TEAM MEMBERS

DEBARATI KUNDU
MEDHA SAHA
POOJA CHAKRABORTY
SATYAKI BOSE
NAME OF THE INSTITUTION
PRESIDENCY COLLEGE,
KOLKATA
THE POLITICAL ECONOMY OF OIL AND ITS
IMPLICATIONS ON INDIA
2
INTRODUCTION:
The major oil produi!" !#$io!% of the &orld are I%l#'i countries mainly comprising of
Middl( E#%$(r! nations such as S#udi Ar#)i#, Ir#* and Ir#!. The main consumers of oil
and natural gas happen to be the U!i$(d S$#$(% and other &(%$(r! ou!$ri(% that do not
have as much of a scope for the production of oil as the I%l#'i countries of the Middl(
E#%$ do and have limited reserves. Hence the i!du%$ri#l ou!$ri(% of the +(%$ have to
depend a large deal on the imports made from these countries. This leads to certain
poli$i#l ,ri$io! between the '#i! oil produi!" and o!%u'i!" !#$io!%.
FIGURE - shows major oil producing countries in red. From FIGURE - it is rather
evident that the main oil reserves of the World are located in Middle astern !sia that is the
"slamic #ountries of Ir#*, S#udi Ar#)i#, Ir#! and Li).#/
FIGURE -
FIGURE 0 shows the flow of crude oil from one country to another. The figure shows the
flow mainly occurs from the countries of the Middl( E#%$ to the U!i$(d S$#$(% o,
A'(ri#/
$
FIGURE 0
Produ(r%
To$#l oil
produ$io!
E1por$(r%
N($ oil
(1por$%
Co!%u'(r%
To$#l oil
o!%u'p$io!
I'por$(r%
N($ oil
i'por$%
Saudi Arabia
-2/30
Saudi Arabia
4/56
U!i$(d
S$#$(%
02/67
U!i$(d
S$#$(%
-0/00
Ru%%i# 7/53 Ru%%i# 5/63 C8i!# 3/03 J#p#! 6/-2
U!i$(d
S$#$(%
4/93 Nor&#. 0/6: J#p#! 6/00 C8i!# 9/::
Iran
:/-0
Iran
0/60 Ru%%i# 9/-2 G(r'#!. 0/:4
M(1io 9/3-
United Arab
Emirates
0/60 G(r'#!. 0/59 Sou$8 Kor(# 0/-6
C8i!# 9/4: Venezuela 0/02 I!di# 0/69 Fr#!( -/47
C#!#d# 9/09 Kuwait 0/-6 C#!#d# 0/00 I!di# -/57
U!i$(d Ar#)
E'ir#$(%
0/7: Nigeria 0/-6 Br#;il 0/-0 I$#l. -/65
Venezuela
0/4- Al"(ri# -/46 Sou$8 Kor(# 0/-0 Sp#i! -/65
Norway 0/37
Mexico
-/54
S#udi
Ar#)i#
0/23 T#i&#! 2/7:
Kuwait 0/53 Li).# -/60 M(1io 0/29 < <
Nigeria 0/::
Iraq
-/:9 Fr#!( -/73 < <
Br#;il 0/-5 A!"ol# -/95
U!i$(d
Ki!"do'
-/40 < <
Iraq
0/2- K#;#=8%$#! -/-- I$#l. -/3- < <
%
TABLE -
OPEC '(')(r% #r( i! italics
&.Table includes all countries with $o$#l oil produ$io! e'ceeding 0 'illio! )#rr(l% p(r
d#. in 0225/ ("ncludes rud( oil, !#$ur#l "#% li*uid%, o!d(!%#$(, r(,i!(r. "#i!, #!d
o$8(r li*uid%.)
2. "ncludes all countries with !($ (1por$% e'ceeding - 'illio! )#rr(l% p(r d#. in 0225/
$. "ncludes all countries that o!%u'(d more than 0 'illio! )#rr(l% p(r d#. in 0225/
%. "ncludes all countries that i'por$(d more than - 'illio! )#rr(l% p(r d#. in 0225/
*ource+ E!(r". I!,or'#$io! Ad'i!i%$r#$io! >EIA?/
,ur point is further consolidated when we consider the &2 major oil producing nations of
the world as shown in T!-. &."t is evident that the reserve life of the middle east !sian
nations are the most with the e'ception of C#!#d# which has the highest reserve life the
reserve lives of middle east !sian countries such as Ku&#i$, $8( U!i$(d Ar#) E'ir#$(%
>UAE? and Ir#! are ran/ed 0
!d
, 9
rd
#!d :
$8
respectively. ,n the contrary the U!i$(d S$#$(%
o, A'(ri# has a reserve life of only && years and is ran/ed a lowly --
$8.
ven in terms of
total production 0 out of the top 1 countries are from the Middle ast with S#udi Ar#)i#
having the highest amount of reserves. Here too the U!i$(d S$#$(% o, A'(ri# the highest
consumer of oil and natural gas remains a lowly --
$8
with almost &2&% parts of the total oil
reserves of S#udi Ar#)i#. The U!i$(d S$#$(% oil production is however 9
rd
in the world
after Ru%%i# and S#udi Ar#)i# with a production 345,555 cubic meters per day. However
the U!i$(d S$#$(% consumes 605,555 cubic meters per day. Hence the U!i$(d S$#$(% has to
import at least &35,555 cubic meters per day, which is greater than the production of most
countries. Hence it is evident that the U!i$(d S$#$(% o, A'(ri# is dependent on the
"slamic nations of the Middle ast for a part of the supply of its oil and petroleum.
,ver time it has been evident that there has been a lac/ of warmth amongst the various
C8ri%$i#! and I%l#'i countries. Most I%l#'i countries and C8ri%$i#! #ountries have
waged warfare in the name of religion however there have been 7uite notable economic
reasons for these wars. We can cite the e'amples of the Ir#* +#r, which started in 0229
and saw the invasion of Ir#* by a coalition, which mainly comprised of troops from the
U!i$(d S$#$(% o, A'(ri# and Gr(#$ Bri$#i!. The main cause for the war was cited to the
facts that Ir#* was in possession of Weapons of Mass 8estruction (WM8) and terrorist
operations of the Al9@#(d#. However the economic aspect of gaining partial control of the
oil reserves and the oil fields of Ir#* was definitely a reason although :resident -ush did
not include it as a rationale for war in the joint resolution of the ;nited *tates #ongress
/nown as the <Ir#* R(%olu$io!=. This is however a recent e'ample of friction between
I%l#'i countries and C8ri%$i#! majority countries. The turmoil between Mu%li'% and
C8ri%$i#!% can be dated bac/ to the Hol. Cru%#d(%. The Hol. Cru%#d(% were a series of
wars between C8ri%$i#! Europ( and Mu%li'% dating from the &&
th
to the &$
th
century. The
religious aspects of the #rusades was evident to the fact that the C8ri%$i#!% went to war
with crosses on their shields and flags and the Mu%li'% chanted <All#8 8u A=)#r= or
<God i% Gr(#$= before going to war. However inspite of the political colour one cannot
ignore the economic aspect of the Cru%#d(%. Trade was opened up to Europ( and it had
access to goods such as spices, ivory, jade, diamonds, improved glass9manufacturing
techni7ues, early forms of gun powder, oranges, apples, and other !sian crops, and many
0
other products. Hence inspite of having a political aspect the Cru%#d(% had a grave
economic significance.
PRICE MECHANISM OF OIL:
#?OIL PRICES:
"n today>s comple' global mar/ets, the price of crude oil is set by movements on the three
major international petroleum e'changes. They are the ?ew @or/ Mercantile 'change
(?@MA), the "nternational :etroleum 'change in .ondon (":) and the *ingapore
"nternational Monetary 'change (*"MA). ,ne of the most common misconceptions
about ,:# is that the ,rganiBation is responsible for setting crude oil prices from the
early &635s to the mid9&645sC this is no longer the case. "t is true that ,:#>s Member
#ountries do voluntary restrain their crude oil production in order to stabiliBe the oil mar/et
and avoid harmful and unnecessary price fluctuations, but this is not the same thing as
setting prices.
#rude oil is the world>s most actively traded commodity, and the ?@MA 8ivision light,
sweet crude oil futures contract is the world>s most li7uid forum for crude oil trading, as
well as the world>s largest9volume futures contract trading on a physical commodity.
-ecause of its e'cellent li7uidity and price transparency, the contract is used as a principal
international pricing benchmar/. !dditional ris/ management and trading opportunities are
offered through options on the futures contractC calendar spread optionsC crac/ spread
options on the pricing differential of heating oil futures and crude oil futures and gasoline
futures and crude oil futuresC and average price options.
1

