Second oil shock (79) led to see oil business as one of the most lucrative businesses out there.
Geology students hired for $50,000 after school.
Real estates in oil producing states skyrocketed.
Shale Oil Development pursued by different companies in the United States
However, after two years, price and demand of oil dropped.
Exon decided to abandon the Colony Project (Shale Oil Development) in 1982 as a result.
The oil boom that was promised by oil US companies died fast.
How Oil Prices Dropped
- Federal Reserve applied restrictive monetary policy that increased interest rates to 21.5%
- Many other countries outside OPEC begun producing more oil like Alaska, Mexico and North Sea. Also, Egypt, Malaysia, Angola, China begun producing oil.
- Technology improved and the flow of new producing countries increased (i.e. Alaska). US oil production increased in the first half of 1980.
- Many governments that were heavy oil consumers turned to various policy programs to avoid oil-dependence. Conserve energy, nuclear energy, coal came back, liquid gas…
- 1975 legislation that mandated doubling the fuel efficiency in vehicles. US became 25% more energy efficient and Japan 31% by 1983. So, Demand dropped and output from OPEC increased.
- US hit recession in 1980 and 1982.
In 1982, non-OPEC overtook OPEC production. Russia dominated with its production and The Spot market was the place where countries competed to get best prices. Prices in Spot Market this time were $8 cheaper than in the contract deals between states.
OPEC was in trouble and was faced with two options to weather the storm. Either cut Price or reduce Production
Cut Price Option
- They didn’t want to reduce prices because many countries depended on oil income and lose economic and political structure at home.
- Also, they would not reduce prices because they feared industrial countries would profit from higher taxes and excise in their market.
Cut Production Option
- (Production) OPEC decided to reduce production. From 31 million barrels a day in 1979, cut its production in 18 million barrels a day in March 1982. They were trying to manage production to try to preserve Price.
Various Circumstances that occurred in 1982:
a) Iran was gaining the upper hand against Iraqis, b) Israel intervened in Lebanon c) and King Khalid in S. Arabia died in June 1982.
Þ The fear that Yamani was projecting, not to run after high prices because it might backfire, came true when he stated in 1982, “our price is too high in relation to the world market.”
Þ British North Seal oil cut process even further to $30 a barrel in 1983 and that hurt Nigeria enormously since they over-depended on oil revenues.
Þ OPEC met in London in March 1983 and decided to slash prices from 34 to $29 a barrel.
Þ OPEC also agreed on 17.5 million barrel a day production quota
Þ Saudis, however, refused to set a quota
OIL JUST ANOTHER COMMODITY
Þ Oil begun to be viewed just another commodity since the price dropped and it was not viewed as a major security isue. This happened because:
1. Countries increased the inventories that turned to be a major surplus &
- 2. The market shifted from long-term contracts to Spot market. In 1982 – half of oil was sold in the Spot Market
Eggs to Oil Exchange
Þ 1983 Establishment of NYMEX (NY Mercantile Exchange)
– Gave right buyers to lock in the future prices (buyer lock in purchase price)
– Producers could sell their production forward (seller lock in selling price)
Þ Objective for such market was: a) minimize risk & b) reduce exposure to volatility
Þ Within few years, most of the major oil companies and some of the exporting countries, and large financial houses were participating in crude futures in the NYMEX.
Þ Price Set History before NYMEX
- First, Standard Oil set the price
- Texas Railroad Commission
- Then OPEC
- Now it was open market – NYMEX
The Merging of Oil Companies begin to happen – T. Boone Pickens being a major player.
1984 – Mexico was in huge debts. Couldn’t achieve to meet its interest, forget about the principal. Many banks in the U.S. owned Mexico’s stocks. When Mexico stocks became worthless, one bank Continental Illinois failed and the Federal Reserve walked in to bail them out.