d id not s t o p them from r i s i n g bu t c e r t a i n l y increased

t h e drag.

I n short Saudi Arabia did n o t lead OPEC a long a price path of

its choice . Every o i l producer w a s a t t i m e s a 'price maker' h l a

Arrow. Without Saudi Arabia each would have taken full advantage of

the slope i n i ts demand curve. I n the end, however, with the market

reaching equi l ibr ium every producer would have become a price t a k e r - not of a price set by a dominant s u p p l i e r , b u t of a price determined by

t h e i n t e r s e c t i o n of t o t a l demand and t h e aggrega te supply curve .

Y e t , because of Saudi Arabia 's p r i c i n g po l i cy , the outcome was

d i f f e r e n t . Most O P E producers followed a d i f f e r e n t price pa th to t h a t

traced by the market. The two paths went up i n the same d i r e c t i o n , but

they r a r e l y coincided. Curiously they i n t e r s e c t e d a t a p o i n t where

market prices were beginning to f a l l (having reached a peak which

o f f i c i a l prices never a t t a i n e d 1, while official prices w e r e con t inu ing

t o rise. The impor tan t p o i n t i s t h a t a d i s t i n c t i o n was preserved

between OPEC's and the marke t ' s price behaviour when very powerful

f o r c e s were a t tempt ing to a b o l i s h t h i s d i s t i n c t i o n .

29

The P r i c e U n i f i c a t i o n of 1981

(a) 1981 Output

Again, a review of the output changes over 1981 i s an impor tan t

prerequis i te to understanding the price movements Over the year . As we

noted earlier, Saudi Arabia increased its product ion to around 10.5 mbd

i n October 1980 i n response to t h e I r a n / I r a q war, It maintained t h i s

h ighe r ou tpu t c e i l i n g ( t r a d i t i o n a l l y f ixed a t 8.5 mbd) u n t i l the end of

August 1981 - a p o l i c y which had very important i m p l i c a t i o n s f o r the

whole of the o i l market i n the f i r s t t h r e e q u a r t e r s of t h e year . By t h e

end of 1980, Saudi Arabian prices w e r e s o m e $8/b below the rest of OPEC

and t h e d e c i s i o n to r e t a i n such a h i g h "al lowable output" i m p o s e d very

marked c u t s i n sales on many o t h e r OPEC producers . Despite the f a c t

t h a t I r a n and Iraq's combined ou tpu t only recovered to some 2.4 mbd,

the market s lackened s u f f i c i e n t l y f o r Libya and K u w a i t t o l o s e 1 mbd;

Niger ia some 1.3 mbd; Venezuela 0.5 mbd; and Qatar, Algeria and the UAE

some 200,000 bd i n the e i g h t months to August 1981 . As we s h a l l see,

t h e p re s su re which such l o s s e s of o u t p u t pu t on price d i f f e r e n t i a l s

w i t h i n OPEC w e r e to prove s u f f i c i e n t t o p u l l most prices down to the

Saudi l e v e l . More f l e x i b l e p r i c i n g i n the f i r s t h a l f of 1981 enabled

m o s t non-OPEC producers to maintain their output i n the f a c e of Saudi

A r a b i a ' s ' f l o o d i n g ' of the market.

( b ) 1981 Spot P r i c e s

This emergence of an excess supply of o i l was r e f l e c t e d most

immediately i n the s p o t markets. Having peaked i n November 1980 ( a t

$41/b for Arabian L igh t ) , spot crude prices f e l l by some $8 t o $10 by

mid-1981 t o the then p r e v a i l i n g o f f i c i a l marker price of $32/b. Spot

product prices a l s o began to d e c l i n e i n December 1980 ( t h i s t i m e

i nc lud ing 3.5% S f u e l o i l ) and s t a b i l i s e d by June/July a t prices not

incompatible with t h e $32 Marker. The d e c l i n e i n product prices i n the

f i r s t h a l f of 1981 was less than i n spot crude prices, they having

achieved a r a t h e r lower peak i n 1980. A l l of t h i s , coupled

wi th the drop i n sales ou t l ined above, provided producers wi th a clear

s i g n a l of the s lackening of t h e market - a s l ackness which cont inued

30

throughout 1981, w i t h only a weak recovery i n spot prices i n the w i n t e r

quarter. Spot price movements over 1981 are graphed on Figure 3.

(c) O f f i c i a l P r i c e s

Unlike t h e spot price d e c l i n e i n the f i r s t ha l f of 1980, this t i m e

o f f i c i a l prices followed the s p o t p r i c e down. F igure 5 i l l u s t r a t e s the

price cuts which took place before the OPEC meeting of l a te October

1981. Seve ra l i n t e r e s t i n g f e a t u r e s emerge:

Almost wi thout except ion , non-OPEC producers c u t their prices

s u b s t a n t i a l l y between A p r i l and August 1981 - befo re any moves by the

v a s t ma jo r i ty of OPEC. As we suggested above, these c u t s were i n

response to t h e aggress ive Saudi Arabian p o l i c y of selling 10.5 mbd a t

i t s r e l a t i v e l y l o w price of $32/b. The non-OPEC producers ' cu t s i n

prices brought them a l l back to around the Saudi l e v e l ( t h e r e s u l t a n t

d i f f e r e n t i a l s are examined i n Id) below), enab l ing them to compete and

pushing s t i l l more of t h e burden of output ad jus tment onto t h e

high-priced OPEC producers . Whilst s t i l l lagging spot price movements

by around s i x months, t h e o f f i c i a l price chronology shown i n F i g . 5

aga in sugges t s a g r e a t e r f l e x i b i l i t y and s e n s i t i v i t y t o spot price

changes on t h e part of non-OPEC producers than OPEC c o u n t r i e s .

The f i r s t t h ree q u a r t e r s of 1981 s a w a prolonged series of

disagreements w i t h i n OPEC. As noted earlier, 1979/80 had seen t h e

emergence of a two-t iered p r i c i n g system, with t h e o f f i c i a l Marker a t

$32/b and a de f a c t o Marker price of $36/b, around which much of OPEC

w a s c l u s t e r e d . The Saudi p o l i c y of main ta in ing a very h igh ou tpu t

d e s p i t e the weakening demand, and thereby i n f l i c t i n g very l a r g e c u t s in

sales on the rest of OPEC, w a s pursued with t h e s o l e a i m of p u l l i n g t h e

rest of OPEC back down to around i t s o f f i c i a l Marker price. It w a s a

clear attempt by Saudi Arabia t o reassert its p o s i t i o n i n the

Organ i sa t ion and indeed i n the whole world o i l market.

B y A p r i l

1 5 A p r i l

-10% I

1 M a y

7 M a y

14 M a y

18 M a y

1 J u n e

1 0 J u n e

1 5 June

1 July

10 July

17 Julv

1 Aug

26 Aug

1 om

29 Oct

EARLY 1981 OFFICIAL PRICE CUTS Figure 5

I - Price arts by all oil producers before the OPECrneeting of October 1981 -

- l 7 % I

E c u a d o r

-6% -1

C h i n a

M a layr ia

B r u n e i U S A E g y p t

Mexim USA

Malaysia

USSR U.K. Brunei

Mexico Libya Syria

Malaysia

China Egypt

Mexico Syria

Nigeria

USSR

OPEC

-:.$ - 3 %

- 1 0 % I - 3 % l

-2% -8%,

- l l % c - ? l % r 1

- 3 % J

-7%

-5% ’ 4%,

- 8 % ’

-3% - -7%

32

The OPEC meeting i n late May 1981 brought the c o n f l i c t w i t h i n

OPEC i n t o t h e open. Saudi Arabian attempts t o p u l l the rest of the

members' prices down from t h e i r $36/b "marker" were r e s i s t e d and indeed

the o t h e r twelve agreed p r d u c t i o n c u t s (of some 1 .25 mbd) i n an

attempt to defend t h e i r h ighe r r e fe rence price. Much of the summer was

then spent t r y i n g to urge product ion c u t s on Saudi Arabia, as spot

prices and output continued t o tumble. A f u r t h e r meeting of OPEC i n

mid-August 1981 again f a i l e d to agree on a r e u n i f i e d price s t r u c t u r e , a n d by this t i m e , as we have seen , a lmost every non-OPEC producer had

c u t p r i c e s to t h e Saudi Arabian l e v e l , e x e r t i n g s t i l l more pressure on

t h e bulk of OPEC.