This graph illustrates the wide regional variation of prices of various energy products.
However, this is not due to differences in crude prices, but to widely varying levels of
ta'ation in the major consuming nations. The blue portion of the bar shows how much of
the end prices go to oil producers, the yellow is what goes to the refineries, and the red
indicated to the amount attributable to government ta'es. Ta' level can range from
relatively low in ;*! to very high in many uropean countries. "n the ;D, for e'ample,
the government receives substantially more from ta'ation than what ,:# gets from the
sale of its oil.
)?SUPPLY MANIPULATIONS:
Whenever there is an imbalance between demand and supply there are usually two ways to
sort out this imbalanceE>-? To let pri( ta/e care of the i')#l#!( and >0? I'po%(
r(%$r#i!$% on %uppl. or d('#!d. "f there is not enough supply, the consuming countries
3
can restrain demand by imposing price controls, and if there is not enough demand,
producers can cut production. The latter is what the oil producers did over the last one year.
"n the earlier part of its history, the oil industry was mar/ed by more than one attempt to
manage supply, but none have met with much success, mainly because they stuc/ for too
long to a crude price that failed to bring a long9term e7uilibrium between supply and
demand. ,ne was the supply management system administered by the oil majors during the
first &2 years of OPECA% e'istence (-752930), when prices were deliberately /ept under B0
per barrel. This in fact was responsible for the first oil shoc/ of -739 as demand soared and
supply did not /eep up, though the Ar#) "oC(r!'(!$% also added a political hue to their
(successful) attempt to wrest control of their oil industries from the majors. The second was
the supply management system administered mostly by S#udi Ar#)i# in OPEC during
-740946. The /ingdom single9handedly maintained an official selling price of B04 per
barrel despite shrin/ing demand and the emergence of new sources of supplies worldwide.
This inevitably led to the price of oil crashing in -746<45.The problems with identifying a
price that would suit everyone is that nobody /nows what that magical figure is. *ome have
suggested that it should be just a fraction over what the low9cost producers produce at, i.e.,
around B9 per barrel. -ut that removes a large number of high9cost producers from the
scene, leaving the low9cost producers to supply the vast majority of the worldFs consumers
and advance their depletion. Therefore, the world needs some of high9cost production and
it is this figure, albeit a higher one, which will tend to set the world price. There have been
some suggestions that the current e7uilibrium price should be somewhere between B--<-4
per barrel. -ut though it is necessary to resort to some sort of supply management, it is the
mar/et that should play the major role in arbitrating between supply and demand, as was
happening before the price collapse in -773.
GARNERING REDENUE THROUGH IMPORT DUTY ON OIL
Most governments impose a high import duty on oil in order to garner more revenue. "n the
figure shown below it is evident that most G3 countries impose a pretty high import duty
on oil. However the duty varies from country to country, the ;nited *tates of !merica
imposes only a 2&H duty on oil import whereas the ;nited Dingdom imposes an e'orbitant
1&H on oil imports.(REFER TO TECHNICAL APPENDIE MODEL 9?
4
THE ORGANIFATION OF THE PETROLEUM EEPORTING COUNTRIES
The Or"#!i;#$io! o, $8( P($rol(u' E1por$i!" Cou!$ri(% (OPEC) is a group of twelve
states made up of "ran, "ra7, Duwait, Iatar, *audi !rabia, the ;nited !rab mirates, .ibya,
!lgeria, ?igeria, !ngola, JeneBuela and cuador. Kecently, "ndonesia has decided to leave
the organiBation, a move, which will be completed by the end of 2554. The organiBation
has maintained its head7uarters in Jienna since &610, and hosts regular meetings among
the oil ministers of its member states.
JeneBuela was the first country to move towards the establishment of ,:# by
approaching "ran, "ra7, Duwait and *audi !rabia in &6%6, suggesting that they e'change
views and e'plore avenues for regular and closer communications between them. "n
*eptember &615, at the initiative of the JeneBuelan nergy and Mines minister Luan :ablo
:MreB !lfonBo and the *audi !rabian nergy and Mines minister !bdullah al9Tari/i, the
governments of "ra7, "ran, Duwait, *audi !rabia and JeneBuela met in -aghdad to discuss
ways to increase the price of the crude oil produced by their respective countries. ,:#
was founded in -aghdad, triggered by a &615 law instituted by !merican :resident 8wight
isenhower that forced 7uotas on JeneBuelan and :ersian Gulf oil imports in favor of the
#anadian and Me'ican oil industries. isenhower cited national security, land access to
energy supplies, at times of war. When this led to falling prices for oil in these regions,
JeneBuelaFs president Komulo -etancourt reacted see/ing an alliance with oil producing
!rab nations as a preemptive strategy to protect the continuous autonomy and profitability
of JeneBuelaFs natural resource+ oil. !s a result, ,:# was founded to unify and coordinate
membersF petroleum policies.
6
OIL EEPORTS OF THE OPEC AND THE SUBSE@UENT OIL SHOCKS
.arge scale oil shoc/s were e'perienced in the &635Ns during &63$93% and &636945 and
another oil shoc/ of a smaller scale too/ place during the Duwait war in &665. From
F"G;K 2 it is clear that during the large scale oil shoc/s of the &635Ns there are large
differences between the real net oil e'port revenue of the ,:# and the nominal net oil
e'port revenue of the ,:#.
FIGURE 0
The $ major oil shoc/s have been encircled in the above figure. The large scale oil shoc/s
of &63$93% and &636945 have been encircled in orange and blac/ respectively and the
comparatively smaller oil shoc/ of &665 has been encircled in green
From the figure it is evident that there were large differences in the real oil e'port revenue
and the nominal oil e'port revenue for the large scale oil shoc/s of the &635Ns.
For the &63$93% oil shoc/+
The Keal oil e'port revenueO P %55 billion. (appro')
The ?ominal oil e'port revenueO P&20 billion. (appro')
Hence the 8ifferenceO P %55 9&20 O P 230 billion. (appro')
*imilarly for the &636945 oil shoc/+
The Keal oil e'port revenue was O P 032 billion. (appro')
The ?ominal oil e'port revenue was O P 245 billion. (appro')
Hence the 8ifferenceOP 032 E 245 O P 262 billion (appro')
For the oil shoc/ of &665 however the difference was less profound
&5
The Keal oil e'port revenue was O P 255 billion (appro')
The ?ominal oil e'port revenue was O P &05 billion (appro')
Hence the 8ifferenceO P 255 E &05 O P 05 billion (appro').
Hence during the oil shoc/s there was a star/ difference between the real and nominal
e'port revenues of oil. The differences were greater during larger scale oils hoc/s of the
&635Ns and smaller during the small scale oil shoc/ of &665.

@UOTAS OF DIFFERENT MEMBERS OF THE OPEC AS ON 3G-G0226
OPEC *uo$#% #!d produ$io! i! )#rr(l% p(r d#.
Cou!$r. @uo$# Produ$io! C#p#i$.
-?Al"(ri# 47: -,952 -,:92
0?A!"ol# -,722 -,322 -,322
9?Eu#dor 602 622 622
:?Ir#! :--2 9322 9362
6?Ir#* u!#C#il#)l( -,:4- u!#C#il#)l(
5?Ku&#i$ 0,0:3 0,622 0,522
3?Li).# -,622 -,562 -,322
4?Ni"(ri# 0,925 0,062 0,062
7?@#$#r 305 4-2 462
-2?S#udi Ar#)i# -2,277 4,422 -2,622
--?U!i$(d Ar#)
E'ir#$(%
0,::: 0,622 0,522
-0?D(!(;u(l# 9,00: 0,:22 0,622
TOTAL 9-,:00 92,:6- 90,092
TABLE 9
From T!-. $ it is evident that *audi !rabia is by far the most powerful nation amongst
the ,:# countries and has a 7uota of almost one third of the total 7uota of oil of the
,:#. *audi !rabia also produces the highest amount of oil amongst the ,:# countries
and its capacity is also the highest almost one third of the entire capacity of the ,:#.
CARTEL MODEL AND THE ANALYSIS OF THE OPEC CARTEL
:roducers in a cartel e'plicitly agree to co9operate in setting prices and output levels. ?ot
all producers in an industry need to join the cartel and a cartel is formed by only a subset of
the total producers. However if a sufficient number of producers adhere to the cartelNs
agreement, and if the mar/et demand is sufficiently inelastic, the cartel may well drive the
prices well above the competitive levels. !n e'ample of such a case is the ,:# cartel of
the major oil producing countries.
CONDITIONS FOR CARTEL SUCCESS AND THE PRISONERS DILEMMA
There are two conditions for cartel success.
&&
First, a stable cartel organiBation must be formed whose members agree on price and
production levels and then adhere to that agreement. ;nli/e our prisoners in the prisoners>
dilemma, cartel members can tal/ to each other to formaliBe an agreement. This however
does not imply that agreeing is easy as different members can have different price setting
objectives. Furthermore every member will be tempted to adopt various ways and means
i.e. by trying to <cheat= by lowering its price thereby capturing a larger mar/et share.
However if the profits from carteliBation are large enough, the threat of returning to
competitive prices is sufficient to deter cheating of this sort.
The second condition is the potential for monopoly power. ven if a cartel can solve its
organiBational problems, there will be little room to raise prices if it faces a highly elastic
demand curve. :otential monopoly power may be the most important condition for successC
if the potential gains from cooperation are large, cartel members will have more incentive
to solve their organiBational problems.
THE PRISONERS DILEMMA AND THE INSTABILITY OF THE CARTEL
! classic e'ample for the instability of the cartel is the <:risoners 8ilemma=+ suppose 2
prisoners suspected for committing a crime together are 7uestioned by the police in 2
separate cells such that there is no scope for communications between them. The police
ma/e an agreement such that if one of the criminals accepts committing the crime and the
other criminal pleads innocence then the criminal who accepts the crime will get a sentence
of & year whilst the other criminal will get a sentence of &5 years. "f both the criminals
agree to have committed the crime then both the criminals will get a sentence of 0 years
each. However if both the criminals plead their innocence then both the criminals will be
let off with a sentence of 2 years each. "t is evident that since both the prisoners cannot co9
operate they will both accept their part in the crime and accept the sentence of 0 years each,
although the :areto ,ptimal case would be for both the prisoners to accept their innocence
and get a sentence of 2 years each.
We can use a one shot game to cement our point. #onsider the
following pay off matri'.

