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With the price of Oil at 1979 prices, adjusted for inflation, it a good time to understand how did we get here. Many oil experts agree that the weak demand contributes 30%-40% of the decline while the increased supply accounts for 60%-70%. In summary, oil demand was projected at 1.3 million barrels per day but only experiencing 0.5 million barrels. US added 3 million barrels which is the equivalent of added another Kuwait to the world market.
OPEC dominance in oil is being tested on many fronts including overall reduction in market share from 50% in 1974 to 40% today, reduction in the use of oil, and the reliance of many of its members needing oil to pay for their countries budget. Many people remember the 1970’s OPEC oil supply scenario (prisoner’s dilemma) in which the other members cheated on the agreement to cut supply and instead produced more oil to gain more profits. Since Saudi Arabia lost on these profits, they insist on not repeating the same mistake again.
From the Saudi Arabian perspective, the high oil price has increased competition. Any cut in production would benefit the other oil producers. With the average breakeven cost between $60 – $70 per barrel, current levels of oil at $50 per barrel will put short run pressures on US oil producers. The bet by Saudi Arabia oil producers is a cut in US oil production and a return to high oil per barrel price. With the cut in capital expenditures, future supply expansion by the US will be limited without the drilling capacity. Thus, as oil prices rise in the future, only the OPEC and Saudi Arabia oil producers will be able to fully capitalize on the high price without hyper-competition.
As we can see the Saudi Arabian oil and foreign policy are separate, but in practice, they are related. Low oil hurts all of their political and economic competition. Thus, low oil proves to the world that OPEC and the Saudi Arabian oil producers still warrant respect on the world economic stage.
Gary Kapanowski – Lean Six Sigma Master Black Belt – Excelsior
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