The f a i l u r e of the August OPEC meeting was s w i f t l y followed by

one of the few u n i l a t e r a l price c u t s by an OPEC m e m b e r i n 1981 - Niger ia c u t t i n g from $40/b t o $36/b a t the end of tha t month. As Fig. 5

shows, the only previous cuts had been by Ecuador who cont inued to be a

l a w unto i t s e l f , and a small ($1.10/b) cut by Libya i n July.

The b a t t l e by Saudi Arabia t o re-impose i t s e l f as the ' l e a d e r '

w i th in OPEC, and to r e - e s t a b l i s h Arabian Light as " t h e " OPEC marker

crude, w a s thus a long a n d d i f f i c u l t one. It w a s a ba t t l e which i t

f i n a l l y won i n l a te October 1981, when, a t the meeting i n Geneva, a new

s i n g l e Marker price of $34/b was f i n a l l y agreed upon. A l l OPEC prices

thus f e l l s h a r p l y t o new l e v e l s around the $34/b Marker, while Saudi

A r a b i a a lone increased prices by $2/b t o complete the r e u n i f i c a t i o n .

(Fur the r s l i g h t adjustments to prices were made a t t h e D e c e m b e r OPEC

meeting.) It would thus appear t h a t Saudi Arabia had r idden the s t o r m

of the prev ious few years , and had once aga in a s s e r t e d i t s e l f a s t h e

l e a d e r of OPEC. That it had done this i n a s l acken ing market is of

s i g n i f i c a n c e - a p o i n t which we pursue f u r t h e r i n ( e ) below.

b

( d l How Good Was the R e u n i f i c a t i o n of P r i c e s ?

As we poin ted out i n Sec t ion I1 above, the price movements of 1979/80

had t h e e f f e c t of d rama t i ca l ly widening price d i f f e r e n t i a l s between

crudes of d i f f e r e n t q u a l i t y and f r m d i f f e r e n t c o u n t r i e s . The price

changes of 1981 need to be viewed i n a very d i f f e r e n t l i g h t - their

effect , wi thout except ion, be ing to b r i n g prices back t oge the r aga in .

I t is of i n t e r e s t to know how c l o s e l y this was achieved . As we

suggested earlier, t h e d i f f e r e n t i a l s of September 1978 had evolved over

33

two years of r e l a t i v e l y weak prices, and are t h e r e f o r e a good benchmark

a g a i n s t which to assess the price real ignment of 1981. (See also Annex

2.) Table 3 compares the d i f f e r e n t i a l s t r u c t u r e a t the end of 1981 wi th

tha t of 1978, on both a percentage and abso lu te b a s i s .

For most crudes, t h e percentage d i f f e r e n t i a l over Arabian L i g h t

a t t h e end of 1981 d i f f e r e d only margina l ly from that which had

p r e v a i l e d i n 1978. Hence one g e t s an impression of a remarkably c l o s e

r e t u r n to the d i f f e r e n t i a l s t r u c t u r e of 1978, fo l lowing the r e l a t i v e

chaos of 1979/80. This w a s brought about by what, on t h e s u r f a c e ,

appeared t o be a f a i r l y a r b i t r a r y al ignment w i t h i n OPEC, and a n

unplanned and uncoordinated series of price cuts o u t s i d e OPEC. Three

impor t an t q u a l i f i c a t i o n s must be made t o t h i s p i c t u r e , however. F i r s t

of a l l , as we noted earlier, a c o r r e c t d i f f e r e n t i a l is one wich makes

t h e buyer i n d i f f e r e n t between two crudes . It should t h e r e f o r e r e f l e c t

d i f f e r e n c e s i n t r a n s p o r t c o s t s , r e f i n i n g c o s t s , product prices, etc.,

and need not n e c e s s a r i l y be a set percentage of the crude pr ice , If a l l

c o s t s , product y i e l d s and prices remained cons t an t w h i l s t crude prices

rose, then the equi l ibr ium d i f f e r e n t i a l would remain c o n s t a n t i n

a b s o l u t e terms, and f a l l as a percentage of the crude price. An

assessment of t h e 1981 r e u n i f i c a t i o n based pu re ly on pe rcen tage

d i f f e r e n t i a l s may n o t t e l l t h e whole s t o r y , t h e r e f o r e .

Secondly, it is important to no te that, on a percentage b a s i s ,

wh i l e the d i f f e r e n c e s wi th the September 1978 p o s i t i o n s are small, t hey

are almost all i n t h e same d i r e c t i o n . There is a s l i g h t tendency to

undercut Arabian L i g h t which, g iven the previous r e luc t ance of m o s t

producers t o lower t h e i r prices, may appear r a t h e r s u r p r i s i n g . This i s ,

however, the p e r f e c t l y r a t i o n a l behaviour of any producer i n a s l a c k

market. The incen t ive is to price j u s t below the major producer and

t ake a l a r g e r s h a r e of the market. Tnis r e v e r s a l of p o l i c y by most

producers - which, as we s h a l l see, cont inued i n t o 1982 - sugges t s that

t h e earlier r e f u s a l to lower prices had l i t t l e to do with s h o r t run

p r o f i t maximization, and much m o r e to do with the pol i t ical d e s i r e t o

defend an independent marker price. Once the h ighe r marker had been

des t royed , most producers re turned to revenue maximizing behaviour i n

the s lackening market .

34

Table 3 : -Official. P r i c e Differentials aga ins t Saudi Arab ian Light 34 crude

DOLLARS

1 I I 1

I I I 30.9.781 31.12.81 I

I r a n Iraq Abu Dhabi Qatar Kuwait Gabon Libya Algeria Nigeria Shar j ah Dubai Venezuela Ecuador Indonesia

UK Norway USSR Mexico Oman Syria Egypt China Malaysia Brunei

+0.106 -0.124 +O .556 +O .296 -0.434

+O .974 +I .396 +1.416 +O. 586 -0.064 +O .836 -0 . 339 +O. 846

+l. 296 +I. 496 +O .456 +O. 396 +O. 356

+0.106 +O .496 +1 .596 +1 .446

0

-1.069

+0.20 -0.54 +1.50 +1 .30 -1 -70 0

j2.50 +3.00 M.52 +1 .56

+O .58 -1.40 + I .oo

-0.14

+2.50 +3.25 +1 .35 +I .oo +1 .06 -2.50

+o .90 +3.90 +2.10

0

30.1 1.82

-2.80 -0.54 +O .56 to. 30 -1.70 0

+1 .15 +1 .50 +1 .52 +0.59 -0.14 +O . 58 -2.10 +0.53

-0.50 +0.25 -1 .SO -1.50 +O .06 -4.00 -2.25 +O. 50 +3.30 +1.10

I PERCENTAGE

I 30.9.78

+O. 83 -0.98 +4.38 +2.33 -3.42

tl

0

+10.99 +11 .I5 +4.61 -0.50 +6.58 -2.67

+ 7 . m

+6 66

+10.20 +11 .78 +3.59 +3.12 +2.80 -8 41 +O. 83 +3.90

+12.56 + I 1.38 II

31 .12.81

+O .59 -1.59 +4.41 +3.82 -5.00

+7.35 +8.82 +1.53 +4.59 -0.41 + I .71 -4.12 +2.94

0

+7.35 +9.56 +3 97 +2.94 +3.12 -7.35 0

+2 . 65 +11.47

+6.18

I 30.11.82

-8.24 -1.59 +1 .65 +0.88 -5 . 00 +3.38 +4.41 +4*47 +1 .74 -0.41 +1 .71 -6.18 +1 .56

-1.47 +O. 74 -5.29 -4 -41 +O. 18

-1 1.76 -6.62 +1.47 +9.71 +3.24

0

I

35

Third ly , and perhaps most impor tan t ly , for t h e nex t year o r so t h e r e were a number of except ions to t h e gene ra l ly accurate r e t u r n t o

t h e 1978 d i f f e r e n t i a l s t r u c t u r e . Outside OPEC, Brunei, the UK and

Norway were e f f e c t i v e l y undercut t ing the OPEC marker and, more

s i g n i f i c a n t l y , there were a number of problems w i t h i n OPEC. Nigeria and

to some e x t e n t Indonesia , Algeria and Venezuela ended 1981 w i t h more

favourable d i f f e r e n t i a l s a g a i n s t Arabian Light than they had had i n

1978, and, as we s h a l l see below, these d i f f e r e n t i a l s w e r e t o cause

problems wi th in OPEC throughout 1982.

