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OPEC’s Response to Alberta Oilsands Market Share – Part 3

This is part three of a three part series exploring the impact Alberta oilsands projects can have on world market price as dictated by OPEC. Click here for Part 1 and part 2.

OPEC’s Response to an Expanding Oilsands Market Share

If the parameters stated above hold true, what particular market reactions could one expect from OPEC? If Alberta displaces the exports of Venezuela and Saudi Arabia, this will account for just over 4% of total OPEC production. Therefore the new question is: will OPEC attempt to recover their lost market share? Or is it possible that emerging markets elsewhere such as India or China will substitute for the lost market. It is impossible to speculate what future market trends will be, whether developing markets will in fact meet expectations when it comes to crude oil demand. One thing, however, is certain: OPEC will attempt to recover any losses if the US market was the most profitable market for them, and if it was the most accessible. Venezuela may be concerned with their diminished share; 2002 US exports accounted for about 37% of total national production. This number reaches almost 50% with the increase in future US demand, however, diminishes to about 42% once the oilsands ‘steals’ their share. Finding alternate markets with ease may be difficult for Venezuela in comparison with Saudi Arabia due to geographic location. Despite ideas OPEC may be willing to forego production in 2012 for future production, the loss of the Venezuelan market share may be enough to elicit a response from OPEC.

Any firm, or in this case cartel, rarely relinquishes established market shares without concern. What type of actions might OPEC take in attempt to recapture market share? As previously noted, the production cost of oilsands is much higher than conventional production with many OPEC members, namely those in the Middle East. It may be appealing for OPEC to flood the world with too much supply thereby reducing market prices, assuming the market responds the increase supply.

If the market price were to decline to a point that expansion for oilsands ventures were no longer profitable, one would see oilsands development grind to halt. Not only would development slow with lower market prices, yet output would slow as well. Producers will only produce until their MC=MR. If expected MR declines due to a lower market price, production quotas will be adjusted to reflect the new break-even point. This will reduce the amount of supply the oilsands producers will export to the world market. (I will also assume that there are adequate world reserves to justify erroneously increasing supply simply to crowd out competitors.) The lost export supply from oilsands would be compensated by the new supply provided by OPEC. This now suggest that excess supply on the world market would be consumed by those, in our case the United States, who were once relying on the once cost effective oilsands supply. The market would adjust, substituting competitive supply with uncompetitive; downward pressure on the price would cease as the market returns to equilibrium. Although market price for crude will diminish, supply provided by OPEC will increase. If the increase in production accounts for the lost revenue from the reduction in price, then OPEC will support and favour the move. This is one method OPEC may attempt in order to recapture lost market share.

Another argument assumes world reserves do not deplete substantial within the next 10 years, thus the oilsand producers are still price takers in the market and OPEC exhibits some degree of control over market prices. One of the assumptions for the US import model was the continual increase in OPEC production. In retrospect this is not true. OPEC has experienced downward trends with respect to its supply numerous times. The period of 1973-1980, OPEC production fluctuated up and down from previous years 4 times, it was not a steady increase. Simply reducing output to recapture market share may not be viable economically or preferentially. The opportunity cost of producing today or withholding until tomorrow can play a role, as well, particular price paths of either monopolist or price taker will influence ones abilities and desires to fluctuate their output. The Hotelling model considered a monopolistic price path identical to the competitive market; with constant elasticity at every point. Unfortunately according to leading world oil economist Griffin and Teece, this assumption neglects two items:

“…demand for oil is not a static function with constant elasticity. It is an empirical fact that the long run demand schedule is much more price elastics than its short run counterpart…. [Secondly]Hotelling’s model assumes a fixed and homogenous stock of oil reserves available at zero cost.”

Opportunity or user cost is largely dependant on the firm or cartel’s future speculations of the discount rate, future reserves, long run price elasticity of oil demand, and rate of economic growth. These items may differ between firm types. As a result Griffin and Teece argue for a varying short run price elasticity of oil demand between the competitive price path and monopoly. Figure 2 below depicts what this relationship may look like: blue depicts competitive price path, red monopolistic price path.

Depending on where the monopoly lies on this price path may influence their willingness to immediately increase output to reduce prices and push out oilsands producers. OPEC may be exploiting the current market conditions by reaping the benefits of a higher price. They may wish to wait until their price path equals the competitive price before making attempts to reduce world price through increased output. However, this assumes OPEC can even pinpoint the intersection point. As stated, user costs are speculative; price errors of the past will dictate the production of the future but price of today. Price of the future period can decline if OPEC revises their expectations of future output in hopes it will reduce price and damage oilsand market share. If the market responds, they will be successful in reducing market price and overall oilsands output.

Conclusion: Alberta Oilsands – A World Market Player or Spectator?

The simple framework created in this paper analysed the potential impact an expanding oilsands market could have on the world market for crude oil. It was necessary to exclude exogenous and endogenous market shocks from the model in order to create a simple analysis. The problem with excluding variables from the model is the inability to reflect the true nature of the oil market itself-it is unpredictable at best. Devastating market shocks, only explained after they have occurred, routinely plague the industry. Specifically with OPEC, their behaviours will be influence by abilities of securing alternate markets, and their perceptions of future variables. Nonetheless, some certainties were discovered. The impact on the world market is entirely dependent on a market price, one that will support the higher cost of production, and the volume of output producers can achieve through expansion. Problems in the model include the obvious export value. Oilsands producers will not export their entire production to the world market, domestic consumption will be satisfied first, and then the world. There will be an increasing residual supply, and when applied in conjunction with the accessible United States market, will ultimately increase the export quantity. However, it appears that current expansion, technology, and production do not have the combined capacity to disrupt the world market to any damaging degree. It will undoubtedly occur, Alberta increasing their market share of crude oil exports to the United States, yet the magnitude is not as large as the stature of the oilsands reserves. However, how the future oil market is constructed and functions is unknown. Looking abroad over the long run, 10-20 years, the world market suppliers will emerge relatively unscathed from increasing oilsands output. Closer to home, so long as market prices remain high and output ratio to reserve volume remains relatively low, Alberta will continue to reap the benefits of a lucrative energy sector that will remain viable for many years to come.

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