Dollars and Jens
Tuesday, October 24, 2006
OPEC spare capacity and oil prices
Lynne Kiesling notes an article in the Economist on OPEC and oil prices, and calls particular attention to this passage:
Their output today, of some 27.5m b/d, is much the same as it was in the 1970s. What is more, they are scarred by the memory of the 1980s, when slower-than-expected growth in demand and a glut of non-OPEC supply left them saddled with lots of expensive excess capacity. The high prices of recent years are partly a legacy of that glut, insofar as OPEC, still leery of over-investment, allowed its cushion of spare capacity to dwindle to almost nothing, heightening supply concerns.I saw a graph of oil production and global capacity as functions of time several months ago, and that chart of OPEC's market share looks a lot like the portion of capacity in use — there was (as the text notes) a glut of spare capacity in the eighties that ran out a few years ago.
Unfortunately for oil consumers, OPEC has little incentive to expand that cushion in the short term. It would, in effect, be spending money to reduce its revenue, since the price of oil would doubtless fall if traders had no fear of future shortages. Dermot Gately, a professor of economics at New York University, has modelled OPEC countries' income at different levels of production. He concluded that any effort on OPEC's part to expand capacity to maintain its market share would only begin to yield higher revenues after 2015, and even then, the increase would be marginal. Given all the uncertainties involved, a rational OPEC planner would probably resolve simply to maintain exports at today's levels rather than add capacity.