#,?F** 8,?>T #,?F**
#,?F**

8,?>T #,?F**

We analyse the payoff matri' and see that the
?ash 7uilibrium is (90, 90) which is not the :areto optimal situation. The :areto optimal is
an instable e7uilibrium and hence is not achieved similarly the #artel is also unstable and
the only way to nullify the uncertainty of the #artel is by ma/ing void the main assumption
of the prisoners dilemma that is that there is no scope for communication between the 2
players.
90, 90 9&, 9&5
9&5, 9& 92, 92
&2
ANALYSING THE OPEC CARTEL
Total demand T8 is the total world demand curve for crude oil, and *c is the competitive
(non9,:#) supply curve. The demand for ,:# oil 8,:# is the difference between total
demand and competitive supply, and MK,:# is the corresponding marginal revenue and
marginal cost are e7ual at 7uantity I,:#, which is the 7uantity that ,:# will produce. We
see from ,:#>s demand curve that the price will be :
Q
, at which competitive supply is Ic.
*uppose petroleum9e'porting countries had not formed a cartel but had instead produced
competitively, price would then have e7ualled marginal cost. We can therefore determine
the competitive price from the point where ,:#>s demand curve intersects its marginal
cost curve. That price, labelled :c, is much lower than the cartel price :
Q
. -ecause both total
demand and non9,:# supply are inelastic, the demand for ,:#>s oil is also fairly
inelastic. Thus the cartel has substantial monopoly power. "n the &635s it used that power to
drive prices well above competitive levels.
"n the above figure the total demand and non9,:# supply curves apply to a short or
intermediate9run analysis. "n the long run, both demand and supply will be much more
elastic which means the ,:#>s demand curve also will be much more elastic. "t is thus
e'pected in the long run ,:# would be unable to maintain a price that is so much above
the competitive level. "ndeed, during &6429&646, oil prices fell in real terms largely because
of the long run adjustment of demand and non9,:# supply.
A '#$8('#$i#l r(pr(%(!$#$io! o, $8( #r$(l 'od(l, &8i8 #i'% #$ Hoi!$ pro,i$
'#1i'i;#$io!:
This is a mathematical representation of the cartelisation of 2 profit ma'imising firms
We assume that the mar/et has a linear demand curve.
Where,

O The joint level of profit.

& O The level of profit for firm &.

2 O The level of profit for firm 2

&$
: O The jointly agreed upon price.
A O Total amount of the product produced
A& O !mount of the product produced by firm &.
A2 O !mount of the product produced by firm 2.
c O Marginal cost of firm &.
d O Marginal cost of firm 2.
Ma'imise 2 & + =
Given
:O a E bA where a, bR5
#&O cQA&
#2OdQA2 c, dR5
We have,

&O K& 9 #&

2O K2 E #2

where,
K&O Total Kevenue for firm &
K2O Total Kevenue for firm 2
Hence,

=
K& S K2 E (#& S #2)
O : (A& S A2) E (cQA& S dQA2)
O Ta E b (A& S A2)U(A& S A2) E cQA& E dQA2 VV..(&)
8ifferentiating (&) with respect to A& and A2 we get,
X 2
&O a E 2bQA& E bQA2 E c O 5 VV.(2)
X 2
2O a E 2bQA2 E bQ A& E dO5 VV..($)
*olving e7uations (2) W ($) we get,

A&O(a92c9d)2$b.
A2O(aScS2d)2$b.
Hence,

:O a9b (A& S A2)
O a9b T(2a9cSd)21bU
O (%a9cSd)21

&O ( %a
2
S&%c
2
9d
2
9&0acS0cd9$ad )2&4b

2O (%a
2
9c
2
9&5d
2
9acS$ad93cd)2&4b

=
(4a
2
S&$c
2
9&&d
2
9&2ac92cd)2&4b
PRICE RISE OF OIL IN THE -732IS BY THE OPEC AND ITIS POLITICAL
SIGNIFICANCE
&%
The ,:# nations decided to use the <oil weapon= that is they said that they would stop
e'porting oil to the nations(the ;nited *tates, its !llies in Western urope and Lapan) who
were supporting "srael in its conflict with *yria, gypt and "ra7. The ,:# decided to use
their monopoly power of the oil mar/et to raise the prices of oil after the failure at
negotiations with the <the *even *isters= comprising of sso, the Koyal 8utch *hell
amongst other oil companies. 8ue to the dependence of the industrialiBed world on crude
oil and the predominant role of ,:# as a global supplier, these price increases were
dramatically inflationary to the economies of the targeted countries, while at the same time
suppressive of economic activity. The targeted countries responded with a wide variety of
new, and mostly permanent, initiatives to contain their further dependency.
THE OPEC PETRO<DOLLARS AND THE THIRD +ORLD DEBT CRISIS
!s far as accumulation of e'ternal debt was concerned, the performance of the low income
countries in the &635Ns was rather dismal. Foreign borrowing is necessary for economic
development in low income countries or in .ess 8eveloped #ountries. -efore the &635Ns
most of the e'ternal borrowing for the .8#Ns came from international financial institutions
such as the "nternational Monetary Fund("MF) or the World -an/. However the &635Ns and
&645Ns saw the great role of private commercial ban/s in international lending by recycling
,:# <petrodollars= to the developing countries. The developing countries borrowed P
&,24$ billion in &646 as against an e'ternal borrowing of P 14.% billion in &635. Kising
protectionism in industrial countries as well as worldwide recessions caused due to the
soaring oil prices greatly reduced the debt servicing potentiality of many .8#s. The debts
of &3 .atin !merican countries were almost on the verge of default.
The answer to these countries was large uropean or !merican ban/s
which were floating on ,:#>s <petrodollars= and were in search for an international
outlet. Middle ast oil e'port earnings /nown as <petrodollars= deposited in uropean and
!merican ban/s found it>s way to the third world countries. Jery little of the debt service
prospects of these countries was analyBed. The ban/s believed that since most of the debts
were owed by .8# governments and were sovereign debts they would get repaid. !nother
cause for the third world debt crisis was believed to be the second oil shoc/ during &63694&
which had an unprecedented rise in the oil import bills of the developing countries.
There was a <political= conse7uence of the debt crisis. The twin
sisters of the "MF and the World -an/ had to intervene. "n an attempt to remove the debt
the twin sisters heavily influenced by the ;nited *tates advised the countries to go for
macroeconomic stabiliBation programs along with structural adjustments.
T8( Fir%$ Oil Cri%i% o, -739
"t was not till the onset of the Yo' Kippur +#r in -739, and the successful use of oil
as a political weapon that the !rabs fully realiBed the power they wielded through
OPEC. While the outbrea/ of the war caused a drop of around one million barrels of oil
&0
per day (mb2d) in supplies because of the closure of pipelines from "ra7 and *audi
!rabia to the eastern Mediterranean coast to minimiBe loss on account of possible
damage to pipelines, it was "ra7, which first used oil as a political tool. ,n O$o)(r 3,
-739, it nationaliBed two !merican companiesEE11o! and Mo)ilEas well as the Du$8
#,,ili#$( of Bri$i%8 P($rol(u' Co'p#!. to punish HollandFs X,l#"r#!$l. 8o%$il(
#$$i$ud(, #!d i$% %uppor$ ,or $8( Fio!i%$ (!('./X *oon after, the decision to cut
production incrementally by 0 per cent per month was ta/en until I%r#(l withdrew from
occupied Ar#) lands and the rights of the P#l(%$i!i#!% were restored.
-ut in hindsight, it was the eventual hi/e in the price of oil, which caused more damage
to the international mar/et and global economy than the production cuts. ,n O$o)(r
-5, OPEC decided to increase the posted prices of oil by 32 p(r (!$ after negotiations
with international oil companies failed. OPEC announced that the cost of oil to the
producing companies would no longer be a matter for negotiation but would be set by
mar/et prices. ! wee/ later, they announced a further hi/e of -92 p(r (!$.
!ccording to some analysts, the price rise was Xthe !rabsF essay into economic
warfareX, and warned Xunder these conditions rapacious governments would soon find
an e'cuse to impose fresh restrictions on production so as to recreate the state of
artificial shortage which is so profitable to them. #onsumers of oil must accept the fact
that ,:# has now evolved into what is probably the toughest cartel the world has ever
/nown, with the power to restrict supplies and hold the consumer to ransom.X
,ther than the price rise and production cuts, ,!:#"" also imposed a Xselective
embargoX to punish those countries which openly helped "srael, viB., the ;*! and
Holland. When Washington announced P2255 million in emergency military aid to
"srael in ,ctober &63$, .ibya, followed by *audi !rabia, !lgeria, Duwait, Iatar,
-ahrain, 8ubai and !bu 8habi decided to suspend oil e'ports to the ;*. ,man
followed soon after. "t was also decided that the !rab states would ta/e full
administrative control of ;* oil companies operating in their countries and that their
(i.e., the statesF) holdings in these countries should be steadily increased till the ;*
changed its pro9"srael stance. ! few days later, a total oil embargo was imposed on
Holland too because the 8utch government and the oil companies had been supporting
"srael throughout the war.

