Chapter 2

International price of crude oil from 1970s

Part 1 and 2
By Kamaran
 Factors that affect the international oil price
• Oil prices are influenced by number of factors,
with some speculation that they are mostly
short-run impacts. Other factors, such as level
of production by OPEC and expectation about
future world demand for oil, also affect the
international price of oil in the longer term
(Fattouh 2007).

• Demand and supply of crude oil in the

international oil market are balanced via
responses to price movements, and the
fundamental factors which determine demand
and supply expectations are several and
complex.
Based on literature, five factors have influenced
the international price of oil.
• level of OPEC production decisions and
investment.
• the economics circumstance of non-OPEC oil
producers.
• political stability in oil exporters.
• economic growth of industrial countries.
• the economics of other liquid supplies such as
natural gas.
Factors that affect the increase oil price in 1970s

• Hamilton and Herrera (2004) argued that the

main oil price shocks were a result of significant
disruptions of crude oil output triggered by
geopolitical events in oil-exporting developing
countries, such as the Arab-Israel war in 1973.
• There were also changes in monetary policy
regimes by developed nations in the 1970s.
• Herrera et al. (2009) pointed out that the
largest single source of change in exports was
the result of strong growth in demand for oil
from newly industrialised nations such as China
and India after 1990, in addition to the failure of
global output to rise (Barsky, and Kilian 2004).
• the business cycles in developed nations, such
as what occurred in 2008, are other factors of
instability in oil prices.
• The third oil price collapse occurred as a result of
the unexpected economic crisis in Asia. By the
end of 1997, OPEC had enlarged its output by
about 2.5 million barrels per day. At the
beginning of 1998, Asian Pacific oil consumption
dropped due to an economic crisis in many Asian
countries. Therefore, a low demand of oil and an
increase in oil production by OPEC led to a sharp
decline in the oil price.
• However, the decline in oil price did not last long,
as OPEC and non-OPEC countries decided to
reduce their oil production (Mabro 1998).
1.7. The 1970s Oil Price Revolution
- OPEC negotiations Started on October 8, 1973;
- Failure of companies to respond to OPEC
demand;
- Start of process to Nationalize BPC, 1973;
- Oil shortage and US export embargo by Arab
oil-producing countries(except Iraq)
 • Some theories have emerged with different
predictions for the future pattern of oil prices
(Coimbra and Esteves, 2004). Four main theories
will be summarised below:
1 - The property right theory analyses the factors
that led to an increased oil price in 1970s, which
are related to the transfer of the ownership of
crude oil from the international companies to the
producing oil nations (Fattouh and Mahadeva
2013). In 1960, the Organization of the Petroleum
Exporting Countries (OPEC) was formed by five
oil-exporting developing countries (Venezuela, Iran,
Iraq, Saudi Arabia and Kuwait).
This threatened the position of the multinational
companies in an oil-dominated market. As a result,
the multinational companies who dominated the
production of crude oil in developing countries
enlarged the level of oil production before losing
their control on their crude oil. Consequently, the
members of OPEC decided to shift the power of
determining production issues away from the
international oil companies to the home countries.
This change or transfer of ownership to host
nations triggered the oil price to increase in 1970s.
2 - The target revenue theory is a main factor in the
reduction of the production of oil in 1973 and,
subsequently, to the limited absorptive capacity of
the oil-exporting nations, which prevented these
countries from absorbing the massive revenues
from exports at that time. The OPEC members then
had to cut levels of production, which triggered a
rise in international oil price. The research of
Crémer and Salehi-Isfahani (1989 and 1991)
demonstrated that OPEC’s policy rests on dropping
levels of production when oil prices are increased in
order to avoid a high rate of inflation as a result of
low absorptive capacity by developing countries
(El-Anshasy et al. 2005 and Al-Yousef 1998).
3 - The cartelisation theory attributes the increase
in the price of oil to an agreement between the
members of OPEC to set a determined price. A
model has been developed by Pindyck (1978) and
Adelman (1986) in order to clarify the OPEC price
behaviour. They found that the oil market is
controlled by the oil cartel, in order to maximise
their profits. This was done by setting prices with
no competition between OPEC members (Weiqi et
al. 2011).
4 - The market theory claims that, since the 1960s,
the demand and supply of oil has increased
gradually in the oil market. This has triggered the
increase in oil prices, because the size of demand
side has increased more than the size of supply side.
This is due to high economic growth by developed
nations and the fact that demand for oil has
increased significantly; thereafter, the intersection
of the demand and supply curves would be at a
higher price (Aastveit et al. 2011).
• Go to the part two in chapter 2
 Chapter 2

