RI

VERSSTATEUNI
VERSITY
DEPARTMENTOFPETROLEUM ENGINEERI
NG

TOPIC:
THEREASONFORTHECRUDEOI LPRI
CE COLLAPSEIN
THEINTERNATI
ONALOILMARKETI NTHE1980’
s

ATERM PAPERPREPAREDI
NPARTI
ALFULFILMENTOF
THEAWARDOFBACHELOROFENGI NEERI
NG(B.
Eng.
)

BY

NOBLECHIBUEZEI GWE
DE.2018/
1604

COURSECODE:PTE311

LECTURER:ENGR.K.K.DUNE

J
UNE,2021.
 Abs
trac
t

Wi t
ht hebe nefi
tofhi ndsight ,t
hispape rpr ovidesaf r
e shandc ompr e
hensive
l
ookatt her e
asonsbe hindt hedeclensionoft hepr i
ceofc r udeoi li
nthe1980's.
Itdisentanglesthecont r
ibut ionofs upplyandde mandf actors.Ac oll
apsein
oilpricesadverselyaffect
sf irmbor rowi nginr es
our ce-depe ndentcountri
es.In
theshor trunoilmar ketsandpr i
cesaredomi natedbyOPECs upplydeci
sions
(i
ehowmuc hoi lisrel
ease dont othemar ke
torr atherhowmuc hoilthecart
el
i
sabl etoke epof fit
).Int heme di
um- term,howe ver,theke yf act
ors
controlli
ngpr ic
e saretotalde mandandt heavailabili
tyofnon- OPEC
suppliers.Thefallinpr i
ce sandOPEC' sde l
inquenc ytor egulatethewor l
doi l
ma rket,refl
ectedanunde rlyingshiftint heinter
nat i
onaloi lregime

I
NTRODUCTI
ON

Cr
udeoi
lisa 
nat
ural
lyoc
cur
ringpe
trol
eumpr
oduc
tcompos
edofhydr
ocar
bonde
pos
it
s
andotherorgani
cmateri
als
.Atypeoffos s
ilf
uel,c
rudeoilisref
inedtoproduceus
abl
e
product
sincl
udinggas
oline
,di
esel
,andvar i
ousotherf
ormsofpe t
roche
mi c
als
.Iti
s
a nonr
enewableres
our
ce,whic
hme ansthatitcan'
tbereplace
dnat ur
all
yattherat
ewe
consumeitandis,t
her
efore
,ali
mitedre
s ource
.

Crudeoilistherawnaturalre
sourcethatisextr
ac t
e dfromt hee arthandr e
fine
dint o
product
ssuc hasgasoli
ne,j
etfuel
,andot herpet
role umpr oduc t
s .Crudeoilisaglobal
commodi t
yt hattr
adesinmarketsaroundt hewor l
d,bot hass potoi landviaderi
vative
s
contr
act
s.Manye conomist
sviewcrudeoi last
hes ingl
emos timpor tantcommodi tyinthe
worldasitiscurre
ntlythepri
marysourceofe nergypr oduction.

The  
priceofoil,orthe oilpr
ice,generall
yr e
ferstothe spotpr i
ce ofa barrel
 of 
benc hmark
crudeoil—ar efe
rencepriceforbuye rsands el
ler
sofc rudeoi lsuchas  
We stTe xas
Inter
me diate (
WTI ),
 BrentCr ude, 
DubaiCr ude,
 OPECRe ferenceBas ket
, Tapis
crude,
 BonnyLi ght,
 Uralsoil
, Is
thmus  
and We ste
rnCanadi anSe lect 
(WCS) . 
The reisa
diff
erenti
a linthepri
c eofabar relofoilbasedoni tsgrade—de te
r minedbyf actorssuchas
it
sspec i
ficgravit
yor  
APIgr avity 
andi t
ss ul
furcontent—andi tslocation—f orexampl e
,it
s
proximityt o 
ti
de wat
er andrefineri
es.He avi
er, 
sourcrudeoi ls 
lackingintidewat e
r
access
—s uchasWe s
ternCanadi anSe lec
t—ar elessexpe ns
ivethanl ighter
, 
swe ete
r
oil
—s uchasWTI .