E,,($ o, $8( Oil Cri%i%
Though there is no disputing the fact that the industrialiBed West was affected by the oil
crisis in that other than having negative fallout on their economies and leaving a lasting
impression on future economic, business and political practice, the oil embargo did not
achieve the goal (either the short or long9term), which the !rabs had hoped for. While
the demands regarding :alestine and "srael remained unfulfilled, the initial success of
raising the oil price and the huge revenues that it created for the producers were soon
offset by the crac/s that appeared in ,:#Fs set up. !nd though the embargo imposed
&1
on the ;* remained in place till March and the ?etherlands till Luly &63%, the !rabs
soon realiBed that they were losing politically and economically, and lifted the embargo.
However, ,:# did manage to earn a formidable reputation. "n fact, the !rabs were
themselves ta/en by surprise at the initial success of their strategy, prompting the then
Duwaiti oil minister, !bullatif !l9Hamad, to say, X@ou donFt realiBe that on the &1th of
,ctober, we got as great a shoc/ as you did. We thought we were pygmies facing giants.
*uddenly we found that the giants were ordinary human beingsX. For from what was
once regarded as nothing more than a loose and toothless trading organiBation, ,:#
now was Xtransformed from just another trade association into an immensely powerful
cartelEarguably the most powerful the world has ever /nown=. However, it was unable
to consolidate its position and use the oil weapon effectively mainly because of the
relentless growth in non9,:# supply which has ironically been encouraged by ,:#
itself than/s to the oil nationaliBations and a pricing policy which justified the economic
development of high cost reserves.
!mongst the industrialiBed countries, Lapan was probably the hardest hit by the oil
crisis. "n &632, Lapan imported some 43 per cent of its oil, 45 per cent of which came
from the Middle ast. *ince Lapan had not done anything to cultivate special relations
with the !rabs, it was not granted any favored treatment, prompting its then Minister of
Trade, @asuhiro ?a/asone to say that a lac/ of oil supplies could X:rovo/e a civil war in
Lapan such as that triggered by rice hoarding in the pastX as X,il is blood to industries in
Lapan.= "n fact, the outgo of foreign e'change for its oil imports saw its reserves come
down from P&6 billion to P&$ billion in one year, and threatened to be washed away
completely in a few months.
However, it was the developing countries, which were the main victims of the oil price
hi/e. "nitially, the developing countries heralded the ,!:# decision as a new dawn in
world politics, and the oil crunch too/ on the colours of a battle between the *outh
versus the ?orth. -ut as the !rab states made it clear that they would under no
circumstances follow a dual pricing policy in favour of these countries, it was the
developing world, which suffered far more than the industrialiBed nations. For while the
huge price hi/e forced them to pay out more for their oil imports, the cut in non9oil
imports resorted to by the industrialiBed countries, most of whom were the developing
worldFs biggest customers, also hurt their economies. !ccording to a World -an/ study,
the increase in the oil import bill for the developing countries in &63% was around
P%,055 million.
When the crisis began, "ndia, li/e many other developing countries, which enjoyed
friendly relations with the !rab states, had hoped that it would be given favourable
treatment. However, ,:# e'pressed its inability to adopt a dual pricing system. "n
&63$ "ndiaFs oil import bill was to the tune of around P%&% million, and it was projected
to go up to around P&,$05 million in &63% because of the price hi/e. This was around %5
per cent of its potential e'port earnings, and twice the amount of its e'isting foreign
e'change reserves. The other *outh !sian oil importing states li/e :a/istan and *ri
.an/a were similarly affected.
&3
!ccording to estimates made at the time, the oil revenues of the Gulf *tatesE*audi
!rabia, Duwait, .ibya, "ran and "ra7Ein &63% 7uadrupled from around P&$ billion in
&632 to around P02 billion. Hence the oil weapon gave the oil producers enormous
access to wealth at the time as well as financial clout.
OIL CRISIS OF -737
The second oil crisis after the oil crisis of &63$93% too/ place in &636.The main cause of
this oil crisis was the "ranian Kevolution. !mid severe protests, the *hah of "ran,
Mohammed KeBa :ahlavi fled the country in early &636, allowing !yotollah Dhomeini to
ta/e control. The protests shattered the "ranian oil sector. While the new regime resumed oil
e'ports, it was inconsistent and at a lower volume, forcing prices to go up. *audi !rabia
and other ,:# nations, under the presidency of 8r. Mana !lotaiba increased production
to offset the decline, and the overall loss in production was about % percent. However a
widespread panic drove oil prices far higher than they were e'pected to rise under normal
circumstances.
"n ?ovember &634, a stri/e of about $3,555 wor/ers at "ran>s nationaliBed oil refineries,
which initially reduced production from 1 billion barrels per day to about &.0 billion barrels
per day. Foreign wor/ers including s/illed oil wor/ers decided to flee the country in the
wa/e of the revolution. ,n Lanuary &1
th
&636, the *hah of "ran, Mohammed KeBa :ahlavi
fled the country along with his wife at the behest of :rime Minister *hapour -ha/tiar who
sought to calm down the situation.
However the oil shoc/ of &636 in "ran benefited the other ,:# countries as they made
record profits.
!fter &645, oil prices began a si'9year decline that culminated with a %1 percent price drop
in &641. This was due to reduced demand and over9production, and caused ,:# to lose
its unity. ,il e'porters such as Me'ico, ?igeria, and JeneBuela e'panded. The ;* and
urope got more oil from :rudhoe -ay and the ?orth *ea.
THE KU+AIT +AR AND THE OIL SHOCK OF -772

Duwait is regarded as 7uite an important oil field, which can be understood by
merely loo/ing at the countries> share in the world production of oil just before it was
occupied by "ra7. !ccording to ,:# (,il :roducing and 'porting #ountries) the level of
production in &646 was 6& million tons of oil. Till the Duwaiti oil remained under "ra7i
control, "ra7 had a yearly production of &$6 millions tons of oil. Thus "ra7 emerged as an
oil giant which held the fourth place on the world list of largest producers. "t was precisely
this perspective9the rise of powerful !rab oil nations9which the -ritish colonial rulers
aimed at pre9empting when they transformed the Duwaiti oil field into a separate state.
&4
Duwait>s geographical compactness and short lines of communication also confers decisive
advantages. !bout four9fifths of the mirates> population lives in Duwait city. Duwait "nc
(incorporated to form into a corporation) with its 60.% billion barrels of proven reserves is
only one aspect of the nation>s incredible wealth. "ts other is finance capital with e'ternal
assets of P&22 billionC a phenomena that ma/es it a frea/ in global capitalism>s history. This
means that Duwait "nc is primarily an offshore operation. Duwait since &6%1 has survived
economically on oil money, and on the investment incomes derived from the mar/eting of
its oil.
The Duwait war was fought on the cheap that was to catapult the ;* into the
position of paramount power in the Gulf and ostensibly /eep it there. The cost was around
P&0 billion less than 0 per cent of the anticipated budget deficitC a fraction of the costs of
financing the ban/rupt savings and loan operations. !ll these marvelous things were being
done without raising ta'es and given its major role of the determinants of global petroleum
pricing policy9access to an uninterrupted flow of cheap gasoline at a mere rate of P&%9&0
per barrel.
This however would have been unfeasible without the compliance of a client
state such as *audi !rabia. The price per barrel rose from P&6 to P%2 at its pea/. :etroleum
prices fell as the war progressed. ;nli/e Duwait, *audi power is oil power. "t lifted
production from 0 billon barrels a day to 6 billons in a few months. "t was Ding Fahd and
its treasure that imported and paid for the aviation fuel used in the round9the9cloc/ blasting
of "ra7. ?ow at the pinnacle of its power *audi !rabia accounts for one9third of ,:#
mar/et share against a 7uarter beforehand and it has no intentions of relin7uishing that
mar/et share.
"n &665, *audi !rabia alone contained $% per cent of all proven world oil reserves, that of
the Gulf *tates jointly was 15 per cent, and when "ra7 and Duwait were included in the
count, the total percentage was 40 per cent. Future discoveries were also primarily e'pected
in the Middle astern area. ,il reserves were e'pected to be discovered in then *oviet
;nion, but the foreign investments needed for tapping *oviet oil was vast. Thus the western
oil companies and states did not want to spoil their holy chances in the Middle ast.
!nother factor, which played an important role in the Gulf War was the
interests of the producers of war weapons and armaments. ver since &63$93%, western
arms9e'porters have profited heavily from the oil dollars. West !sia became the most
crucial region in the third world for the sale of e'pensive weapons> systems.
Western arms> e'porters9 foremost !merican ones were well benefited by the oil crisis. The
interest which they had in the crisis appeared to be straightforward+ a prolonged total war
would suit them the best.