International price of crude oil from

1970s
Part 2
By Dr. Kamaran
 Decline oil price
The policy makers and economists generally focus on the
economic consequences of an increase in the prices of
natural resources, and oil in particular; however, they
focus less on the consequences of a collapse in oil prices
or a decrease in the volume of oil production in
oil-exporting countries. In the early literature about the
collapse in oil prices, Mabro (1985) highlighted the
reasons behind the decrease in oil demand in 1982.
 Decline oil price
Mabro (1985) highlighted the reasons behind the
decrease in oil demand in 1982. He attributed the
collapse to two main reasons.
• The first factor related to the world-wide
slowdown in economic activities during the
early 1980s, as well as the decrease in world
energy consumption because of an increase in
prices of oil in the early and late 1970s.
• The second factor is the change in the structure
of energy supplies with nuclear power, coal, as
• However, the factor relating to the collapse of the oil
price in 1986 was different to that of 1982. Tatom
(1987) argued that the collapse of the oil price in 1986
resulted in an increased exploration and levels of
production by non-OPEC producers. This led to
increased oil production by non-OPEC oil exporters,
triggering a drop in the share of OPEC as a main
supplier in the oil market.
• From 1983 to 1986, non-OPEC exporting
countries increased output by 10 million
barrels per day. Although OPEC countries
tried to set production quotas low enough
in order to stabilise the oil price, their
attempts were unsuccessful, since many
member countries produced beyond their
quotas. As a result, oil prices declined
sharply to US $8 in May 1986. This was the
second major oil price collapse. This means
that an excessive supply of oil was the main
factor behind the drop in oil price in 1986
(Mabro 1998).
The third oil price collapse occurred as a result of the
unexpected economic crisis in Asia. By the end of
1997, OPEC had enlarged its output by about 2.5
million barrels per day. At the beginning of 1998,
Asian Pacific oil consumption dropped due to an
economic crisis in many Asian countries. Therefore, a
low demand of oil and an increase in oil production
by OPEC led to a sharp decline in the oil price.
However, the decline in oil price did not last long, as
OPEC and non-OPEC countries decided to reduce
their oil production (Mabro 1998).
 Four Reasons Why the Price of Crude Oil Dropped in 2014-2017
• Organization of the Petroleum Exporting Countries (OPEC)
Another leading factor in the sharp price drop of crude oil is that
OPEC, a cartel of oil producers, is unwilling to stabilize the oil markets.
Prices of OPEC’s benchmark crude oil have fallen 50% since the
organization decided against cutting production at a 2014 meeting in
Vienna.
Of the participating countries in OPEC, Iran, Venezuela and Algeria
have wanted to cut production to firm up prices. Saudi Arabia, the
United Arab Emirates and other Gulf allies refuse to do so. Iraq sits
alone as the only OPEC country to not only maintain supply but
actually increase it. If OPEC does not cut production, the result is a
further oversupply of oil, placing downward pressure on crude oil
prices for the long term.
 • Oversupply of Crude Oil
Crude futures declined in late September 2015 given that the global
oversupply is increasing oil stockpiles. Total oil production by year-end
2015 is expected to rise to over 9.35 million barrels per day, higher than
the 9.3 million barrels per day forecasted in February 2015. This shows
that not only is the market oversupplied, but supply is actually
increasing.
Unrelated to futures, oil inventories have risen more than expected.
The Energy Information Administration (EIA) reported on Sept. 30, 2015,
that U.S. commercial crude oil inventories rose by 4.5 million barrels
from the previous week. At almost 500 million barrels, U.S. crude oil
inventories are at the highest level in at least the last 80 years, causing a
decline in prices.
• Declining Demand
While supply is increasing, demand for crude oil is decreasing. The economies
of Europe and developing countries are weakening, and at the same time,
vehicles are becoming more efficient, which has caused the demand for fuel
to lag. China's devaluation of its currency suggests its economy may be worse
off than expected. With China being the world's largest oil importer, this is a
huge hit to global demand.

• Iran Nuclear Deal

The Iran nuclear deal is a preliminary framework agreement reached between
Iran and a group of world powers. The framework seeks to redesign, convert
and reduce Iran's nuclear facilities. The U.S. nuclear deal with Iran allows more
Iranian oil exports. The deal removes Western sanctions against Iran, and
investors fear it will add to the world's oversupply of oil. Markets have already
reacted to this news by decreasing the price of crude oil.
Conclusion
Throughout the last five decades, it can be said that the international
price of crude oil has significantly fluctuated and several different
factors have affected the price of crude oil.