OilPri
cesKe epFall
ingBecauset heEconomi cRe openingIsHitt
ingObs t
acles
.Theoi l
i
ndustr
yi sful
lof 
booms  
and busts.Pri
cestypical
lyris
edur i
ngperiodsofglobaleconomic
st
rengt
handasde mandout pac essupply.Crudeoi lwil
lfal
lwhent here
verseistr
ue ,and
demandc annotkeepupwi t
hgr owi ngs
uppl i
es.Me anwhile
,supplyandde mandaredr ive
n
byanumbe roff
actors
:

 ChangesintheUSdol lar
 OPEC( Organizati
onofthePetr
oleumExpor
ti
ngCount
ri
es)
 Product
ionandi nvent
orysuppl
ie
s
 Theglobale
c onomy
 Dealsandtr
e ati
es

Amaj orri
seorde cl
ineinoilpric
ec anhavebot heconomicandpol iti
calimpacts.The
decli
neonoi lpr i
ceduring1985–1986isconsidere
dt ohavecontri
but edtothefallofthe
SovietUnion. Lowoi lpri
cescouldallevi
atesomeoft henegat
iveeffectsass
ociatedwith
the 
resourcecur s
e,suchasauthorit
arianrule
 andge nderi
nequali
ty.Lowe roilprice
sc oul
d
howe veral
sole adtodome st
icturmoiland di
versionarywar.Ther educti
oninf oodpr i
ces
thatfoll
owslowe roilpric
escouldhavepos it
iveimpac t
sonviole
nc egloball
y.

Resear
chshowsthatdecli
ningoilpri
cesmakeoil
-ri
chstat
e sl
essbel
li
cose.
 Lowoilpri
ces
coul
dalsomakeoil-
ric
hs t
atesengagemor ei
ninter
nati
onalcooperat
ion,astheybec
ome
moredepende
ntonf ore
igninvestments
. 
Theinf
luenceoftheUnite
dSt ate
sreport
edly
i
ncreas
esasoilpr
ice
sde cl
ine,atl
eastj
udgingbythefactt
hat"bothoilimporte
rsand
expor
ter
svotemoreof
tenwi
tht
heUni
tedSt
ate
sint
heUni
tedNat
ionsGe
ner
alAs
sembl
y"
duri
ngoils
lumps
.

Inthefirsthalfof1986crudeoilpri
cesf
ellt
oabout$12abarrel
,backtot
hei
rleve
lof1974
and,whe nadjustedforchangesinthege
ne r
alpri
cel
evel
,cl
osetothere
aloi
lpri
cethat
prevai
ledi n1973j us
tbef
orethefir
stOPECpr ic
eincr
ease
.Thispaperr
evi
ewsthe1986oil
pri
c ec
ollapse,discuss
eswhyitcameasas urpr
ise
,andass
ess
eswhatitmeansf
oroilpri
ces
in1986-87andbe yond.

Thef irsts ecti

onoft heba l
anceoft hepape rpresent sanove rviewoft he1970-86wor l
doil
mar ket:pr i
ce,demandands uppl ybyregion,andout putandr eve nueforOPEC.Thene xt
sect
ionr evi e
wst here cordofe xpertopini
ons incet hefir
stbigpr iceincreas
esin1973-74,
payings pe ci
alattenti
ont ot he1980-81Wor l
dOi lstudybyt heEne rgyMode li
ngFor um
(EMF)andt other e
s ult
sfromas eri
esofpol l
sofe nergyanal ystss i
nce1981byt he
Internat i
onalEne rgyWor kshop.Thet hirdsec t
ionpr esentsane xplanati
onoft he1986
pric
ec ollapse,togethe rwithas imulati
onoft hec hoi c
esfacingOPECf or1986and
thereafter .Thef ourths ec
tione xaminestheque stionofwhats houl dhavebe e
ne xpect
edfor
1985-86,goi ngasf arbac kas1980.I ncludedthe rear eeconome tricesti
matesofoildemand
functionsf ortheUni tedSt atesandf i
veotherc ount ri
esoftheOr ganizat
ionforEc onomic
Coope rationandDe velopme nt(OECD) .