The "ra7i occupation of Duwait had caused a chain reaction, the repetition
of a classical colonial scenario. "n a foregone age uropean powers were induced to wage
cruel wars by their desire to control lucrative raw materials. The Gulf war saw the richest
states of the world seiBe the most profitable raw materials stoc/ed in the southern
hemisphere by military means. The second Gulf War was foremost a war over the
possession of Yblac/ gold>, of oil.
&6

THE PARADOE OF PLENTY: IRA@ AS AN EEAMPLE OF OIL +EALTH
The resource curse or the :arado' of :lenty refers to the parado' that countries with an
abundance of natural resources tend to have less economic growth than countries without
these natural resources. This may happen for many different reasons, including a decline in
the competitiveness of other economic sectors (caused by appreciation of the real e'change
rate as resource revenues enter an economy), volatility of revenues from the natural
resource sector, government mismanagement, or political corruption (provo/ed by the
inflows of easy windfalls from the resource sector).
The oil production in "ra7 averages about 2.% million barrels a day.
Kising output, coupled with the soaring (although now recovering) price of oil should
pump up "ra7>s oil revenue to about P 45 million this year. That, in turn, has allowed the
country>s parliament to boost this year>s budget from P%4 billion to P35 billion in a
supplementary spending bill approved earlier this month. !s security improves, the
government has a lot more cash to spend than it did a year ago.
"ra7 produced $ million barrels per day as recently as ,ctober
255&,despite the crippling ;nited ?ations enforced sanctions at that time. "ra7>s oil
minister, Hussein al9*hahristani, has spo/en of raising output to 1m b2d. "n theory, that is
possible. "ra7>s proven reserves, of &&0 billion barrels, are the world>s third9largest after
*audi !rabia and "ran. @et "ra7 ran/s just &$th in terms of production, suggesting there is
plenty of scope to pump more. Kussia, for e'ample, produced almost &5m b2d last year
from reserves of 45 billion barrels. ,nly 23 of the 45 or so fields that have been discovered
in "ra7 have ever been tapped.
Than/s to almost $ decades of war strife and sanction "ra7 has
remained mostly une'plored. Geologists point to hundreds of promising subterranean
structures where no wells have been sun/. "ndeed, only 2,$559odd wells have ever been
drilled in "ra7, compared to &m in Te'as alone.
-est of all, "ra7>s oil is cheap to e'tract. Most of it lies close to the
surface in relatively porous reservoirs. Tari7 *hafi7, a former e'ecutive at the state9owned
"ra7 ?ational ,il #ompany ("?,#), says that e'panding "ra7>s output from e'isting big
fields should cost P&9$ a barrel, leaving over P&55 per barrel in profit at present prices.
<Geologically,= says *arah Haggas, of "H*, a research firm and consultancy, <"ra7 is
perfect for oil e'ploration.=
:olitics, however, is another matter. "nsurgents have made a habit
of attac/ing the oil infrastructureC the recent rise in output is due chiefly to improved
security. "n particular, the ;nited *tates has paid for a project to reduce sabotage to a
pipeline that lin/s the Dir/u/ oilfield, one of the country>s biggest, to the main outlets for
e'portsZports in the south and a pipeline north to Tur/ey. The Dir/u/9-aiji pipeline is
now protected on either side by a ditch, a dirt barrier, a fence topped with raBor wire, and
three more rolls of raBor wire on the ground. There are two guardhouses at every road
crossingC the government has recruited local tribesmen suspected of mounting many past
attac/s to man them and conduct patrols. ,il has flowed freely since the construction of
these defences began last summer. The !merican army says that, as a result, e'ports in the
&& months to May went up by 6&m barrels, worth an e'tra P4.2 billion.
25
"ra7>s government hopes to improve output by more
conventional measures, too. "t is negotiating contracts with the biggest Western oil firms,
including ''on Mobil, -: and Total, to refurbish five of the country>s biggest oilfields. "t
hopes this will raise output by 055,555 b2d. Though Mr *hahristani said the deals would be
signed <within wee/s= in Lanuary, they have yet to materialiBe. "n any event, it is uncertain
how effective these deals will be. 8avid Dirsch of :F# nergy, a consultancy, argues that
"?,# would not have the capacity to transport all the e'tra oil even if it could be produced.
There is some doubt about whether the contracts would last one or two years, calling the
production target into 7uestion. !nd the oil giants would not station any staff in "ra7, as it is
still too dangerousC they would send only e7uipment and advice.
Meanwhile, critics in "ra7 and abroad have denounced the government for failing to assign
the contracts by public tender. *uspicions abound that the authorities, under !merican
pressure, will be too generous to the oil firms, though no terms have been published, so it is
hard to tell. Four !merican senators have as/ed for an investigation. 8ennis Ducinich, a
congressman, has proposed a law to ban !merican oil firms from see/ing contracts in "ra7.
:erhaps spurred by this fuss, Mr *hahristani said last month that "ra7 would let %0 firms bid
for another round of contracts, which he hopes to award ne't year. 8etails are scant but it
seems these would last for as long as ten yearsC unli/e the short9term ones, they would
re7uire participants to team up with an "ra7i partner.
The government says both types of contract will comply with the present oil law, which
does not allow deals that confer ownership of "ra7i oil on foreigners. "t has resorted to these
arrangements only because a new oil law approved by the cabinet last year has run aground
in parliament. "ts critics say it would give foreign firms too much control over "ra7i fields,
an incendiary claim in a country where the nationaliBation of the oil industry in &63& is still
seen as a moment of triumph. They view the law>s <e'ploration and production contracts=
as thinly veiled production9sharing agreements, whereby firms win the right to a fi'ed
proportion of the output of fields they develop. ,ther critics say the government has
modified it to give too much power to the regions.

However, foreign oil firms are still wary of ma/ing investments in "ra7 due to the present
political turmoil. Huge sums are needed to overhaul the present infrastructure and field
appro'imately &5 billion dollars. !nother large sum of money will be re7uired to e'pand
the level of output.
Than/s to oil, "ra7 is not short of cash. -ut its oil ministry manages to spend only a small
fraction of its investment budget every year. "ra7is complain that the brightest employees
have long since goneC many of the remainder are corrupt and overwor/ed, and the ministry
is driven by political shenanigans. Wor/ers at the *outh ,il #ompany, an "?,# subsidiary
that controls the majority of "ra7>s production, have been protesting against the proposed
oil law. The government, in turn, has reassigned several prominent employees and split the
firm in twoZhardly a top priority for the industry. ;ntil a comprehensive oil bill is signed,
"ra7 will continue to lose huge sums it would otherwise earn from the investment it so
badly needs. Hence there is a PARADOE OF PLENTY in "ra7.
2&
POLITICAL LOBBYING
The major oil conglomerates dominating the oil industry have been
historically /nown to engage in political lobbying ma/ing donations to poltical parties in
order for the government to legislate in their favour. The ;.*. oil industry as a whole has
donated P&45 million to political candidates since &646, ma/ing it the eighth biggest
spender out of 45 industries analyBed. ,ne such e'ample is the oil giant ''onMobil which
ran/s among the top two donors in the oil and gas industry ."n lobbying dollars ''on
outspends its competitors accounting for nearly ten percent of the industry total. #urrently,
''onMobil has donated over P155,555 to political candidates ."n 2555, ''onMobil spent
almost P&.% million on campaign donations 9 second only to the nron #orporation. *ince
2555, ''onMobil has managed to give in e'cess of P% million to political candidates. "n
comparison, politicians received about P&.% million from the entire alternative energy
sector during that same period.
While campaign contributions are not the only factor influencing how a loyal ''on9
bac/ed #ongress will vote, the trend demonstrates that campaign contributions are a /ey
factor in who gets elected and who stays in office. The return ''onMobil gets for the
millions it spends on lobbyists and campaign contributions comes bac/ in the billions. The
industry as a whole receives up to P&&$ billion per year in direct federal subsidies,
according to e'perts. The 2550 nergy -ill is a prime e'ample of how political dollars
translate into legislation. The nergy -ill, in effect until 25&5, authoriBed P% billion in
federal subsidies to the oil and gas industry.
THE IRA@ +AR OF 0229 AND ITIS IMPLICATIONS ON THE PRESENT OIL
MARKET
The "ra7 war,began on March &6, 255$ with the ;nited *tates9led invasion of "ra7 by a
multinational coalition composed of ;nited *tates and ;nited Dingdom troops supported
by smaller contingents from !ustralia, 8enmar/, :oland, and other nations.
22
The invasion led to the 7uic/ defeat of the "ra7i military, the flight
of :resident *addam Hussein, his capture in 8ecember 255$ and his e'ecution in
8ecember 2551. The ;.*.9led coalition occupied "ra7 and attempted to establish a new
democratic government. -ut shortly after the initial invasion, violence against coalition
forces and among various sectarian groups led to asymmetric warfare with the "ra7i
insurgency, with estimates of the number of people /illed ranging from over &05,555