It is worth not ing , f i n a l l y , that the Arabian L i g h t spot price

f o r December 1981 was $34.26/b - only 26 c e n t s above t h e o f f i c i a l

marker price. 1981 t h u s ended w i t h spot and c o n t r a c t prices i n

remarkable harmony - with one or two important excep t ions .

( e l Leadership i n t h e Reun i f i ca t ion of 1981

The ques t ion arises, whether Arrow's c h a r a c t e r i z a t i o n of a market i n

d i sequ i l ib r ium, i n which a l l producers faced s lop ing demand curves and

hence were price-makers, he ld €or t h e o i l market i n t i m e s of excess

supply a s well as it appears to i n t i m e s of excess demand. 1981 can

perhaps be termed a 'h inge ' year between t h e t i g h t market of 1979/80

and t h e s l a c k market of 1982. It w a s a year of i n i t i a l l y marginal but

ever i nc reas ing excess supply. W e would sugges t t h a t a l though the re i s

evidence (as always i n d i sequ i l ib r ium cond i t ions 1 of Arrow-type

behaviour, the most s i g n i f i c a n t f e a t u r e of o i l developments i n 1981 i s

Saudi Arabia seeking s u c c e s s f u l l y to r e - e s t a b l i s h i t s e l f as the

l i n c h p i n of t h e world o i l market.

The Saudi t ac t ics w e r e c lear - to a l low buyers to l i f t as much

o i l as p o s s i b l e a t i t s low price i n o r d e r t o b r ing the whole of the

rest of t h e system to its l e v e l . It w a s , of course, a ided by t h e

g e n e r a l weakening of the market i n 1981 which meant tha t i t w a s seeking

to p u l l the system i n the same d i r e c t i o n as the market. Equally, t h e

Saudis w e r e no t d i c t a t e d to by the market . They maintained prices w e l l

above any compet i t ive l e v e l , whilst achiev ing a s t r e n g t h e n i n g of t h e i r

own p o s i t i o n i n the system. In this respect, the Saudi A r a b i a n p o l i c i e s

of 1981 f i t w e l l i n t o a pure 'dominant producer ' l e a d e r s h i p model. By

v i r t u e of its p o s i t i o n as the l a r g e s t s u p p l i e r , it w a s able t o en fo rce

its chosen price regime on the rest of the system. The f i n a l agreement

36

on t h e $34/b marker pr ice w a s something of d p o l i t i c a l compromise by

Saudi Arabia, its desire being as always to hold OPEC toge the r . It had,

however, made it clear from e a r l y 1981 that it would be happy t o see

t h e r e u n i f i c a t i o n a t $34/b and hence u l t ima te ly achieved its aim. It is

significant that it could do so when market cond i t ions supported its

policies, unl ike du r ing t h e previous t w o years when its attempts to

resist market p r e s s u r e s w e r e no t very s u c c e s s f u l .

The policies of Saudi Arabia were t h u s r e l a t i v e l y s t r a i g h t -

forward du r ing 1981. What, then, of the r o l e of t h e rest of the

producers i n t h a t yea r? !Ihe non-OPEC producers cont inued t o act i n a

revenue maximizing manner, given the p o l i c i e s of o t h e r agents. Having

followed the market to i t s peak i n November 1980, they sought to keep

prices h igh f o r the f i r s t q u a r t e r of 1981 and so enjoy the enhanced

revenue. When by t h e second quarter, the e f f e c t s of the Saudi p o l i c y

began to be f e l t on t h e i r ou tput l e v e l s , they q u i c k l y fol lowed the spot

price down to l e v e l s close t o Saudi Arabia's prices, and thus were able

t o main ta in t h e i r ou tpu t a t the expense of t h e rest of OPEC. The

non-OPEC producers w e r e thus dictated t o by Saudi Arabian product ion

p o l i c i e s and the s lackening market, and w e r e quick to respond.

The behaviour of t h e bulk of OPEC i s much more d i f f i c u l t t o

e x p l a i n . As we have seen , their a t t empt t o defend t h e i r h ighe r 'marker'

price cost them d e a r l y i n terms of l o s t ou tpu t and revenue, and y e t

t hey r e s i s t e d the p r e s s u r e s to c u t prices f o r f u l l y t e n months. This

c l e a r l y does not t ie i n with their 1979/80 policies except i n so f a r as

t hey wished t o see high prices. Nor, indeed - as w e examine i n Sec t ion

I V below - does it t i e i n with t h e i r behaviour i n 1982, when aga in they

appeared t o seek to maximize t h e i r s h o r t term revenue. One can only

conclude t h a t t h e i r motives were p o l i t i c a l . That they r e s i s t e d so

long, and a t such a h i g h c o s t , i n d i c a t e s t h e s t r e n g t h of these

non-economic f a c t o r s . That they u l t i m a t e l y had to concede

demonstrates the very s i g n i f i c a n t power of the dominant producers i n

t i m e s of marginal ly s l a c k markets.

37

I V

The S lack Market of 1982

(a) 1982 Output Cuts

The p r i c i n g a c t i v i t y of 1982 cannot be understood wi thout f i r s t recognis ing the very s u b s t a n t i a l excess supply which developed i n the

o i l market. The s i t u a t i o n of i n c r e a s i n g s lackness i n the market i n 1981

tu rned , i n 1982, to one of major g l u t - presen t ing producers wi th very

major problems which, i n IIEITIY ways, w e r e of a t o t a l l y d i f f e r e n t kind t o

those of the first h a l f of 1981. The change was not merely one of

degree .

A t i t s p e a k i n 1979, world oil product ion w a s ove r 65.7 mbd.

This f e l l to a l o w p o i n t of j u s t over 53 mbd i n A p r i l 1982 and l a t e s t

estimates, f o r October 1982, w e r e j u s t 56 mbd - f u l l y 15% lower than

t h e 1979 peak. OPEC product ion had f a l l e n by a much l a r g e r percentage - 39%, from 31.8 mbd i n Ju ly 1979 t o 19.3 mbd i n November 1982. Again, i t

hit a l o w p o i n t i n April 1982 of 16.7 mbd - j u s t 53% of OPEC' s

capac i ty .21 In r a t h e r stark c o n t r a s t , non-OPEC output i n October 1982

stood a t 38 mbd ( inc lud ing C e n t r a l l y Planned Economies 1, having grown

s t e a d i l y throughout the e igh teen months s i n c e mid-1 981. Whilst OPEX: w a s

ope ra t ing a t on ly ha l f capac i ty , non-OPEC producers w e r e a t record

l e v e l s of ou tpu t , d e s p i t e the very s u b s t a n t i a l downturn i n t o t a l world

demand.

(b ) 1982 Spo t Prices

This s l ackness w a s r e f l e c t e d i n the spot market, where prices showed a

f a i r l y cons i s t e n t downward t r end fo l lowing the modest recovery i n t h e

w i n t e r of 1981 /82 (see Figure 3 I . Low p o i n t s (of around $28/b f o r

Arabian L i g h t ) were ' reached i n Piarch and aga in i n November 1982. Indeed

spot crude prices remained markedly below o f f i c i a l c o n t r a c t prices

throughout t h e year . Spot prices of expensive products aga in matched

21 Petroleum I n t e l l i g e n c e Weekly, May 3rd, 1982, p.1 I , es t ima ted t o t a l OPEC c a p a c i t y a t 31,185 thousand b/d.

