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Oil and its Economics

Since 1974 oil-exporting nations have substantially increased their imports in order to finance development plans and to pay for highly technical military training, equipment, and sophisticated defense systems such as the airborne warning and control system, AWACS. From 1972 to 1983, OPECs imports increased approximately sevenfold. Furthermore, exports to OPEC from OECD as a percentage of the latter’s total exports increased from 4. 1 percent in l972-73 to 8. 8 percent in 1975-82, then to 8. 4 percent in 1983; and it dropped to 7. rcent in 1984. (http://www. georgetown. edu/users/johnsonj/oweiss/petrod/increase. htm) Dynamic forces of oil supply and demand led to all excess supply in world markets since 1980, which in turn led to a de facto decline in the price of oil even before OPEC’s London agreement of March 1983 in which the official price was reduced by approximately 14 percent.

This oil glut in world markets was the result of at least three mutually dependent dominant forces: high oil prices, increase in production, and reduction in demand. (http://www. rgetown. edu/users/johnsonj/oweiss/petrod/since. htm) First, following the initial leap of 1973 the price of oil was once again drastically increased in l979. This rise led to a substitution of other sources of fuel and a reduction in real income, which contributed eventually to a decline in the demand for oil after a three-year time lag. A second factor in the oil glut was the increase in world oil production–a predictable economic consequence of rise in its price. A third factor in the oil glut was decreased demand for oil.

The 1980 economic recession, which had plagued the world economy and which had markedly reduced the productive capacity of industrial nations by its greatest percentage decline since World War II, was a dominant force in reducing the demand for oil yet further. As their gross national products headed downward because of the recession, industrial nations reduced their imports. This, in turn, led to a reduction in foreign exchange earnings of the less-developed countries. These had, therefore, to curtail their purchases from abroad, including imports of oil.

A multiplier effect of all such factors had a marked effect on the demand for oil in world markets. (http://www. georgetown. edu/users/johnsonj/oweiss/petrod/since. htm) Demand for Oil over Time (http://www. georgetown. edu/users/johnsonj/oweiss/petrod/time. htm) A conventional downward-sloping demand curve is not, in [Dr. Oweiss]opinion, sufficient to explain the interaction of oil prices and quantity demanded over time. In studying the dynamics of international oil markets which differentiates between upward and downward trends in prices.

A small rise in the price of oil, from its low, pre-1973 level, will not change the quantity demanded, for demand at such a low level may he regarded as perfectly inelastic. Yet, as oil prices are substantially increased, quantity demanded must be somehow reduced. Such a response makes the demand curve at higher prices less inelastic than before. This suggests that as prices are increased over time, the demand curve becomes concave in relation to the original axis. Yet as oil prices fall in response to a glut or for other reasons, a conventional downward-sloping demand curve could be applicable.

As oil prices rise slowly from PA to PC, the demand curve is inelastic as it moves from point A to point C. Quantity of oil demanded is perhaps slightly reduced from QA to QC. For a small rise in the price, however, demand is perfectly inelastic, as consumers may not be willing to change their consumption patterns in response to only small increases in price, especially for a necessity such as oil. After a certain period in applying a time series analysis, demand could move from point C to point E, with substantial increase in the price of oil as price moves from PC to PE.

As it moves upward, the demand curve becomes less inelastic, which means that quantity demanded becomes more responsive to higher changes in price. Quantity demanded is then reduced from QC to QE, as consumers may change their pattern of consumption by driving small and more fuel-efficient cars, insulating their homes, converting their home-heating and air-conditioning fixtures, and adopting numerous substitution and conservation measures. At higher prices, demand for oil is reduced while supply is increased, resulting after a certain interval in all excess supply or an oil glut.

If a glut occurs at point E, market forces will dictate a drop in the price so long as no monopolistic market power exists to reduce the supply substantially through a carefully designed policy or contrived scarcity. Nevertheless, it may be observed that a small decrease in the price of oil will not increase quantity demanded. If the price drops from PE to PG, quantity demanded will only be increased from QE to QG. If the price drop is even smaller, the demand curve may be perfectly inelastic, since consumers will not alter their consumption habits by adopting anti-conservation measures for a small reduction in oil prices.

If, however, the drop in price is substantial, as from PG to PI, an increase in quantity demanded from QG to QI becomes evident, as consumers eventually resume some of their former consumption patterns. A theoretical derivation of a demand for oil from a utility surface can be based on conventional income and substitution effects using either a Hicksian or Slutskyian approach. In the right hand side of the Slutsky equation, the first term refers to substitution effect while the second refers to the income effect, both of which determine a response of quantity demanded to changes in price.