of
more than one million.
-y their nature, crises tend to have a negative impact on mar/ets and economic activity.
The "ra7 War was no different. "n mar/ed contrast to the wea/ oil mar/ets leading up to the
!ugust &665 invasion of Duwait and the subse7uent Lanuary &66& Gulf War, oil mar/ets in
the months prior to the 255$ "ra7 War were generally strong. However the global outloo/
became increasingly gloomy during the course of 255$ due to the rising prospects of a ;.*.
led war in "ra7. ,il prices rose to a range of $59%5 dollars per barrel reflecting a fear of a
major disruption to oil production. Higher oil prices raised production costs and dampened
consumer spending power. #onsumer and business confidence fell in many countries in the
wee/s leading up to the war and during the course of the war to historically low levels.
:rices in the si' months prior to the March &6 start of the war went through three main
phases+
F#lli!" Pri(%JPri(GI!C(!$or. P#r#do1. The period from ,ctober & through mid9
?ovember was one of generally falling prices, with the spot ?@MA price at its lowest
(P20.$1) on ?ovember 3.
Ri%i!" Pri(%J$8( +#r Pr('iu'. The second period was one of rising prices
starting ?ovember && and pea/ing at P$1.61 on February 23, and at P$3.43 on March &2.
This period is reflective of the so called Xwar premiumX that assumes that an increasingly
li/ely military conflict between the ;nited *tates and "ra7 could damage oilfields, pipelines
and e'port terminals in some !rabian Gulf states.
F#lli!" Pri(%J$8( Gul, +#r S.!dro'(. The final period up to the beginning of
hostilities has been one of generally falling prices. -eginning around March &$, 255$ with
the possibility of war with "ra7 just days or even hours away, oil mar/ets rode a wave of
optimism as the anticipation of a 7uic/ war led traders to go <short= e'pecting prices to
fall following the onset of the war.
The chart below shows the sudden drastic drop in oil production in
"ra7 during the war. From a phenomenal 2.0 million barrels per day in 2552 which is
considered by many analysts as the highest ever achieved by the oil producing sector in
"ra7, oil production plummeted to baseline Bero during the war and it has been a sluggish
rise in the post war period.
2$

The recovery of "ra7i production remains one of the
greatest uncertainties currently affecting the oil mar/et. "ra7>s reserves are the third largest
in the world after *audi !rabia and Kussia. :roduction potential is enormous. "ra7 has
proven reserves of 34 billion barrels and an estimated &54 billion barrels of probable
reserves. ,f 3$ discovered fields, only &0 have been developed.
The "ra7 war led to several repercussions globally primary among which were lowering the
rate of global economic growth and increasing the rate of inflation. Moreover during the
war a number of oil fields were set on fire and subse7uent looting damaged surface
installations and led to loss of data which has severely dampened the road to recovery for
the "ra7i oil producing sector leading to further clamping down on the world economy.

The war induced political ris/s in "ra7 are e'pected to persist
for a long time. From the point of view of the rest of the world, the principal channel
through which these political disturbances will be felt is the price of crude oil. "f the supply
of oil is actually or e'pected to be disrupted then oil prices will rise leading to considerable
adverse effects on future developments.
THE CURRENT OIL CRISIS
Than/s to the lessons learned from the &63$ oil crisis, the industrialiBed countries, have,
consciously and systematically, reduced their dependence on oil. Whereas prior to the
crisis, oil demand in the ,#8 countries comprised around two9thirds of total global
demand, today, these same countries now consume less than a third of total world
consumption. This is partly due to the strict conservation policies followed by the
governments of the industrialiBed countries as well as the conscious research and
development of alternative sources of energy, including natural gas and nuclear power,
2%
as well as unconventional sources of energy such as wind, solar and more recently,
development of hydrogen as a source of energy. !t the same time, though oil still
continues to be an important source of energy, especially for transportation, the Western
countries have turned increasingly towards non9,:# sources of supply, such as the
?orth *ea and Me'ico as well as *outh !merica, and more recently are investing huge
amounts to develop the #aspian region as well as offshore !frica as a source of oil as
well as natural gas.
Hence, today, while the ;* continues to be the largest consumer of crude oil, it has
reduced its imports from the !rab Gulf states from around &6 per cent in the early &665s
to less than &3 per cent currently. The same case applies to Lapan, which previously
imported 65 per cent of its oil, 45 per cent of which came from the Middle ast. Today
Lapan only imports less than 00 per cent of oil, though this mainly comes from ,:#
sources.
However, as in the 35s, it is still the developing countries, especially those belonging to
the !sia9:acific region that continues to be vulnerable to oil politics. With their
economies growing at a bris/ pace, notwithstanding the &663964 financial crisis, which
overtoo/ some of the *outh ast !sian economies, demand for energy is burgeoning in
this part of the world. For instance, #hina, which till &66$ was a net oil e'porter, now
has to import around 405,555 b2d, which is e'pected to go up to &.4 mbd by 2550. -y
25&5 #hinaFs net imports of oil (crude and refined products combined) are forecast to
reach 2.4 mbd.
I!di# fares no better. :rojected to become o!( o, $8( %(C(! l#r"(%$ o!%u'(r% o,
(!(r". &i$8i! # d(#d(, "ndiaFs indigenous oil and gas reserves are not e'pected to last
beyond 25&%9&1 at current levels of consumption. #urrently, "ndia produces less than $$
million tonnes of oil compared to demand for around 61 million tonnes, calling for
imports to the tune of around 1% million tonnes. "ndiaFs oil import dependency has gone
up from around $3 per cent in &646965 to around 14 per cent in &66692555, and with no
major accretion to its domestic oil production e'pected, its import dependency is
e'pected to go up to around 65 per cent by 25&5.
Therefore, with all the developing countries of !sia becoming increasingly reliant on
energy imports, and with oil constituting a large portion of those imports, any price hi/e
is bad news, as it would have a bearing on a countryFs fore' reserves. For "ndia
specifically, the oil import bill is projected to go up to around Ks 15,555 crores, against
an earlier e'pected outgo of around Ks 0%,555 crores. This is a huge amount to pay for
any single commodity.
#oncerned about the current increase of around &30 per cent in oil prices and its impact
on the global economy in the long term 9 though the inflationary impact on the ,#8
countries has been relatively low till now, the ;* government has urged the oil
e'porting countries to increase production and bring an end to this artificial increase in
oil prices/ I!di# too has urged these countries to /eep the interest of the global economy
in mind and rationaliBe prices.
20
IMPLICATIONS ON INDIA
Poli$i#l S(!#rio:
With oil prices touching nearly &$5 dollars a barrel the ;nited :rogressive !lliance (;:!)
government of "ndia was in Lune,2554, compelled to raise petrol prices by &&H, diesel
prices by 6H and coo/ing gas prices by &3H, while also eliminating the import ta' on
crude oil and lowering import duties on refined fuels which spar/ed angry protests across
"ndia and was the occasion for much posturing on the part of the political establishment.
!s they rippled through the economy, the fuel price hi/es
further drove up the cost of food and other essentialsZand at a time when the wholesale
inflation rate was already at a four9year high of 4.2% percent and soaring food prices are
depriving ever9wider sections of the population of ade7uate nourishment. More than 35
percent of "ndia>s population of &.& billion lives on some 25 rupees (or less than 05 cents
;*) per day.

*everal state government responded to the central government>s
price increases by reducing the ta'es they charge on gasoline, diesel and natural gas. These
cuts are less than meets the eye, as in most cases the levies are percentages of the retail
price and would therefore have increased automatically with the central government9
ordered price increases.
-ig business has long been demanding that the government reduce
the subsidies it pays for imported energy. The state9owned or partially9state owned "ndian
,il, -harat :etroleum, and Hindustan :etroleum joined the clamor, claiming that the
government>s refusal to raise fuel prices in accordance with the increase in world mar/et
prices was causing them unsustainable losses.
THE INDIAN PETROLEUM INDUSTRY
The "ndian petroleum industry is heavily dependent on foreign imports of oil to suffice for
it>s large demand of oil. "ndia produces a very small amount of oil in certain poc/ets of the
country such as Gujarat, !ssam, !runachal :radesh, !ndhra :radesh and Tamil ?adu as
shown in Table 2 . !s shown in Table & "ndia imported 31H of it>s total crude oil
consumption in the period of 255092551, and on an average imports 30.1H of it>s total
consumption of oil. Hence it is evident that "ndia is dependent on the international oil
mar/et. Hence oil spi/es have a significant effect on the "ndian economy.
TABLE FOR CRUDE OIL TABLE -
0229<2: 022:<26 0226<25 0225<23 0223<24K
RESERDES>METRIC
TONNES?
399 397 345 365 306
CONSUMPTION>METRIC
TONNES?
-0-/4: -03/:0 -92/-- -:5/66 -65/-
21
PRODUCTION>METRIC
TONNES?
99/93 99/74 90/-7 99/744 9:/--3
IMPORTS>METRIC
TONNES?
72/:9 76/45 77/:- ---/6 -0-/53
L IMPORTED OUT OF
TOTAL CONSUMPTION
3:L 36L 35L 35L 33L