The1986pr i
cecollapsewast her es
ultofade c
isi
onbySaudiAr abiaands omeofi t
s
neighborstoincreasethei
rs har eoftheoi lmar ket.Unlikeot he
rpr oducer
s ,theydidnot
suffergreatr
evenuel oss
es,bec ausethepr icede c
lineswe reoffs
etbyt he
irout putincre
ase
s.
Butwi thoilpri
cesasl owas$12abar rel
,t heirrevenuewoul dals odecl
ine,sothatt he
ycan
bee xpect
e dt
or es
trictoutputatt hatpr i
ce ,evenunilate
r all
y.Iexpect,t
here f
ore,that
OPEC' sAugust1986agr eeme ntinGe nevat orestri
ctout putwillbesucce
s sful
.Byno
me ansdoe st
he1986pr i
cecollapsere presentthede athofOPEC,ashasof t e
nbe en
proc l
aimed.

Ove rthene xttwode cades,pricec anbee xpe ctedt oincreases ubstantiall

y,alt
houghOPEC
willcontinuetohavedi ffi
cultyr est r
ict
ingout putifitraisespr icetoof arabovewhati s
war r
antedbymar ketc onditi
ons .Thewor ld'soilresour cesares ti
llheavilyconcent
ratedin
thePe rs
ianGul f
,andt hereisnoal t
ernati
vee nergysour cenowont hehor i
zonthatischeap,
cle
an,andpl enti
ful.Wi t
hc ontinui ngwor lde c onomicgr owt he ventual l
youtweighi
ngt he
demand- reduc i
ngadj us t
me nttot he1973- 74and1979- 80pr iceincreases,andwithlimite
d
prospectsforc ontinuinge xpans ionofnon- OPECpr oduc ti
on,t hede mandf orOPECoi l
willgrows ubstantiall
y,andOPECwi llr
es pondbyr aisingt hepr i
c e
.ButOPEC,e s
pe c
ial
ly
SaudiAr abiaandi tsalli
es,willpr obabl ybec autiousint hef utureaboutabr uptprice
i
nc rease
s,havi ngse enthec onse que ncesdur ing1980- 86.

Intheeventofamajordis
rupt
ion,however
,pri
cecoul
dgoups har
ply,andt
heWe s
twil
lbe
onlysl
ightl
yles
svul
nerabl
ethanitwasin1979-
80.Alt
houghthere
sult
ingpr
icei
ncr
ease
neednotbepe r
manent,i
twouldagainhaveasubs
tant
ialne
gati
veef
fectont
heworld
economy.
Unde
rst
andi
ngt
he1986Pr
iceCol
laps
e

Earlyin19 86,aft
eryearsoffutil
eattemptstogetitsOPECpar tnerstoobservethei
r
productionquotasands harethebur denofoutputrest
ri
c ti
onmor eequit
ably,SaudiArabia
anditsallie
sunde rt
ooktopr oducetheir"f
airshare"andl e
tpr i
cefallasaconsequenceThe
dir
ef ut
ur eaboutwhi c
ht heSaudishadwar nedtheirpartnersbecameadi rereal
ity.
Althought herevenueoft heSaudishasbeenrelat
ivel
yunaf fect
edbyt hepricedecreas
es,
therevenueofot herOPECme mbershasbeengr e
atlyreduced.

Aslongast hepri
cecutsa renotc ar
rie
dt oofar,t
heyofferlonger
-ter
mbe ne f
it
sforSaudi
reve
nueandf orthecredibil
it
yofanyf ut
ureSaudithreatstoincr
easeoutput.Becaus
eoft he
Saudis
'hugeoilrese
rves,theyandt hei
rAr abne i
ghboursont hePersi
anGul fhaveag r
eater
l
ong-ter
ms takeinthewor ldoilmar kett
handomos totherOPECme mbe rsandmos tnon-
OPECpr oduc e
rs,whowi llhaver el
ati
vel
ylitt
leoill
efti
nt wentyyears
.TheSaudi sdonot
wantthelong-t
ermhe alt
hoft he i
rmar ke
tjeopardiz
edbyi rre
versi
blefue
l-s
wi t
chingorthe
devel
opme ntofalt
ernati
v eenergysources.