38

t h e s p o t crude p a t t e r n very c l o s e l y , w i t h low p o i n t s i n m r c h and

November. The main product , 3.5% S f u e l o i l , w a s r a t h e r more s t a b l e ,

f l u c t u a t i n g between $24/b and $25.5/b throughout the yea r , except f o r a

l o w p o i n t i n August of $23.3/b.

( c 1 O f f i c i a l Price Undercut t ing

Such a s i t u a t i o n of excess capac i ty and low spot prices places downward

p r e s s u r e on official prices which may man i fe s t i t s e l f i n two ways.

F i r s t l y , t h e r e is an i n c e n t i v e f o r a gene ra l , agreed, reduct ion i n a l l

official prices i n an attempt to s t i m u l a t e worldwide demand and allow a

r e t u r n nearer to capac i ty product ion for a l l producers ( t h e eff icacy

of such a policy c l e a r l y depends on t h e price e l a s t i c i t y of demand €or

o i l , t h e t i m e l ags involved, e tc ) . Secondly, t he re is i n c e n t i v e f o r a n

i n d i v i d u a l producer to attempt to undercut h i s compet i tors ' o f f i c i a l

prices, the reward be ing a l a r g e r sha re of the market and hence t h e

p o t e n t i a l f o r maintaining h i s product ion d e s p i t e t h e c o n t r a c t i o n of

worldwide product ion . He e f f e c t i v e l y can pass on the product ion cuts t o

h i s compet i tors .

F i r s t of a l l , it should be e s t a b l i s h e d t h a t the p r e s s u r e for a

g e n e r a l reduct ion i n a l l official prices was resisted throughout 1982,

and for t h i s a t t e n t i o n must aga in focus on Saudi Arabia. Having

succeeded, f i n a l l y , i n drawing down a l l of the rest of the wor ld ' s

p roducers to a $34 r e fe rence price by la te 1981, Saudi Arabia chose t o

defend t h e newly agreed marker price i n 1982 despite the s h a r p l y

c o n t r a c t i n g demand. Possible exp lana t ions of the Saudi a c t i o n are

many. F i r s t of a l l , it may be a simple consequence of its long-term

desire to smooth ou t f l u c t u a t i o n s , both upward and downward, i n the

price of oil. Saudi Arabia may have f e l t t h a t the long-term benef i t s ,

both economic and p o l i t i c a l , of such a p o l i c y outweigh the short- term

costs of a l o s s i n ou tpu t . Such an exp lana t ion would of course a l s o t i e

i n wi th the Saudi p r i c i n g behaviour of the preceding three y e a r s .

To quote D r Abdulhady Hassan Taher, Governor of Petromin and

Saudi Minis te r of State i n November 1982 : "Saudi Arabia remains

committed to i ts long-term goals of t r y i n g to maintain a reasonable

equ i l ib r ium i n t h e i n t e r n a t i o n a l o i l market for the mutual b e n e f i t of

both producers and consumers and f o r t h e common good of the world

39

economy as a whole. m22 Moreover, as D r Taher went on to argue, the

Saudis s a w t h e downturn i n Wes te rn economic a c t i v i t y as a s h o r t run

problem, recovery b r ing ing about a renewed t i g h t e n i n g of t h e market:

".... we be l i eve that t h e o i l market w i l l r e t u r n to a better ba lance i n

about s i x months from now (Nov 1982) ." Long-term s t a b i l i t y i n o i l

prices was c l e a r l y cons idered to be worth any c o s t i n t e r m s of l o s t

shor t - run revenue.

It is worth no t ing t h a t i t is u n l i k e l y t h a t Saudi Arabia's

attempts to hold prices h igh i n 1982 w i l l have won t h e m many f r i e n d s i n

t h e W e s t - indeed s t a t emen t s coming out of t h e USA i n t h e e a r l y months

of 1983 suggested tha t the West would have p re fe r r ed p r i c e s t o f a l l ,

a l b e i t i n a reasonably c o n t r o l l e d manner.

Some may e q u a l l y argue t h a t Saudi Arabia did not even view it

a s i n t h e i r short- term in t e re s t s t o l o w e r prices. There m s a r a t i o n a l

economic i n c e n t i v e t o lower prices only if Saudi Arabia f e l t t h a t i t

faced a p o s i t i v e marginal revenue over some f u t u r e per iod of t i m e .

Marginal revenue is given by:

where p is price, d is t h e coun t ry ' s market s h a r e , and z t h e e l a s t i c i t y

of world demand for oi l .

T w factors may sugges t t h a t Saudi Arabia f e l t i t s e l f t o be

f a c i n g a negat ive marginal revenue i n 1982. F i r s t l y , it holds a l a r g e

s h a r e of t h e market (40% of OPE€ and 20% of k e e World output i n

January 19821, i.e. i t s Id' i s l a rge . Secondly, Saudi Arabia may w e l l

have perceived t h a t it faced a very i n e l a s t i c demand curve ( i .e. a ve ry

low z ) , expec t ing any c u t i n i t s prices to be followed ve ry qu ick ly by

other producers , and so r e s u l t i n g in l i t t l e or no i n c r e a s e i n Saudi

sales. Chamberlin23 developed the notion of an o l i g o p o l i s t i c f i rm

22 D r . Abdulhady Ifassan Taher , The I n t e r n a t i o n a l O i l Market: Anarchy or

Order?, a paper to t h e Oxford Energy Pol icy C l u b , November 27, 1982.

23 E.H. Chamberlin, The Theory of Monopolis t ic Competit ion, ch . 3, Harvard Un ive r s i ty P r e s s , 1 93 3.

40

f a c i n g two demand curves - one assuming no r e a c t i o n by r i v a l s to a

price change ( " sub jec t ive" demand curve) and one assuming h i s r i v a l s do

react ( "ob jec t ive" demand c u r v e ) . Rapid r e a c t i o n to a Saudi price c u t

by o t h e r producers would imply t h a t Saudi Arabia would slide down the more i n e l a s t i c ' o b j e c t i v e ' demand curve and n o t a long i t s own

' s u b j e c t i v e ' curve.

If o t h e r producers set prices a l w a y s t o undercut s l i g h t l y t h e

Saudi marker, a s many d i d i n 1982, price c u t s by Saudi Arabia which are

fol lowed by everyone else may not have any impact on Saudi sales u n t i l

a l l o t h e r producers are producing to c a p a c i t y . The Saudi d e c i s i o n to

hold prices i n 1982 could then be related to a pe rcep t ion of nega t ive marginal revenue, as l i t t l e output growth would have been gained from a

price c u t . (If t h i s were true, it would suggest a revenue maximizing

behaviour by Saudi Arabia which w a s c l e a r l y absen t dur ing 1979/80.)

There would thus appear to be p o l i t i c a l , and s h o r t and long run

economic reasons why Saudi Arabia may have resisted the p r e s s u r e to c u t

i t s prices i n 1982.

By r e s i s t i n g t h e p re s su re to c u t its o f f i c i a l prices i n 1982,

Saudi Arabia e f f e c t i v e l y decided t h e l e v e l a t which the "p r i c ing game"

w a s to be played. As w e mentioned earlier, a s l a c k market i nvo lves

tempta t ions f o r i n d i v i d u a l producers t o undercut the formal price

s t ruc ture . 1982 d i d see s e v e r a l such moves. But compet i t ion took place

just below t h e $34 r e f e r e n c e l e v e l f i xed by Saudi Arabia. Competit ion

may have occurred i n t h e same way a t a lower price level had Saudi

A r a b i a u n i l a t e r a l l y cut the Marker price.

The price reduc t ions of 1982 w e r e very d i f f e r e n t i n n a t u r e to

those o f 1981, which w e r e aimed a t a r e u n i f i c a t i o n of c o n t r a c t prices,

achieved i n October of that yea r . I n 1982 t h e name of t h e game was

competi t ion, and one r e s u l t of u n i l a t e r a l price c u t s w a s t o d i s t u r b the

u n i f i e d d i f f e r e n t i a l price s t r u c t u r e .

F igure 6 graphs the chronology of the o f f i c i a l price

changes i n 1982. It is perhaps b e s t to cons ide r the a c t i o n s of OPEC and

non-OPEC producers s e p a r a t e l y .

