{"id":1720,"date":"2017-03-14T00:27:30","date_gmt":"2017-03-14T04:27:30","guid":{"rendered":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/?post_type=chapter&p=1720"},"modified":"2017-05-15T20:13:18","modified_gmt":"2017-05-16T00:13:18","slug":"case-study-oil","status":"web-only","type":"chapter","link":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/chapter\/case-study-oil\/","title":{"raw":"Case Study - Oil Markets","rendered":"Case Study – Oil Markets"},"content":{"raw":"[caption id=\"attachment_2028\" align=\"aligncenter\" width=\"970\"]\"\" (Credit: A7x\/ Wikimedia Commons\/ CC BY-SA 3.0[\/caption]\r\n\r\nSome hate it and some love it, but regardless of how you feel oil is still a key part of our daily lives. The average Canadian uses about 20 barrels of oil each year, equivalent to about one and a half swimming pools. Since it is such a major part of our expenses, oil is\u00a0a product where, when price changes, we really notice.\r\n\r\nIn 2008, <\/span>China's expansion sparked\u00a0<\/span>a<\/span>\u00a0long period of high prices. In this case study, we will analyze what has happened to\u00a0these prices over time and the impact this has had on\u00a0oil producers from the lens of producer theory.\u00a0<\/span>\r\n\r\nTo simplify our case study, let's assume that the oil market is perfect competition.<\/span>\r\n\r\n1. Consider the following producer theory model for a single firm producing oil, and the aggregate supply and demand.\u00a0What is the firm\u2019s equilibrium price and quantity?<\/span><\/strong>\r\n\r\n\"\"\r\n\r\n2. What is the firm\u2019s profit at this level?<\/span><\/strong>\r\n\r\n3. What will occur in the long-run for this market? Show this on the new graph below.<\/span><\/strong>\r\n\r\n\"\"\r\n\r\nThe period of high prices indeed\u00a0incentivized private firms to search farther than ever before -\u00a0<\/span>in the Arctic, Brazil\u2019s pre-salt fields, deep waters off Angola, and Canada's oil sands to ever expand the supply of oil. Investors encouraged this activity, rewarding future growth as much as profitability.<\/span>\r\n\r\n[caption id=\"attachment_2027\" align=\"aligncenter\" width=\"640\"]\"\" (Credit: Adam Jones\/ Flickr\/ CC BY-SA 2.0)[\/caption]\r\n\r\nOil prices have been quite volatile. Recently, from mid 2014 to early 2016 oil prices plummeted from $110 a barrel to around $27.\u00a0This sharp decline has been due to a number of causes. A key cause\u00a0was when sanctions were lifted from Iran, a new producer entered the market with large quantities of oil. In addition, growing fears about action on climate change, coupled with the emergence of alternative-energy technologies, caused producers to\u00a0pump as hard as they can, while they can.<\/span>\r\n\r\n\"\"\r\n

Read more about the reasons for changing\u00a0oil prices<\/a><\/p>\r\n3. Use the producer theory model from above to show the impact of Iran's entry, assume this brings the market from long-run equilibrium to a price of $27.<\/strong>\r\n\r\n4. What are the firms profits at this price?<\/strong>\r\n\r\nIn the industry at large, the incentive is to keep producing \u201cas flat out as you can\u201d, once investment costs have been sunk into the ground, says Simon Henry, Shell\u2019s chief financial officer. He says it is sometimes more expensive to stop production than to keep pumping at low prices, because of the high cost of mothballing wells. He suggested that\u00a0firms\u00a0will not pack up so long as prices cover day-to-day costs, in some cases as low as $15 a barrel.<\/span>\r\n\r\nIt may be uneconomic to drill new deepwater wells at prices under $60 a barrel, he says, but once they are built it may still make economic sense to keep them running at prices well below that. Such resilience is used by some to justify why they expect prices to remain \u201clower for longer\u201d.\r\n\r\n\"\"\r\n

Read more about the impact of price changes on oil firms<\/a><\/p>\r\n6.\u00a0What does this excerpt suggest about how firms will behave in the short run?<\/strong>\r\n\r\n7.\u00a0Based on the information given about this market, what do you think the time horizon will be for this industries 'long run'? What will happen in the long run?<\/strong>\r\n\r\nNotice that in our model when prices fall, even in the short run individual firms will decrease production.\u00a0In reality, firms part of the Organization of Petroleum Exporting Countries (OPEC) made a pact to keep production high, to try to retain market share and keep out competitors.\r\n\r\nIn his book \u201cThe Prize\u201d, Daniel Yergin quotes an American academic writing as far back as 1926 about the \u201cspectacle\u201d of massive overproduction. \u201cAll saw the remedy but would not adopt it. The remedy was, of course, a reduction in the production.\u201d<\/span>\r\n\r\n8.\u00a0Comment on\u00a0the effects of OPEC's actions on the market.<\/strong>\r\n\r\nIn this case study we have shown how microeconomic concepts of monopoly and monopolistic competition\u00a0can be used to understand current events in the news. Do you have a story you think would make a good case study? Contact economics103@uvic.ca to propose your own case.<\/span>","rendered":"

