Lower Gas Prices: Thank Saudi Arabia?

If you own and regularly drive a car then you’ve undoubtedly noticed your wallet has a little extra money in it these days. You’ve also probably made the connection between that extra spending money and the low price of gas, which since June 2014 has steadily decreased as the world price for a barrel of oil has fallen more than 70%. I have been driving for four years now which makes me old enough to remember what it felt like trying to fill up for $4 a gallon. Being that that was the price of gas when I first got behind the wheel I inevitably feel as if I am saving money every time I roll up to Arco and grab the pump and I am certainly not the only one who’s excited. The past few months practically everyone I know – friends, professors, coaches, coworkers, and basically any person who I bump into around Tacoma – has at some point expressed their joy over the falling price of oil, and the extra local Northwest coffee that affords them. And though I must admit there are few things as satisfying as sharing my delight for $2 a gallon prices with someone else while both of us sip on our 10th latte of the week accompanied by an ever more affordable MSM sandwich, I cannot help but feel a little concerned about the fact those with whom I share my joy seldom know the reasons underlying the tumbling prices. So for the sake of sounding smart the next time you find yourself discussing global events with your Starbucks barista let me quickly explain.

At this point you’ve probably heard of the Organization of the Petroleum Exporting Countries, or OPEC, and you also probably know that they have an enormous influence over the world market for petroleum, i.e. gasoline. What you may not know is that OPEC is a group of 13 countries, the most notable of which is Saudi Arabia, which together account for 40% of the world’s oil production. Because the 13 countries in OPEC have a large influence over the global market for oil, OPEC is considered a cartel, which in economic terms is a group made up of a small number of producers with a large share of the market. Cartels are created because prominent producers in a market realize that if they cooperate they stand to make more money than if they were to compete, so they form agreements to collectively manipulate the supply of the market in order to make higher profits. In the case of OPEC, this manipulation takes the form of a collective agreement to limit the amount of oil each country supplies, which in turn leads to higher prices and greater profits for each individual country. The agreement may strike you as surprisingly simple: each country in OPEC produces and sells a little less oil so that all the countries in OPEC can sell it for a much higher price. In fact, it just about is that simple. Sell a little less for a lot more and earn more money! Admittedly, there is just a tiny bit more that goes into this story, not to mention the other 60% of the market which includes countries like the U.S. and Canada, but at a fundamental level, this really is the whole story.

So how does OPEC have anything to do with the fact you’re reading this in a coffee shop instead of in the library? Well, since 1960 when the cartel was founded, the countries have cooperated surprisingly well, each holding their respective ends of the bargain and producing a little less. OPEC had hummed along so successfully for so long, it had basically become a given that the world’s most influential cartel would forever drive up the price of oil. But something surprising happened in late 2014.

Amidst an increase in oil production in several countries around the world including the United States, Canada and Russia and a decrease in the world demand for oil, prices for oil began to drop and drop quickly. In three months they fell from around $115 a barrel to $80, and by November of that year when OPEC countries met in Vienna for one of their annual meetings, several of them had already made up their mind that they would not stand idly by and watch their profits slowly disappear. Despite pleading from the likes of Venezuela and Iran to cut back on oil supply, Saudi Arabia, (remember the most important member) stood its ground and proclaimed it would increase its oil supply in order to not lose its share of the market to competitors outside OPEC. And so just like that, a 50 year agreement and all the good-natured cooperation it stood for went flying out the door as fast as you can spell $30 a barrell. The Saudi’s proclamation meant it was every country for itself as failing to increase production would now mean a decrease in customers rather than an increase in prices. And so since that fateful day in November 2014, the price of oil has continued to drop. Past $80 and past $70, lower than $60 and $50, and yes even plummeting below $40. In fact, as listed on OPEC’s website, the world price for a barrel of oil last Friday was $31. And the price at your local gas station is a cool $2 a gallon.

Again, the story is not quite so simple, there are of course other factors contributing to the fall in prices such as diminishing global conflict and the slowing of Chinese industrialization, not to mention the intricate interplay of the aggregate global supply and demand for something as complicated as oil production and consumption. But, fundamentally, that is, at its core, the OPEC story is the whole story, and it continues to be as long as OPEC members act like rivals (which in reality they always have been) rather than teammates. So next time you step out of your car and take a whiff of gasoline fume-filled air, be thankful even 50 year old marriages can end in divorce.

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