29 ocr 1 Nov

Range 4 t . 3 +3%

-3% r

-3% 1 -196-

OPEC

U.K.. F l o n v a ~ k x i m

pun#, oman

I +4%

- +1 +5%

USSR Egypt

1 Dec

7 Dec OPEC

20 Dec Oman

14 Jan Syria

USA

I ran

7 F- 9 Fen U.K. Norway 19 Fe4 Ewdt i. 12. 21 Feb

China E w P i . USA U.K. USSR Mexim

M Mar OPEC

USA USSR

1 Aor

I J u n e

25 June

1 J u l y

1 *U9

1 sepr

1 ccl

I No“

Emador USSR

USSR Ecuador USA

Indonesia

-3%

-17% -12%r-;.-i

Figure 6

1982 OFFICIAL PRICE CHANGES

t3% -g-r +7 x

1 Oec

-3% _1

42

Non-OPEC producers followed t h e 1981 r e u n i f i c a i o n wi th a series

of r educ t ions i n o f f i c i a l prices i n the first q u a r t e r of 1982

which undercut OPEC o f f i c i a l prices, by s u b s t a n t i a l amounts i n many

cases. For example, t h e U K price-cut i n e a r l y March p u t its F o r t i e s

crude $3.5/b below comparable Niger ian Bonny; Mexico's pr ice-cu t i n

March p u t i ts Isthmus c rude $2.5/b below Arabian Light ; t h e S o v i e t

Union's huge 17% c u t i n e a r l y March pu t i ts Export Blend fully $5/b

below the Saudi Marker and successive cuts by Egypt pu t its Suez Blend

$3/b b e l o w by mid-March.

Non-OPEC price changes s i n c e the OPEC meet ing of l a te March

1982 have been r e l a t i v e l y f e w , wi th most c o u n t r i e s s t i c k i n g throughout

the y e a r to prices j u s t under the OPEC prices which they secured i n the

first t h r e e months. There have, indeed, been a number of non-OPEC price

i n c r e a s e s i n the l a s t three q u a r t e r s of 1982 - notably from the UK,

USSR, USA and JZgypt, a l l of whom have brought o f f i c i a l prices back up

towards those of OPEC. Such moves would sugges t that their earlier

unde rcu t t ing had been excess ive i n terms of t h a t requi red to main ta in

ou tpu t , and/or t h e i r earlier cu t s had been made i n a n t i c i p a t i o n of

l a r g e r c u t s from OPEC a t t h e i r March meeting than a c t u a l l y occurred.

Table 3 presen t s t h e o f f i c i a l price d i f f e r e n t i a l s of

non4PEC c rudes a g a i n s t Arabian L i g h t a t the end of November 1982 and

r e v e a l s a clear widening of d i f f e r e n t i a l s . Without except ion , non-OPEC

producers were p r i c i n g w e l l below what w a s requi red t o r e s t o r e the

d i f f e r e n t i a l s t r u c t u r e of 1978. I n o rde r to achieve the same percen tage

d i f f e r e n t i a l s as 1978, non-OPEC prices would have needed t o be

inc reased by, for example, $3.97 ( U K ) ; $3.75 (Norway); $3.02 (USSR);

$2.56 (Mexico); $2.53 (Egypt) ; $2.77 (Brune i ) . The e f f e c t of this

unde rcu t t ing by non4PEC members w a s t o allow them to maintain t h e i r

ou tpu t despite the fall i n worldwide demand i n 1982. Hence, w h i l s t OPEC

as a whole w a s ope ra t ing a t only 58% of its c a p a c i t y , non4PEC o u t p u t

had inc reased s t e a d i l y over the yea r , and by September had reached its

43

h i g h e s t e v e r t o t a l of over 2 0 m i l l i o n ba r re l s /day . This w a s 6% h ighe r

than September 1981; OPEC output for t h e same month w a s 1 1 % lower than

t h e previous yea r .

OPEC producers made r e l a t i v e l y fewer changes t o o f f i c i a l

pr ices in 1982, as Figure 6 shows. The full OPEC meeting i n

March r e s i s t e d p r e s s u r e t o c u t the Marker crude price (and hence a l l

O P E prices) and s e t t l e d i n s t e a d for some f u r t h e r re-adjustments of

d i f f e r e n t i a l s . mese, i n f a c t , had the e f f e c t of t ak ing the s t r u c t u r e

somewhat away from t h e 'correct ' 1978 s t r u c t u r e - with the sole

excep t ion of Nige r i a , whose $ l / b i n c r e a s e r e s t o r e d p a r t of the

d i f f e r e n t i a l with Arabian Light though s t i l l l eav ing d l a r g e problem.

I n t o t a l , four OPEC c o u n t r i e s c u t their prices a t the meeting (Abu

Dhabi, Qatar, Libya and Alger ia ) , and i n each case the e f f e c t was t o

undercut the Saudi marker r a t h e r more than had been the case a t the end

of 1981.

Y e t t h e p o l i c i e s of OPEC and non4PEC producers i n t h e s l a c k

market of 1982 caused problems and p laced s e r i o u s s t r a i n s on the

p r i c i n g system w i t h i n OPEC. The main problems w e r e :

1 . D i f f e r e n t i a l s between d i f f e r e n t u u a l i t v c rudes . This r e f e r s i n

p a r t i c u l a r t o t h e d i f f e r e n t i a l between Middle Eas te rn L i g h t crudes

( e s p e c i a l l y Arabian L i g h t ) and Afr ican Light crudes of h i g h e r

q u a l i t y . As we have seen, whilst a l l of the Afr ican producers were

p r i c i n g above Arabian Light, t h e i r percentage d i f f e r e n t i a l s were

s u b s t a n t i a l l y lower than they had been i n 1978 and indeed l a r g e

i n c r e a s e s i n Afr ican crudes would have been r equ i r ed t o r e s t o r e these

d i f f e r e n t i a l s : $7 .46 (Libya) ; $2.24 ( A l g e r i a ) and $2.27 (Nigeria 1 . Saudi Arabia i n p a r t i c u l a r demanded t h a t t hese d i f f e r e n t i a l s be

r e s t o r e d , to reduce the p res su re on Saudi sales. However, whilst the

o f f i c i a l $35.52 charged for Nigerian Bonny, f o r example, w a s $2.27/b

less than requi red t o r e s t o r e 1978 d i f f e r e n t i a l s , i t w a s s t i l l $2.02/b

more expensive than comparable UK F o r t i e s crude. With such compet i t ion

from non4PEC sources, t h e Afr ican OPEC members were u n l i k e l y t o agree

to any increase i n t h e i r prices.

44

Other c o u n t r i e s who reduced t h e i r d i f f e r e n t i a l s a g a i n s t lower

q u a l i t y Saudi Light were Venezuela and Indones ia - t h e l a t t e r ' s move

having come a t t h e end of November 1982. The ex ten t of the narrowing

was r a t h e r less than i n Niger ia and Algeria's cases.

2 . O f f i c i a l price d i f f e r e n c e s for s i m i l a r c rudes . In th ree s e p a r a t e

moves in February 1982, I r a n u n i l a t e r a l l y c u t a t o t a l of $4/b from the

o f f i c i a l price of its crudesl thus seve re ly unde rcu t t ing a l l of t h e

rest of OPEC. As Table 3 shows, I r a n i a n L igh t w a s some 8% cheaper a t

the end of 1982 than Arabian Light , despite a $l/b i n c r e a s e by I r a n i n

l a t e June, In February, the I r a n i a n cu t s d id n o t cause the uproar that

they might have done as I r a n i a n output w a s a mere 500,000 b/d. When

ou tpu t recovered t o 2.3 m i l l i o n b/d, the unde rcu t t ing of t h e OPEC price

s t r u c t u r e began to cause i n c r e a s i n g alarm. Its e f f e c t , as witnessed by

the r ap id rise i n I r a n i a n ou tpu t , like t h e squeezed d i f f e r e n t i a l s

d i scussed above, w a s t o place the major i ty of t h e burden of ad jus tment

t o the s l a c k market on those c o u n t r i e s who were holding t h e o f f i c i a l

O P E price l i n e .

