Tuesday, February 1, 2011

Oil Shock Potential of OPEC Nations

While we are all having our minds focussed anew on the wisdom of deriving economically critical commodities from unpleasant autocratic regimes, it seems a good moment to review the potential impact on oil prices of revolutions in each of the various OPEC countries.  This is a rather uncertain exercise for at least these reasons:
  • It is not certain how much oil production in any given country would be affected by a revolution.
  • It is not certain how long any disruption would last.
  • It is not certain how much other countries (particularly Saudi Arabia) would be willing and able to make up the difference.
  • To the extent Saudi and other spare capacity was used up in response, it is not certain how markets would price that.
  • It is not certain how oil prices would respond to actual reductions in supply that were much larger than recent excursions.
Still, we can probably get some general idea of the order of magnitude of the potential effects.  In this post, I make the following assumptions:
  • I assume that oil production for the country in question is a total loss for long enough to fully affect prices (this might not be true in a more "velvet" revolution, so is basically intended to size the worst case).
  • I consider two cases: one in which no additional spare capacity is effectively available, and one in which an additional 2mbd is put on the market (except in the case of a Saudi revolution).  It's realistic that the Saudi's would make at least some oil available, but I put in the no response case to give some idea of the upper limit of what the market might do in pricing in the fact that there would then be no remaining spare capacity.
  • I assume that the price elasticity of oil is -0.05.  This is based on this analysis I did of the global price/supply relationship during the last oil shock, and also this study of gasoline demand during 2001-2006 in the US.  Although this may be a reasonable assumption for the smaller oil producers, it's likely in the face of a really big oil shock that oil elasticity might turn out to be somewhat higher (and thus prices somewhat lower).
  • I assume that the pre-shock price of oil is $100/barrel (roughly where it is currently), and then based on each countries current production (BP, 2009 figures), figure what the shocked price would be (also in $/barrel).  
These can probably be described as "worst reasonable case" assumptions.  At any rate, under those assumptions, I get the following graph:

As you can see, serious revolutions in most OPEC countries would probably only cause a few tens of dollars rise in oil prices.  The big exceptions are Iran, which would likely push oil over $150, and Saudi Arabia, which would send it into the stratosphere.

My assumption is that Iranian protesters will be exhausted for some time by the failure of the protests of 2009 to revoke the fraudulent presidential election.  Therefore, Saudi Arabia is the case of most interest.

Update: initial version of the graph had the labels reversed - fixed now.


biffvernon said...

We learnt in 2008 that when the price rises too far the world economy goes into recession, choking off demand and reducing price. A shortage of oil at a low price may result in recession rather than price rise.

jdl75 said...

And when is the US going to put a $2 tax a gallon, at least ?
Do we have to conclude that the US committment towards total enconomic suicide is perfectly stable ?

Stephen B. said...

In response to biffvernon I'd say that I agree in the medium term, but in the very short term (a few weeks to a couple of months), higher prices wouldn't be all that surprising I think while the world economy at first, attempts to continue working on what oil it had been expecting and used to.

BOP said...

What is interesting about this graph is what it suggests about the 2008 price peak of $140 a bbl.

There was no supply disruption that I can remember. This appears to lend credence to the 2008 hike being a consequence of investor speculation and hoarding behavior rather than demand fundamentals.

Interesting. Thanks.

Stuart Staniford said...


I think the best way to think about the 2005-2008 spike is that it began as a result of strong demand meeting a plateau of supply when the world ran out of deployable spare capacity in about 2005 and production could not easily be raised further. So these were fundamental factors. But then I think it's reasonable to suggest there was some speculative overshoot at the end.

Stephen B. said...

Responding to BOP,

There actually were disruptions in the Southeast. Gas was in tight supply as was diesel fuel in Kansas and Nebraska for a time.

Then too, because there weren't price controls like there were in the 1970s, we had better product rationing by price compared to back in the Old Days when we had rationing by availability and time.

In general, however, I agree with Staniford in that we had demand that smacked up against a more or less fixed supply and prices peaked. As that was happening, speculators piled in.

Still, one needs tight market fundamentals in order for speculators to be able to push price higher. As a counter example, in the 1990s, when the world was awash with oil, speculators simply couldn't have done much to push up prices.

Kenneth D. Worth said...

Always hard to tell what effect the speculators have. But where financial players had a very clear effect was in the currency markets (much easier to store those ones and zeros than barrels of oil.) The dollar index fell as low as 72.5 in 2008 and then surged to 90 in the 08-09 meltdown which made the fall in the price of oil seem far more dramatic than it was on a global basis.