\"\"
(Credit: A7x\/ Wikimedia Commons\/ CC BY-SA 3.0<\/figcaption><\/figure>\n

Some hate it and some love it, but regardless of how you feel oil is still a key part of our daily lives. The average Canadian uses about 20 barrels of oil each year, equivalent to about one and a half swimming pools. Since it is such a major part of our expenses, oil is\u00a0a product where, when price changes, we really notice.<\/p>\n

In 2008, <\/span>China’s expansion sparked\u00a0<\/span>a<\/span>\u00a0long period of high prices. In this case study, we will analyze what has happened to\u00a0these prices over time and the impact this has had on\u00a0oil producers from the lens of producer theory.\u00a0<\/span><\/p>\n

To simplify our case study, let’s assume that the oil market is perfect competition.<\/span><\/p>\n

1. Consider the following producer theory model for a single firm producing oil, and the aggregate supply and demand.\u00a0What is the firm\u2019s equilibrium price and quantity?<\/span><\/strong><\/p>\n

\"\"<\/p>\n

2. What is the firm\u2019s profit at this level?<\/span><\/strong><\/p>\n

3. What will occur in the long-run for this market? Show this on the new graph below.<\/span><\/strong><\/p>\n

\"\"<\/p>\n

The period of high prices indeed\u00a0incentivized private firms to search farther than ever before –\u00a0<\/span>in the Arctic, Brazil\u2019s pre-salt fields, deep waters off Angola, and Canada’s oil sands to ever expand the supply of oil. Investors encouraged this activity, rewarding future growth as much as profitability.<\/span><\/p>\n

\"\"
(Credit: Adam Jones\/ Flickr\/ CC BY-SA 2.0)<\/figcaption><\/figure>\n

Oil prices have been quite volatile. Recently, from mid 2014 to early 2016 oil prices plummeted from $110 a barrel to around $27.\u00a0This sharp decline has been due to a number of causes. A key cause\u00a0was when sanctions were lifted from Iran, a new producer entered the market with large quantities of oil. In addition, growing fears about action on climate change, coupled with the emergence of alternative-energy technologies, caused producers to\u00a0pump as hard as they can, while they can.<\/span><\/p>\n

\"\"<\/p>\n

Read more about the reasons for changing\u00a0oil prices<\/a><\/p>\n

3. Use the producer theory model from above to show the impact of Iran’s entry, assume this brings the market from long-run equilibrium to a price of $27.<\/strong><\/p>\n

4. What are the firms profits at this price?<\/strong><\/p>\n

In the industry at large, the incentive is to keep producing \u201cas flat out as you can\u201d, once investment costs have been sunk into the ground, says Simon Henry, Shell\u2019s chief financial officer. He says it is sometimes more expensive to stop production than to keep pumping at low prices, because of the high cost of mothballing wells. He suggested that\u00a0firms\u00a0will not pack up so long as prices cover day-to-day costs, in some cases as low as $15 a barrel.<\/span><\/p>\n

It may be uneconomic to drill new deepwater wells at prices under $60 a barrel, he says, but once they are built it may still make economic sense to keep them running at prices well below that. Such resilience is used by some to justify why they expect prices to remain \u201clower for longer\u201d.<\/p>\n

\"\"<\/p>\n

Read more about the impact of price changes on oil firms<\/a><\/p>\n

6.\u00a0What does this excerpt suggest about how firms will behave in the short run?<\/strong><\/p>\n

7.\u00a0Based on the information given about this market, what do you think the time horizon will be for this industries ‘long run’? What will happen in the long run?<\/strong><\/p>\n

Notice that in our model when prices fall, even in the short run individual firms will decrease production.\u00a0In reality, firms part of the Organization of Petroleum Exporting Countries (OPEC) made a pact to keep production high, to try to retain market share and keep out competitors.<\/p>\n

In his book \u201cThe Prize\u201d, Daniel Yergin quotes an American academic writing as far back as 1926 about the \u201cspectacle\u201d of massive overproduction. \u201cAll saw the remedy but would not adopt it. The remedy was, of course, a reduction in the production.\u201d<\/span><\/p>\n

8.\u00a0Comment on\u00a0the effects of OPEC’s actions on the market.<\/strong><\/p>\n

In this case study we have shown how microeconomic concepts of monopoly and monopolistic competition\u00a0can be used to understand current events in the news. Do you have a story you think would make a good case study? Contact economics103@uvic.ca to propose your own case.<\/span><\/p>\n","protected":false},"author":58,"menu_order":6,"comment_status":"closed","ping_status":"closed","template":"","meta":{"pb_show_title":"","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-1720","chapter","type-chapter","status-web-only","hentry"],"part":29,"_links":{"self":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/1720","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/users\/58"}],"replies":[{"embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/comments?post=1720"}],"version-history":[{"count":7,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/1720\/revisions"}],"predecessor-version":[{"id":2163,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/1720\/revisions\/2163"}],"part":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/parts\/29"}],"metadata":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapters\/1720\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/media?parent=1720"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/pressbooks\/v2\/chapter-type?post=1720"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/contributor?post=1720"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/pressbooks.bccampus.ca\/uvicecon103\/wp-json\/wp\/v2\/license?post=1720"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}