3. U n o f f i c i a l discount ing. I n a d d i t i o n to the two forms of r educ t ions

i n o f f i c i a l prices desc r ibed above, 1982 a l s o s a w t h e emergence of

d i scoun t ing . Through a v a r i e t y of techniques - o f f e r s of "improved

terns" to e q u i t y ho lde r s , which spread t o non-equity buyers i n the form

of s t r a i g h t d i scoun t s , p rocess ing d e a l s e tc . - producers so ld c o n t r a c t

crude w e l l below o f f i c i a l prices. b b t s u r p r i s i n g l y , price d i scoun t ing

enabled some c o u n t r i e s to increase s u b s t a n t i a l l y the volume of t h e i r

sales.

(d) T h e o r e t i c a l C h a r a c t e r i z a t i o n s of the 1982 O i l Market

We s a w i n Sec t ion X I t h a t most of the wor ld ' s o i l producers , wi th the

except ion of Saudi Arabia, ac t ed as price makers i n the d i s e q u i l i b r i u m

market of 1979/80. In this, we argued, t hey conformed t o Arrow's

no t ion , t h a t i n d i s e q u i l i b r i u m a l l producers f a c e a sloping demand

curve. Tb h a t e x t e n t , then, d i d t h i s hold f o r the 1982 oil market - aga in i n d i sequ i l ib r ium, b u t this t i m e one of s u b s t a n t i a l excess

supply?

45

First of all, it is clear from the evidence above that the bulk

of the world's producers, OPEC and non-OPEC alike, did not act as a

passive price-taking fringe. They did not simply accept the price

determined by either OPEC or Saudi Arabia. Rather, they acted to

maximize their revenue by cutting prices individually in attempts to

capture a larger share of the declining market. To use Chamberlin's

terminology, they operated on their own downward sloping 'subjective'

demand curves, whose elasticities were sufficiently large to give, at

least in the short run, a perception of positive marginal revenues. In

this, they acted as rational "Arrowian" sellers in a disequilibrium

market, mirroring their behaviour in the tight market of 1979/80, but

this time operating on negatively sloping demand curves.

There is, however, a very important difference between the

experience in 1979/80 and that of 1982. As we have seen, in 1979/80 the

influence of Saudi Arabia, the dominant supplier, on the so called

'fringe' oil producers was rather weak. This was not mirrored in the

experience of 1982. The unilateral price setting of the 'fringe'

producers was a l l done within sight of the marker price. Saudi Arabia

effectively chose the level at which the pricing game was to be played,

and to that extent retained a form of price-leadership. It was clear

throughout the year that any movement down by the Saudis would be

followed very quickly by all other producers.

This If leadership" by Saudi Arabia was achieved at substantial

cost to itself in terms of lost output and hence revenue - costs which resulted from its unwillingness to prevent the competitive price

undercutting by the rest of the world's producers. Being the lowest

cost producer with the largest reserves gives Saudi Arabia the potential

ultimate sanction, of being able to drive out any producer which

undercuts its prices in a slack market. As we have seen, the nature

and meaning of leadership is entirely different in a tight market.

46

Conclusions

L e t us review b r i e f l y the main f e a t u r e s of t h e post-I978

h i s t o r y of o i l price movements which emerge from our s t u d y .

- September 1978 t o March 1979. The f i r s t price rises came i n the spot

markets i n t h e t h i r d quarter of 1978, a l l of which had shown

s u b s t a n t i a l i n c r e a s e s by t h e end of 1978. There is l i t t l e t o sugges t

t h a t t h e small i n c r e a s e s introduced by OPEC at their D e c e m b e r 1978

meeting were i n d i rec t response t o these spo t price movements. I n f a c t

t h e f i r s t c o u n t r i e s to respond t o spot price rises were non-OPEC

producers , beginning with t h e UK. They w e r e followed by some of

the smaller OPEC m e m b e r s i n February 1979. OPEC as a whole d id n o t

in t roduce comparably l a r g e inceases u n t i l t h e i r meeting i n March 1979.

- 1979/1980 w a s a confused pe r iod of pr ice- leapf rogging . Again, s p o t

prices w e r e the l ead ing edge, wi th a rnglge of c o n t r a c t price rises

fol lowing. Seve ra l of t h e smaller producers a t tempted to s t a y close t o

t h e spot price, whilst o t h e r , o f t e n larger producers lagged f u r t h e r

behind. Saudi Arabia kept its p r i c e s below a l l o t h e r s throughout t he

pe r iod - consequent ly price d i f f e r e n t i a l s a g a i n s t Arabian Light widened

enormously.

- 1981. In t h a t year prices - spot, OPM3 and non-OPEC , o f f i c i a l -

f i n a l l y tended to regroup around the re fe rence set by the Piarker

crude. This w a s brought about by a combination of two f a c t o r s : the

s l acken ing of w o r l d demand f o r OPEC o i l , and the s t r o n g export

advantage enjoyed by Saudi Arabia i n t h i s depressed market thanks t o

i t s low price p o l i c y . Non-OPEC producers ad jus t ed t o the s i t u a t i o n by

c u t t i n g t h e i r prices f a i r l y s w i f t l y ; b u t most OPEC m e m b e r s he ld o u t

through the f i r s t three quarters of 1981 a g a i n s t the Saudi attempts to

reun i fy the o i l price s t r u c t u r e . The i n e v i t a b l e r e s u l t w a s s u b s t a n t i a l

l o s s e s of sales which u l t i m a t e l y encouraged everybody to agree a price

real ignment around a new Marker price of $34/b a t t h e OPEC meeting of

October ? 981 .

47

- 1982. Demand cont inued t o d e c l i n e , b u t OPEC remained t h e o r e t i c a l l y

committed to t h e $34/b marker price despite d e c l i n i n g s p o t crude and

product prices. A l l major non-OPEC producers set c o n t r a c t prices b e l o w

the Marker, and consequent ly managed to produce a t near-capaci ty

throughout the yea r . I n mid-1982 s e v e r a l OPEC producers began to

undercut t h e Marker price - e i t h e r openly o r through a v a r i e t y of

d i sgu i sed means.

I n t i g h t markets Saudi Arabia w a s n o t ab le t o exercise

e f f e c t i v e l eade r sh ip : i t could n o t l ead o t h e r c o u n t r i e s a long t h e price

path of its choice . It had however some in f luence on behaviour,

p rovid ing an oppos i t e pole t o the spot market. The behaviour of

i n d i v i d u a l OPEC producers was shaped by t w o f a c t o r s - a n almost

i rresist ible l ead from a nervous market and a long-standing h a b i t of

c a r e f u l and r ig id price admin i s t r a t ion . Nobody - except Saudi Arabia - fol lowed the OPEC price-deterr@nation system; nobody - s a v e Ecuador - followed b l i n d l y t h e price movements of spot markets.

The s t o r y was not a s t o l d by t h e 'dominant producer/

compet i t ive f r i n g e ' models. A l a r g e producer set a pr ice but could n o t

i m p o s e it on its peers. Very small producers took the s p o t market

pr ice and gave up a l l pretence a t a d m i n i s t r a t i o n . A l l o t h e r s made

prices la Arrow. I n s h o r t , we observe t h a t producers have some

d i s c r e t i o n over the i r own prices when excess demand o b t a i n s , and this

d i s c r e t i o n can be exe rc i sed d e s p i t e the r e s t r a i n i n g a c t i o n s of t h e

dominant suppl ier . But the producers ' freedom i s not w i thou t bounds.