Somes i
mul ati
onr unsfrommyOPECPr ici
ngSimulat
ionMode lwills
hedlightuponthe
1986oilpricecol
lapseandhi ghl
ightthec
hoice
sfaci
ngOPECf orthefutur
e.The
proje
cti
onst hatf
ol l
owar eil
lust
rati
veandarenottobeinte
rprete
dasf ore
casts.Al
thoughI
beli
evethattheunde rl
yingparame t
erval
uesass
ume darequit
ereasonable
,Iamawar eof
theunavoidableunc e
rtaint
yinvolved.

Themode li
sanannualmodeloftheworl
dmarketforc r
udeoil
.Init
,pri
ce,measure
din
1985dol
lars
,isdet
ermi
nedbyOPEC,whi chproducesthedif
fer
encebet
weenwor l
doil
demandandnon-OPECs upply.Themodeli
sdis
aggregatedre
gional
lyi
ntonon-OPECand
acountr
y-by-
countr
ydis
aggregati
onofOPEC.

Thethirt
e e
nme mbe r
sofOPECar edividedintot hreegr oups.The" Core"ofOPECc onsi
sts
ofSaudiAr abiaandi t
si mme diateneighbors,Kuwai t,theUni tedAr abEmi r
ates,and
Qatar.Ir
anandI r
aqaregr oupe dtogetherbe c
aus ethe i
rout puthasbe enre ducedbywar
andwi l
lincre
as ewhent hec onfl
ictisresol
ved;t heiroutputl evel
sar eass
ume dtobe
exogenoustot hemode l.Ther estofOPECc onsistsofAl geria,Ec uador,Gabon,I ndone s
ia,
Libya,Nigeri
a,andVe nezue l
a.The yareas s
ume dtopr oduc eatt hes amele velin1986as
theydidin19 85.30For1987andbe yond,the ysha reequal l
ywi tht heCor eanyi ncreasesin
thedemandf orOPECoi l(
abovet hatproduc edbyI ranandI r
aq);t heyalsos haredecreases
withtheCor e,butnote qually:theCor ebears70pe rcentoff urtherc ut
bac ksne eded.

Sixcasesaresimulated:thr
eedi ffer
entiniti
alpri
c es-
$26,$18,$10-f ore achoftwoOPEC
outputce i
li
ngs-25mi l
li
onbpdand3 5mi ll
ionbpd.Pr icest
artsatoneoft hreeinit
ialpric
es
i
n1986andr e
mai nsatthatlevelunt i
lthedemandf orOPECoi lreac hestheassume d
outputce i
li
ng,afterwhichti
met hemar ket-cl
eari
ngpr icei
scalculated.The$26i nit
ialpri
ce
i
sintende dasar efer
encecaseandc anbet houghtofast he1985s tatusquo.Wi ththeother
two,the1986pr i
cedropstoe it
he r$18or$10be c auseofoutputinc reasesbyOPEC' sCor e
.
Thepatht oa25mi l
li
onbpdout putc e
ili
ngc anbet houghtofasas tyli
zed"returnto
normality"forOPEC. 3'The35mi ll
ionbpdl evelisanalter
nativec eili
ng,suggestedby
somewhobeli
evei
ttobepre
fer
abl
efort
heCor
e,f
romwhomt
headdi
ti
onal10mi
ll
ionbpd
outputi
sas
sumedtocome.

Ove rthelongerrun,theCor ewoul

dpr e
ferani ni
tialpri
celowerthanthe1985s t
atusquoof
$26,whi chwouldr e
quirethemtorest
rictoutputfortenmor eyears,wit
hr evenuedecli
nes
forthene xtfe
wye ars.Buttheywoul
dhavenos t
rongpr e
fere
nceforanyoft heothercas
es
simulated.TherestofOPEC,howe ver,woul dclearl
yprefert
helowe routputc e
il
inganda
higheriniti
alpri
ce,espec
ial
lyift
heyuseahi gherdiscountrat
e.