Mean H of import out of consumption O (3%S30S31S31S33)20O 30.1H.
PRODUCTION OF CRUDE OIL IN INDIA
TABLE 0
#? ONSHORE
I222 To!!(% 0229<2: 022:<26 0226<25 0225<23 0223<24
GuH#r#$ 5-9- 5-43 506- 50-0 5-33
A%%#' :670 :329 ::3: ::22 :965
Aru!#8#l
Pr#d(%8
33 49 -2: -27 -20
T#'il N#du 936 97- 946 969 074
A!d8r#
Pr#d(%8
04- 005 0-5 060 037
To$#l>#? --:65 --672 --:92 --905 --0-0
)? OFFSHORE
N222 To!!(% 0229<2: 022:<26 0226<25 0225<23 0223<24
ONGC -3533 -4-56 -5927 -3779 -4202
JDC :0:2 :005 ::6- :557 :446
To$#l>)? 0-7-3 0097- 02352 00550 00726
To$#l >#M)? 99939 9974- 90-72 99744 9:--3
T!-. 2 shows us the brea/ up of oil production all over "ndia. Gujarat has the highest
offshore production. While ,?G# has the highest offshore production. Hence "ndia
produces a mere share of it>s total consumption and has a mere 320 million metric tonnes
of oil remaining as reserves as of 2553 . "t is amongst the highest consumers of oil and
barely produces enough oil to suffice it>s needs. Hence it has to depend largely on imported
oil as we have specified earlier and the government of "ndia imposes large import duties on
the oil (T!-. $) in order to garner revenue ( KFK T, T#H?"#!. !::?8"A).
Ks billion 255$95% 255%950 2550951 2551953
Koyalty from
crude oil
$&.3% %2.3& 05.13 04.03
Koyalty from
gas
4.0% 4.26 4.1$3 &5.30
,il
development
0&.%$ 00.$3 0&.61 3&.33
23
cess
'cise W
custom>s duty
053.$$ 01$.60 1$&.%$ 3&4.6$
*ales ta' $24.%6 $65 %06.$% 0$5.41
8ividend 1$.& 6%.$1 3&4.6$ &&0.23
Grand Total
TABLE 9