They c a n make t h e i r own prices w i t h i n a given range. As they move

towards the upper end of the range they become t a k e r s of the

competi t ive equ i l ib r ium price (as exempl i f ied by the spot market ) . And

those who remain c l o s e t o the dominant s u p p l i e r are indeed t a k e r s of an

adminis te red pr ice . The s t r o n g e r t h e in f luence of market forces, t h e

more r e s t r i c t e d is t h e price d i s c r e t i o n enjoyed by producers . Hence,

Mabro's view t h a t the sma l l OPEC m e m b e r s , in the t i g h t market

cond i t ions of 1979, w e r e ' apparent price makers'. "They appear as

price makers because they keep on posting h ighe r and h i g h e r prices (1

a m r e f e r r i n g , to g ive one example, to what w a s wi tnessed throughout

19791, but t h e i r pos t ings follow ( u s u a l l y with t i m e l a g s and a t a

48

d i s t a n c e ) , and never lead price de termina t ion on the market."24

thus possible to go one s tep beyond Arrow's c h a r a c t e r i z a t i o n , and

recognize t h a t i n this c o n t e x t price making is u l t i m a t e l y a success ion

of imperfec t responses to market s i g n a l s . I t is price taking of

s o r t s . When equi l ibr ium is reached small producers have no o t h e r

choice bu t t o take unambiguously the r u l i n g price.

I t i s

I n very s l a c k markets, the s m a l l producers of the 'compet i t ive/

p r i ce - t ak ing f r i n g e ' a l s o en joy d i s c r e t i o n . They are always tempted to

undercut t h e r e fe rence price set by the dominant s u p p l i e r i n o rde r to

maximize short- term revenues. Again, they are price makers of sorts,

and the Arrow c h a r a c t e r i z a t i o n becomes r e l e v a n t . But the in f luence of

the dominant producer is now very s t r o n g . The ' compet i t ive /pr ice-

c u t t i n g T 2 5 seller u s u a l l y quotes i ts own prices j u s t below the l e v e l

set by t h e l e a d e r . In this sense t h e small producer is a price t a k e r

of s o r t s , s i n c e the price he makes is c l o s e l y related to d given

ref e rence .

P r i c e l eade r sh ip o b t a i n s when the market i s a l i t t l e slack.

Saudi Arabia was able to e x e r c i z e price l e a d e r s h i p of a convent ional

type i n 1981 when producers just began to g a i n confidence i n a

turn-round i n market cond i t ions . They agreed t o price realignment

around the marker as they f i n a l l y perceived t h a t the market had ceased

t o be t i g h t . I n the very short per iod dur ing which the market i s j u s t

a l i t t l e s l a c k , no producer can b e n e f i t from r a i s i n g h i s price above

t h e l e v e l def ined by the market, and no producer feels a s t rong urge t o

24 Robert Mabro, i n M . W . Khouja (ed.) , The Chal lenge of Energy, Longman, 1981, p.40.

'The D i l e m m a between Shor t and Long-Term Oil P r i c e s ' ,

25 Note t h e t w o d i f f e r e n t meanings of the term ' compe t i t i ve ' . sense , compet i t ive r e f e r s to a market s t r u c t u r e i n which agents are too small o r t o o numerous t o be able to in f luence prices. Y e t i n common usage, compet i t ive r e f e r s to the aggress ive behaviour of those who seek t o s c o r e bet ter r e s u l t s than others. To compete i n a market may involve d i r e c t a c t i o n on prices, such as unde rcu t t ing , i n o rde r t o i n c r e a s e sales a t the expense of somebody else. I n some contexts , compet i t ion means t h a t economic agents are price t a k e r s , and i n o t h e r con tex t s it means j u s t t h e oppos i t e !

In one

49

undercut the r e fe rence p r i c e . An equ i l ib r ium of s o r t s is then

a t t a i n e d . lhis is n o t the convent iona l compet i t ive equ i l ib r ium s i n c e

t h e r e fe rence is determined by an a d m i n i s t r a t i v e d e c i s i o n and need n o t

relate to the r e l e v a n t c o s t concept. As i n t h e textbook m o d e l of the

o i l market, a dominant group of producers s e t s a p r i c e which the fringe

producers t ake . But t h e r e is a d i f f e r e n c e . The p r i c e set by the

dominant group may w e l l c l e a r the market from time to t ime; bu t it is

d o u b t f u l whether p r i c e s s e t i n t h i s way could ever clear markets i n

s u c c e s s i v e pe r iods Over the long run.

50

Annex 1

The d i scuss ion i n t h i s paper is based on o f f i c i a l price data

f o r the main world c rudes , drawn c h i e f l y from Petroleum I n t e l l i g e n c e

Weekly over t h e period s i n c e September 1978. For convenience,

a n a l y s i s of the behaviour of i n d i v i d u a l c o u n t r i e s is founded on the

movements i n t h e price of a 'key' crude f o r each count ry i .e. tha t

crude of which the count ry produces most. These are l is ted i n the

table below. W e have ensured t h a t a l l "premia" and "surcharges" which

are sometimes app l i ed to a coun t ry ' s price are included i n the

a n a l y s i s and indeed tha t they are inc luded i n the database. F i n a l l y ,

i n order to help i d e n t i f y any price-leadership, the data used in the

paper p resen t s a l l price changes on t h e date a t which the d e c i s i o n

w a s made and not n e c e s s a r i l y on the date at which the price change

became e f f e c t i v e . U s e of r e t ro -ac t ive price changes has been common,

p a r t i c u l a r l y within OPEC, and can g ive the impression that prices are

changed i n unison when i n f a c t s e v e r a l weeks may separate the

d e c i s i o n s of i n d i v i d u a l producers.

S p o t price data i s taken l a r g e l y from OPEC B u l l e t i n s and is

expressed i n t h e form of monthly averages throughout the paper u n l e s s

o therwise s t a t e d . As a l l spo t crude prices have moved toge ther it is

n o t unreasonable to talk in terms of "the" spot crude price. Spot

product price movements have been r a t h e r less uniform.

F i n a l l y , a l l data on c rude oil output used here is drawn f r o m

the r e g u l a r tables of World Oil Product ion in Petroleum Economist.

They are expressed i n barrels-per-day throughout .

52

'ReDresentat ive ' crudes chosen for each count rv

OPEC : Saudi Arabia

Iran

Iraq

Abu Dhabi

Qatar

Kuwait

Gabon

Libya

Algeria

Niger ia

Venezuela

Ecuador

Indonesia

Shar jah

Dubai

Non-OPEC : UK

Norway

USSR

USA

Mexico

Oman

Syria

EWPt

China

Malaysia

Brunei

Angola

Cameroon

Light 34

Ligh t 34

Basrah L igh t 35

Murban 3 9

Marine 36

Kuwait 31

Mandji 30

Es S i d e r 37

Saharan 44

Bonny 37

T i a Juana 31

Orien te 30

Sumatran Light 34

Mubarak 38

Fateh 32

F o r t i e s 36.5

Ekofisk Blend 44

Export Blend (Mediterranean 1 33

Louisiana Light Sweet 37.5

Isthmus 33

Oman 36

Suwaidiyah 24

Suez Blend 34

Daquing 33

Tapis Blend 43.5

S e r i a 36

Cabinda 31.7

Kole 33.5

Annex 2

September 1978 as t h e base d a t e

As noted i n S e c t i o n 11, w e have chosen September 1978 as the

base d a t e €or the a n a l y s i s of official crude o i l price movements. Ln

s o doing , we s e e k to i d e n t i f y a t i m e a t which w e can view the

s t r u c t u r e of p r i ce d i f f e r e n t i a l s as being broadly i n equi Librium.

This we d e f i n e as t h a t s t r u c t u r e of p r i c e s which more-or-less

r e f l e c t e d the buyers ’ v a l u a t i o n of the d i f f e r e n t q u a l i t y c rudes , so

a s t o make him i n d i f f e r e n t between any t w o . M e a ccep t , of cour se ,

t h a t i n the r e a l wor ld w e are un l ike ly to f i n d the oil market i n

perfect equi l ibr ium i n t h i s s ense ; w e m u s t seek r a t h e r to f i n d a time

a t which the price s t r u c t u r e appears to be “less imperfect“ than a t

others .

The choice of d a t e w a s in f luenced by t w o f a c t o r s :

1 . P r i c e S t a b i l i t y .

September 1978 marked t h e end of a prolonged per iod of r e l a t i v e

s t a b i l i t y i n c o n t r a c t p r i c e s . Table A, below, shows the last date

prior t o September 1978 a t which OPEC members changed their o f f i c i a l

prices.