Oilpr ice
sc ol
lapsedint hemi d-1980sasde mandcontract
edduet or e
cess
ionar
yc onditi
ons
andi mpr oveme ntsineffici
ency,whilenon-OPECs uppl
ygr ewt hankstotheprolongedhi gh
oilpricesofthe1970s .Sa udiAr abi
ac utoutputdramatic
allyinanat tempttoboos tpri
ces,
butt histi
me ,itdidn’twor k.From1980t o1985,theKingdom’ spr oduct
ionfe
llfrom
around10mi l
lionbar r
elspe rdayto3. 6mbdi n1985,whichbr oughtaboutadr amat i
closs
ofmar ketshare.From1983t o1986,thepr i
ceofWe stTexasInt e
rme di
ate(WTI )wasc utin
half,fall
ingfrom$30pe rbarrelto$15. 

Dur i
ngthesecondoilshockthegree
dofmone ymoti
vate
dOPECt ooverproduceoi
l,whi
le
highoilpri
cesweredecreas
ingoilc
onsumpti
on.Thi
soilgl
utle
dtothemajoroilmarket
crashof1985–1986,duri
ngwhichoilcompani
esl
aidoffmanyoft
heire
mploye e
sorfil
ed
forbankruptcy.

HowWor
ldCr
ise
sImpac
tOi
lPr
ice
s

Worldc r
isesinoi
l-produci
ngcountr
ies
,orconc
ernaboutcr
ise
s,dr
amatic
all
yi nc
reas
eoi
l
pri
ces.Thisisbec
auset r
adersworr
ythecri
si
swilll
imi
tthes
upplyofoi
l,i
ncreasi
ngdemand
andtheref
or epr
ices.

CONCLUSI
ON

Oilpric
eshavefal
lensharpl
y.Ourbas
e -
casesc
enari
oist
hatoilpr
ice
swi l
lrec
oversomeof
thei
rrecentl
oss
es.Howe ver
,ther
eact
ionfuncti
onofOPECt oloweroilpr
icess
eemsmore
unpredic
tabl
e,s
oi tmaytakemuchlongerforpri
cest
orecove
rparti
all
y.

Inatimeofgr e
atuncer
taintyforoilpri
ces,thisr
eportexplor
e shows e
nsit
iveeachLat am
countr
ywi t
hinourcoverageistoloweroilpr i
ces
.Mos thaveas igni
fi
cantexposuretooil.
Intheshortte
rm,ArgentinaandBr azi
lgainf romade cl
ineinprices
,whileMe xic
o’sloss
es
arecontai
ned.However,intheme diumtol ongterm,Argentina,Brazi
landMe xi
cohave
mucht
olos
e,asi
nve
stme
ntsinthei
rvas
toi
landgasr
ese
rve
smays
uff
er.Chi
lei
sthec
lear
wi
nner
,whi
leCol
ombiai
sthelose
r.

REFERENCES

Gat
ely,D.Le
ssonsf
romt
he1986Oi
lPr
ice[
PDFFI
LE]

Pr
iceofoi
l.(
2021,9J
une
).Wi
kipe
dia
.ht
tps
:/
/en.
m.wi
kipe
dia.
org/
wiki
/Pr
ice
_of
_oi
l
AMADEO,K.( 2021,10June.“WhatAf
) f
ect
sOilPri
ces
?Thre
eCri
ti
calFact
ors”:How
Worl
dCris
esI
mpac tOilPri
ces
.htt
ps:
//
www.t
hebal
ance.
com/
how-
are-
oil
-pr
ice
s-det
ermi
ned
-
330
5650

Crudeoi
l.(
2021,26May)
.Inve
stope
dia
.ht
tps
:/
/www.
inve
stope
dia.
com/
ter
ms/
c/
crude
-
oi
l.
asp