Chapter 36 Energy PricesChapter OutlineYou Are HereReal Oil and Gas Prices 1996 dollars Per gallon (1 barrel=42 gallons)Historical Events Relating to Oil and Gas PricesWorld Oil ReservesOPECWas OPEC a Cartel?The Cartel ModelWhy Oil and Gas Prices Change So FastSlide 11From $1 to $4 in Ten YearsGasoline Prices 1998-2008Gasoline Prices and HurricanesElectricityTypes of MonopoliesMonopoly in the Market for Residential ElectricityAn Unregulated Simple MonopolyAn Unregulated Natural MonopolyAn Regulated Simple MonopolyAn Regulated Natural MonopolyThe California ExperienceChapter 36Energy PricesCopyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin36-2Chapter Outline•HISTORICAL VIEW•OPEC•WHY PRICES CHANGE SO FAST•WHAT WILL THE FUTURE HOLD•ELECTRIC UTILITIES36-3You Are Here36-4Real Oil and Gas Prices1996 dollars Per gallon (1 barrel=42 gallons)36-5Historical Events Relating to Oil and Gas Prices•1972 Arab-Israeli War–US support for Israel prompted an embargo by Arab oil producers against the US and Europe. This led to a significant increase in crude oil prices.•1979 Iranian Revolution–Iran’s Islamic revolution led to instability in the Persian Gulf. This led to a significant increase in crude oil prices.•1980’s–Rapid increases in profits led to significant discoveries of oil in Mexico and the North Sea•1980-1988 Iran-Iraq War–The war led to increased production by both parties as each needed to fund their war effort. This caused a precipitous fall in crude oil prices.36-6World Oil ReservesGroup Billions of Barrels in ReservePercentage of World ReservesPersian Gulf 755 58%Non-Persian Gulf OPEC168 13%Rest of the World387 29%36-7OPEC•The Organization of Petroleum Exporting Countries (OPEC) –Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela•OPEC began as a cartel. –A cartel is an organization of individual competitors that join to form as a single monopolist.36-8Was OPEC a Cartel?OPEC production has always been a significant part of the oil market but it has never reached the level of monopoly. The cartel model is still useful because it has been a dominant player.36-9The Cartel ModelOne Country’s OilMCATCPQMRPcartelMR’QcartelPQDS=MCMarket for OilQPCPPCMRQPCQquotaProfitQcheatProfit36-10Why Oil and Gas Prices Change So Fast•Because expected price is a determinant of supply and demand a world event that causes people to expect a price increase will–Increase current demand (as middlemen and consumers try to buy as much as possible) –Decrease current supply (as middlemen and gas stations try to hold onto their current stocks)•This causes an immediate increase in prices.36-11•1990 Iraq Invasion of Kuwait•1992-1998 OPEC massive overproduction•1999 OPEC discipline•2003 US invasion of Iraq•2004-2005 Hurricanes in the Gulf of Mexico•2007 Iran-US tensions; Commodity Speculation•2008 Global Financial CrisisHistorical Events Relating to Oil and Gas Prices36-12From $1 to $4 in Ten Years1) OPEC production cuts; Low stocks of oil; bad weather2) Release of oil from the Strategic Petroleum Reserve; recession3) Political unrest in oil producing Venezuela and Nigeria; War in Iraq4) Hurricanes Damage Platforms in the Gulf of Mexico5) Threatened Conflict b/w U.S. Iran6) Global Commodity Speculation7) Global Financial Crisis36-13Gasoline Prices 1998-200836-14Gasoline Prices and HurricanesA significant portion of refining capacity in the US is in the Gulf of Mexico36-15Electricity•Residential electric power tends to be sold by a regulated monopoly. •It has been a monopoly because of significant barriers to entry.•It has been regulated because prices would be much higher than is socially optimal.36-16Types of Monopolies•Simple Monopoly: a monopoly in which marginal costs of production are rising.•Natural Monopoly: a monopoly in which marginal costs of production are falling.36-17Monopoly in the Market for Residential Electricity•The market for residential electricity is likely to be a natural monopoly for nuclear power because of the very high fixed costs (transmission lines and the power plant and diminishing marginal costs.)•The market may be characterized as a simple monopoly or natural monopoly for coal or gas generated electricity.36-18An Unregulated Simple MonopolyPQMCMonopolyDMRQmonopolyPmonopoly36-19An Unregulated Natural MonopolyPQMCMonopolyDMRQmonopolyPmonopolyATC36-20An Regulated Simple MonopolyPQMCMonopolyDMRQmonopolyPmonopolyPregulatedQregulated36-21An Regulated Natural MonopolyPQMCMonopolyDMRQmonopolyPmonopolyATCPregulatedQregulated36-22The California Experience•California produces electricity with natural gas.•California “deregulated” by–Having its utilities sell their productive capacity to a variety of competitive producing firms–Having them buy electricity from these producers–Letting the market price for wholesale electricity float.–Continuing to fix residential electricity prices.•Natural gas prices increased dramatically•The utilities could not buy the power because they were selling it at regulated prices that were lower that the deregulated prices at which they were buying