54

T a b l e A

OPEC M e m b e r

Iraq I r a n Qatar Ve n e z ue 1 a Indonesia Gabon

Saudi Arabia Abu Dhabi

D a t e of L a s t P r i c e Change

before Sevtember 1978

December 1976

J u l y 1977

Kuwait January 1978

Alger ia Libya Niger ia

A p r i l 1978

Only Kuwait and t h e t h r e e Afr ican producers a l t e r e d t h e i r

prices i n the f i f t e e n months p r i o r t o September 1978 - and then by

o n l y very s m a l l amounts, as they sought to adjust t h e i r d i f f e r e n t i a l s

w i th the res t of OPEC.

Tables B and C compare the pe r iod from January 1977 t o

September 1978 w i t h p r i o r and subsequent pe r iods of similar l eng th .

Together they show c l e a r l y both t h e r e l a t i v e infrequency and s m a l l

s i z e of price changes i n t h e months approaching September 1978. Both

tables p r e s e n t a p i c t u r e of s u b s t a n t i a l d i sequ i l ib r ium i n the 1973-74

oil market, followed by four years of i n c r e a s i n g s t a b i l i t y , ending i n

l a te 1978 with t h e s t a r t of t h e 1979/80 price explos ion .

Outside OPEC, official price changes were r a t h e r more

f r e q u e n t , bu t aga in w e r e no t of any s i g n i f i c a n t s i z e over t h e two

y e a r s from the end of 1976. North Sea prices, f o r example, d r i f t e d

down by around 40 c e n t s (2.8%) from January 1977 to A p r i l 1978, and

then recovered around half of this f a l l over the next two quarters.

Such movements w e r e f a i r l y t y p i c a l of non-OPM: prices over t h e pe r iod

- g r e a t e r frequency of change t h a n o f f i c i a l OPEC prices, b u t still a

pe r iod of relative s t a b i l i t y .

55

ISaudi Arabia ' Iran

Table B: N u m b e r of O f f i c i a l Price Changes in key crude of main OPE€ producers

7/73-3/75 4/75-12/76 1 /77-9/78 1 O/78-6/8O

8 2 1 7 11 8 2 0 I 1 \

2 2 3

8 ! A h Dhabi \ 'Qatar 8 Libya 7 Algeria 7 6 Nigeria 8 4 Venezuela 7 4 Indonesia 5 2

Mean 7.45 2.91

Table C: Percentage Changes i n O f f i c i a l Prices of key crude of main OPEC producers

8 8

11 9

1 0 3 3 3 9 0 8 0 10

1.09 9.36

Saudi Arabia Iran Iraq Kuwait Abu Dhabi Qatar Libya Algeria Nigeria Venezuela Indonesia

7/73-3/75 4/75-12/76 6/77-9/78 I 0/78-6/ao

288 16 5 120 298 20 0 176 293 20 0 130 30 1 19 -1 1 4 0 31 2 1 0 6 138 297 20 0 140 243 25 -0.5 167 22 6 19 -1 171 f 91 32 -1 160 254 1 20 0 139 238 8 0 132

56

2. S t a b l e Outwut Shares

Arabia

Stable price d i f f e r e n t i a l s would n o t i n themselves sugges t

equi l ibr ium i n the o i l market, i f a t t h e same t i m e t he re w e r e wide

f l u c t u a t i o n s i n t h e s h a r e s of the t o t a l market going t o each

producer . Table D shows t h e sha res of e i g h t major OPEC producers i n

t o t a l O P E product ion over the year t o September 1978.

Dhabi -uela

Table D:

Sep O c t Nov D e c Jan

Shares i n t o t a l OPEC output, Sep.1977 t o Sep.1978

1 I I I 1 1 I 1 1 1 I

19.2 18.2 19.4 19.6 19.3

1977 7.3 5.2 6.5 6.5 7.6 6.1 5.5 6.9 6.4 7.6 7.4 5.0 6.6 6.1 6.6 8.2 5.0 6.0 5*7 6.1

I 6.2 5.0 1 6.5 \ 5.9 6.5

, 7.3 5.0 6.5 5.2 7.2 I 6.7 4.6 6.4 5.7 7.5 ! 6-3 5.2 6.7 6.0 7.8 ! 6.6 4.9 6.8 6.4 8.0

! 6.0 5.2 6.3 5.4 5.5

I 6.6 4.9 6.8 6.5 7.8 ~ 7.9 4.9 6.9 6.9 7.3

8.1 4.5 6.6 6.6 7.1 I

1978

Mar A p r May Jun J u 1 Aug Sep

1 I r an1 I r aq1 Saudi1 Kuwait! Abu 1 Libya1 N i g e r i a ( Venezl

19.4 19-1 19.9 19.7 19.9 19.5 19.0

7.9 8.1 7.9 7,6 7.6 8.7 8.6 8-5 8.4 8.2 8.2 8.8 9.0

27.7 28.2 28.3 29.4 28.1 29.0 26.5 27.1 25.3 25.5 25.2 23.9 26.2

Var ia t ions i n a coun t ry ' s ou tpu t may be caused by a number of

f a c t o r s o t h e r t han price d i f f e r e n t i a l s with competing producers ( f o r

example, phys i ca l p roduct ion problems, s easona l f a c t o r s , changes i n

demand p a t t e r n s f o r d i f f e r e n t c rudes , e t c . 1. With t h i s impor tan t

cavea t , t h e evidence from Table D does suqges t a high degree of

s t a b i l i t y i n ou tpu t s h a r e s among OPEC producers over t h e pe r iod .

It i s aga in u s e f u l t o compare t h i s s t a b i l i t y with o t h e r

p e r i o d s . Table E shows Standard Devia t ions of sha res i n total OPEC

product ion - a s a measure of t h e i r v a r i a b i l i t y - € o r OPEC producers

over t h r e e sub-periods from 1975 t o 1980. It does not confirm very

c l e a r l y t h e no t ion of i nc reas ing ly s table shares up t o September

1978; but i t does c e r t a i n l y r evea l the d i sequ i l ib r ium i n the

post-September 1978 market, h igh l igh ted by t h e very s u b s t a n t i a l

i n c r e a s e i n the S .D.s of t h e major OPEC c o u n t r i e s .

57

Comparing 1975-76 wi th 1977-Sep.1978, he f i n d t h a t t h e S . D . s

tend to be lower i n our r e f e r e n c e per iod for most c o u n t r i e s except

Saudi a r a b i a . I n o t h e r cases where t h e S . D . s appear t o bs higher i n

the second per iod , the d i f f e r e n c e s a r e not very s i g n i f i c a n t .

Table E:

Standard Devia t ions of Country Shares i n T o t a l OPEC Output

I 1974-75 1975-76 1977-Sep.78 Oct.78-1980

Saudi Arabia I r a n Iraq Kuwait Abu Dhabi Qatar Libya Alger ia Niger ia Ve nezue 1 a Indonesia

1.67 1.05 1 . 2 6 0.89 0.94 0.32 1.36 0.27 0.63 0.90 0.31

1.74 1.07 1.07 1.06 0.84 0.30 1.15 0.27 0.50 1.02 0.29

2.09 1 .14 0.59 0.88 0.30 0.19 0.28 0.36 0.60 0.66 0.27

4.08 4.04 3.00 1 .23 0.28 0.18 0.33 0.35 0.60 0.61 0.53

Our a n a l y s i s i s t h a t most producers enjoyed much g r e a t e r

s t a b i l i t y i n t h e i r monthly ou tpu t sha res i n 1977-78 than i n the

preceding and subsequent p e r i o d s , p a r t l y because t h e price s t r u c t u r e

was c l o s e r to equi l ibr ium and p a r t l y because Saudi Arabia absorbed

more r e a d i l y OPEC random output f l u c t u a t i o n . September 1978 would appear to sepa ra t e a f a i r l y prolonged

pe r iod of s t a b l e p r i c e s and ou tpu t s h a r e s from one of marked

d i s e q u i l i b r i u m i n both . As such it provides us wi th an appropr i a t e

s t a r t i n g p i n t and base da te for our a n a l y s i s .

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