In an upward trend of prices in the demand curve we presented for oil, the algebraic addition of the two terms must be equal to zero if demand is perfectly inelastic as prices increase from a low level. However, as quantity demanded responds to a further rise in the price of oil, the addition of the two terms must be negative. Similarly, in a downward trend of prices, the addition of income and substitution effects must be equal to zero if demand is perfectly inelastic.

As quantity demanded increases with further decline ill the price of oil, the algebraic addition of the two effects must be negative while the resulting amounts, in absolute terms, keep increasing as prices fall farther. (http://www. georgetown. edu/users/johnsonj/oweiss/petrod/time. htm) In 1973, the Arab oil embargo dealt the U. S. economy a major blow. This, combined with OPEC subsequent price hikes and a growing American dependence on foreign oil, triggered the recession in the early seventies. As of the first quarter of 1998, the U. S. nomy was strong and oil prices were falling, however, overall reliance on foreign oil has increased. In 1973, foreign oil accounted for 35 percent of total U. S. oil demand. By the beginning of 1998, the figure had risen to 50 percent. Though OPEC provided 46 percent of U. S. imports, the dominant suppliers are non-Arab members (notably Venezuela, America’s number one supplier, and Nigeria). In fact, Saudi Arabia (#3), Algeria (#9) and Kuwait (#12) were the only Arab countries among the top 20 suppliers of petroleum products to the United States in 1997.

The Persian Gulf states supply less than 20 percent of U. S. petroleum imports. (http://www. jsource.. com/US-Israel/usoil. html) Egypt’s President Sadat persuaded the late Saudi King Faisal to threaten to withhold oil from the West to exploit for political advantage the growing dependence of the industrialized West on Arab oil. The tactic was effective: Soon the major American oil companies backed the Arab cause in public, and privately worked to weaken U. S. support for Israel.

According to a 1974 report of the Senate Foreign Relations subcommittee on Multinational Corporations, the ARAMCO consortium-Exxon, Mobil, Texaco and SOCAL-attempted to block America’s emergency airlift to Israel. During the war, the companies cooperated closely with Saudi Arabia to deny oil and fuel to the U. S. Navy. On other occasions, the major oil firms have advocated the positions of the Arab countries, particularly Saudi Arabia. The major oil companies vigorously lobbied Congress on behalf of the sale of F-15s in 1978 and AWACS aircraft in 1981.

Together with Saudi foreign agents, these corporations enlisted many other American firms to lobby on the Saudis’ behalf. Saudi Arabia has a powerful lobby in the United States because hundreds of America’s largest corporations do billions of dollars worth of business with the Kingdom. And each of these corporations, Hoag Levins noted, had hundreds of subcontractors and vendors equally dependent on maintaining the good graces of Muslim leaders whose countries now collectively represent the single richest market in the world. (http://www. jsource.. com/US-Israel/usoil. html)

The Saudis often attack what they claim is the excessive influence of Israel’s supporters in the United States, but investigative journalist Steve Emerson turned that claim upside down. After detailing many of the ties between Saudi Arabia and U. S. businesses, universities, lobbyists and former high-ranking government officials, he concluded: The breadth and scope of the petrodollar impact is beyond any legal remedy. With so many corporations, institutions, and individuals thirsting after-and receiving-oil money, petrodollar influence is ubiquitous in American society.

The result is the appearance of widespread, spontaneous support for the policies of Saudi Arabia and other Arab oil producers by American institutions ranging from universities to the Congress. The proliferation of vested ties has allowed special interests to be confused with national interests. Never before in American history has any foreign economic power been as successful as Saudi Arabia in reaching and cultivating powerful supporters all across the country.

The Saudis have discovered that one quintessential American weakness, the love of money, and the petrodollar connection has become diffused throughout the United States. The growing reliance on imported oil has also made the U. S. economy even more vulnerable to price jumps, as occurred in 1979, 1981, 1982 and 1990. Oil price increases have also allowed Arab oil-producers to generate tremendous revenues at the expense of American consumers. These profits have subsidized large weapons purchases and nonconventional weapons programs such as Iraq’s.

America’s dependence on Arab oil has occasionally raised the specter of a renewed attempt to blackmail the United States to abandon its support for Israel. PLO chairman Yasir Arafat suggested such a tactic, for example, in 1990: When the North Sea oil dries up in 1991, the United States will want to buy Arab petroleum. And when American oil fields themselves run dry and oil consumption in the United States increases, the American need for the Arabs will grow greater and greater. The good news for Americans is that the principal suppliers of U. S. oil today are more reliable and better allies than the Persian Gulf nations.

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