IMPACT ON LARGE SCALE INDUSTRIES IN INDIA:
I? THE ADIATION INDUSTRY
The rising global crude oil price is ma/ing air travel a costly affair in "ndia. Most of the
airlines in the country are contemplating a hi/e in airfares to stay afloat, but the cut throat
competition in the mar/et is a detractor.
"n the developed mar/ets, the airline industry has witnessed many by ban/ruptcies and lay
offs due to high crude oil price. "t is said that such eventualities would happen in the "ndian
airline industry soon.
World oil prices have settled at more than P&&5 a barrel. "n 255%, cost of crude oil was P&0
per barrel, but today it is more than P&55 per barrel. !ccording to the annual !irline
Iuality Kating survey, 0223 was the &or%$ .(#r .($ ,or #irli!( o'p#!i(% around the
world.
The service shortfalls are driven in good part by high fuel prices. Flying in a harsh cost
environment has reduced the operational efficiency of many companies. ,il companies
have recently announced a huge hi/e in aviation turbine fuel (!TF) as prices are not
government regulated. "t is e'pected that the !TF price hi/e would impose &5925 per cent
increase in fares on major domestic routes. The oil companies hi/ed !TF prices by &% per
cent as a result of global rise in crude oil prices in end 2553 9 2554. "n a bid to escape from
the impact of price hi/es, companies are said to be contemplating surcharge on fares.
The "ndian aviation sector is e'pecting a &5 percent growth rate during the ne't five years.
"f the crude prices sustained at the high level, it could be difficult to attain this target. The
!TF prices have already reduced the margins of the airlines to a large e'tent.
!s there is now no sign of downward movement in price, the "ndian airline industry is now
thin/ing of innovative methods to increase their profitability. *ome of the airlines have
started selling consumer products in the flights. They are also trying to cut costs as far as
possible. "t is e'pected that consolidation would be intensified in the airline industry in the
24
coming months of 2554. "n 2554, "ndia had witnessed many large ta/eovers and
ac7uisitions.
The number of people traveling by air has fallen to 9/2: 'illio! in Luly, down &2.10H from
a year ago, the civil aviation ministry has said. "t is the %8#rp(%$ ,#ll i! #ir p#%%(!"(r% i!
$8( ,our .(#r% %i!( I!di#N% #Ci#$io! )oo' %$#r$(d i! $8( %u''(r o, 022:/"n Lune this
year, air passenger demand, measured by passengers flown, had shrun/ $.4H from Lune
2553.!irlines, fighting to contain the effects of record jet fuel prices, have raised air fares
at least si' times this year. The increased fares have resulted in fewer people flying. Luly to
*eptember is also typically a lean season for air travel. 8espite airlines cutting down
heavily on the number of flights92&%% flights a wee/ were pulled bac/ from route maps of
domestic carriers in Luly from nearly &&555 wee/ly flights earlier9carriers are still reporting
lower occupancy rates. !irlines carried $.50 million passengers in Luly compared with $.%6
million in the same month of 2553. <The decline is largely a result of higher fuel prices=,
said *amyu/th *ridharan, chief commercial officer of low9fare carrier *pice Let .td.
8eccan !viation .td9run simplify 8eccan, which is merging with Dingfisher !irlines .td,
saw its sharpest dip in load factors9a measure of how full a flight is9at %6H in Luly
compared with the same month in 2553 when it flew its planes 13.3H full. ,ther low9fare
carriers *pice Let, "nterGlobe !viation :vt. .td.9run "ndigo and Let.ite "ndia .td, too, saw
their flight occupancy drop to 03.4H, 06H and 15.%H respectively, compared with 3&.%H,
3&.0H and 14H respectively, last year. Dingfisher flew its planes 1$H full compared with
11.3H last year. Kivals Let !irways, ?ational !viation #o. of "ndia .td>s !ir "ndia and
:aramount !irways "ndia :vt. .td. reported 13.6H, 00.0H and 31.&H occupancy on their
flights in Luly compared with 13H, 16.&H and 0$.&H respectively, in Luly 2553. M.
Thiagaranjan, managing director of :aramount !irways, said the slowdown would be
worrisome if it continues into the three months starting ,ctober. <Then it is a major
problem. -ut " don>t thin/ it would be that low in the pea/ tourist season.= !irlines in "ndia
e'pect to post a combined loss of about P2 billion (Ks. 40%5 crore) this fiscal year to March
2556.
Category Jul-07 Jul-08
Deccan Aviation LTD. 67.70% 49%
Spice Jet 7.40% !7.80%
"n#igo 7.!0% !9%
JetLite 68% 60%
$ing%i&'er 66.70% 6(%
Jet Air)ay& 67% 67.90%
Air "n#ia 69.0% !!.!0%
*ara+ount Air)ay& 76.0% !(.0%
26
Lo)er occupancy rate& in %lig't&
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
D
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2007
2008
From the above chart and table it is evident that baring the e'ception of Let !irways all the
other domestic carriers have e'perienced a fall in the number of passengers from 2553.
However, we can cast out Let !irways as an e'ception since Let !irways has corporate ties
hence does not e'perience a fall in the number of passengers.
8ue to the high prices of crude and the subse7uent high prices of tic/ets,
most people in "ndia choose to travel by train instead of plying by air. !lthough the
railways is not a perfect substitute of the aircraft most people in "ndia choose to burn their
time rather than their money.
II? THE AUTOMOBILE INDUSTRY OF INDIA :AN EEAMPLE OF
CONTRADICTION
The automobile industry is intrinsically connected to the oil industry
and therefore its fortunes are lin/ed to the oil prices. ,il provides us with 63H of the
transportation fuels that helps us to run cars, truc/s and other vehicles all over the world.
Thus when the price of oil rises it clearly concerns the automobile industry as the
companies compete with each other to meet the new demands for more fuel efficient cars at
$5
reduced prices which then becomes a major challenge. There is no doubt that this affects
the profit margin of the companies in the automobile industry. Moreover an increase in oil
prices also affects the /ind of vehicles demanded by the consumer and the way in which
these vehicles are designed.
With current oil prices s/y roc/eting to nearly &$5 dollars a barrel
the "ndian automobile industry is facing some tough times. The industryFs overall sales fell
%H during the last fiscal (2553954) as compared to a growth of &$.0H during the previous
year(2551953), even though some segments within the industry posted growth .The "ndian
automobile industry is fighting hard to /eep driving on the growth lane.
,nly two of the four segments within it grew during the last fiscal and only one posting a
double digit growth. :assenger vehicles grew &2H, with the passenger car category
growing a shade below it. Hyundai, $"ic" grew &&H during the period, says industry
growth has been slower than e'pected and the reasons could also be due to the sub prime
crisis in the ;*. The motorcycle segment was largely responsible for the overall decline of
the automobile industry. The &2H fall in motorcycles and %%H drop in the small category
of electric two9wheelers negated the growth of &&.1H in scooters and &1.1H in mopeds and
resulted in an 4H drop in overall two9 wheelers. !nd volumes in the commercial vehicles
segment, also considered as a barometer of the economy fell over %H. The figures may not
give the actual picture as the industry is moving towards multi9a'le vehicles with better
carrying capacity than the conventional truc/s. *ales of medium and heavy commercial
vehicles fell close to 2H and light commercial vehicles grew a little over &2H. Three9
wheeler sales, which fell close to &5H, also impacted overall industry growth.
While higher oil prices started causing havoc far beyond the petrol pumps, $8( ,i"ur(%
r(l(#%(d ). $8( Soi($. o, I!di#! Au$o'o)il( M#!u,#$ur(r% >SIAM? 8#C( %urpri%(d
(C(r.o!(/
!ccording the recent figures released by *"!M, "ndiaFs automobile industry reported an
4/27 p(r (!$ ri%( i! i$% oC(r#ll C(8il( %#l(% i! M#., 0224. While the domestic passenger
car sales registered a growth of &%.21 per cent $o$#l $&o<&8((l(r %#l(% &(r( up ). 3 p(r
(!$ i! M#. $8i% .(#r/
This growth in automobile sales in the country, despite s/yroc/eting oil prices (crude oil
price has already up to P&$5 compared to P25 per barrel five years bac/) has made e'perts
thin/ that I!di#A% #u$o'o)il( i!du%$r. &ill o!$i!u( $o "ro& $8i% .(#r d(%pi$( #ll
o)%$#l(%< oil pri( 8i=(, 8i"8(r i!$(r(%$ r#$(% #!d ,i!#!( #C#il#)ili$. o!$i!ui!" $o )(
# '#Hor i%%u(/
!ccording to the report released by *"!M, the passenger car segment cloc/ed sales of
&,&5,3%$ units during May, 2554, against 61,62$ units in the same month previous year
while total domestic vehicles sales stood at 4,02,432 units, against 3,46,5%& units in the
same month last year.
*"!M reports that total two9wheeler sales during the same period rose by seven per cent at
1, %3,$04 units, compared to 1, 50,5&% units in the same month last year. ,n the
motorcycles front, the sales jumped by 3.$6 per cent at 0, &$,256 units, against %, 33,65&
units during the year9ago month. !s reflected in the report presented by *"!M, most of the
manufacturers from all automobile sectors have recorded high growth sales in May, 2554
compared to sales in the same month 2553.
$&
For e'ample, small car *egment leader Maruti *uBu/i "ndiaFs sales grew by &1.&$ per cent
(from %6,$0% units to 03,$&0 units) while Hyundai MotorsF sales grew by %3.%4 per cent
(from &1,1&3 to 2%,051 units). *imilarly, General Motors "ndiaFs sales rose 1.&2 per cent
(from $,120 units to $,4%3 units) while Tata Motors sold &%,224 units, against &%,2&3 units
in the same month previous year.
"n the two wheeler sector, motorcycle mar/et leader Hero Honda MotorsF sales grew by
&5.$$ per cent (from 2,16,0$2 units to 2,63,$43 units) while -ajaj !uto and TJ* MotorFs,
however, recorded a marginal increase (from &,26,32% units to &,$5,514 units, and %&,32%
units to %&,65& units, respectively.
*cooter mar/et leader Honda Motorcycle W *cooter "ndiaF sales grew by 2.$5 per cent
(from 0%,15& units to 00,404 units) while Hero Honda MotorsF pushed its sales by &0.4& per
cent at 6,%22 units in May, 2554 from 4,&$1 units in the same month last year.
The recent hi/e in oil prices in "ndia has led to a sudden increase in
demand for #?G2.:G cars. "n order to cater for the growing demand for such cars and to
$2
cash in on this opportunity, vehicle manufacturers have launched #?G2.:G variants of
their e'isting models "n additionC the cost of running #?G fitted cars is substantially lower
than the cost of running gasoline fitted vehicles. !s well as cost issues, demand is being
driven by growing environmental concern and the "ndian governmentFs proactive measures
to implement uro9"" emission norms. .eading car manufacturers such as Maruti *uBu/i
and Hyundai are providing #?G variants of their most preferred car brands. "ndeed,
Hyundai has recently introduced a #?G variant of its mid9siBe *edan F!ccentF in order to
cater for the increasing demand for #?G2.:G fitted vehicles, and more manufactures are
loo/ing to follow suit.
These facts and figures suffice it is to say that "ndian
automobile will only grow from strength to strength in the coming years despite all odds,
and even if oil prices continue to push up in inflation and drive interest rates higher. From
&464 when the first car rode down "ndiaFs roads, "ndian automobile industry has come a
long way and it is all set to carry on the momentum in the foreseeable future.
CONCLUSION
T8(r(,or(, $8( *u(%$io! )(,or( u% i% $8#$, #! $8( urr(!$ Ori%i%O, &8i8 8#% )((!
#r$i,ii#ll. r(#$(d ). $8( u$)#= i! produ$io! ). #rou!d 6 'illio! )#rr(l% p(r
d#. $o )#il ou$ $8( oil r(C(!u( d(p(!d(!$ produ(r%, )( o'p#r(d $o $8( -739
OPEC d(i%io! $o i!r(#%( pri(% #!d u%( oil #% # &(#po! $o pr(%%ur( $8( US #!d
i$% #lli(% i!$o poli$i#l #!d (o!o'i %u)'i%%io!P
"n &63$, the world was unprepared to deal with the !rab decision to use oil as a weapon.
That is no longer the case and the &63$ crisis spawned a number of contingency plans,
including maintaining strategic reserves, which would negate any attempt to use the
XweaponX effectively. Hence it can be assumed that the present cutbac/ is directed at no
more than reducing the surplus inventory, as ,#8 stoc/s of oil and oil products were
about &5 per cent higher at the start of &666 than they were three years ago, when prices
were P25 per barrel. ,nce e'cess stoc/s are reduced and the emergency which re7uired
the cuts will be over, the current supply management system will become increasingly
less necessary.
However, for developing countries li/e I!di#, who over the years will become major oil
consumers, and becoming increasingly dependent on imports for their energy, any pri(
,lu$u#$io! #! 8#C( # !("#$iC( i'p#$ o! $8(ir )ud"($% #!d $8(ir (o!o'. as a
whole. "n an oil price shoc/ li/e those witnessed in &63$, &64& and &66& "ndia would be
vulnerable to the heavy drain of foreign e'change and conse7uent macro9economic
instability.
Till very recently, I!di# did not have an energy security policy or contingency plans to
fall bac/ on in crisis situations. ?either is it a member of any organiBation li/e the "!,
which was born in the aftermath of the &63$ crisis to protect members from any future
disruptions in the energy mar/et. With "ndiaFs hydrocarbon demand growing at a rate of
$$
1 per cent per annum and its reserves showing no signs of pic/ing up, it needs to
formulate a policy whereby not only its short9term but also its long9term energy needs
are secured. ! tentative step has been ta/en recently with the recent launch of the
XHydrocarbon Jision 2525X programmed, which is aimed at securing the countryFs
energy re7uirements over the ne't two decades. With the countryFs hydrocarbon reserves
showing signs of rapid depletion, the government introduced the ?ew 'ploration
.icensing :olicy (?.:) in &663 in an effort to promote investment in the e'ploration
and production of domestic oil and gas and boost indigenous reserves. Though the initial
response of international companies to bidding for e'ploration bloc/s under ?.: were
modest, it is e'pected to pic/ up along with the rise in price of oil. ,ther obstacles to
foreign investment also need to be loo/ed into, such as the continuation of the
administered price mechanism (!:M), limited pipeline infrastructure, and controls on
private companiesF rights to mar/et transport fuels. #ontinuing subsidies on petroleum
products li/e diesel and /erosene result not only in wide distortions in consumer prices
but also lead to over9consumption, which in turn increases demand.
!lthough the aviation industry has ta/en a beating due to the hi/e in the fuel prices the
automobile industry in "ndia continues to be bright despite the oil price hi/es.
.i/e the ,#8 countries, I!di# developing countries also need to develop their non9
hydrocarbon sources of energy, such as hydro and nuclear power, as well as develop
alternative non9conventional sources of energy such as solar and wind power, to reduce
hydrocarbon imports. However, this can only happen in the medium to long term.
Therefore in the short9term, these countries will continue to be dependent on
hydrocarbons for their energy re7uirements. However, there is a growing gap between
supply and demand in the region, which necessitates that energy security cooperation be
put on the policy agenda of these countries. !nd the prospect of settlement of the gap
may depend on the success of multilateral cooperation. #ooperation in energy security
issues becomes more important for developing !sian countries in the light of the fact
that unli/e industrialiBed countries, which have ade7uate foreign capital, resources and
the mechanism to use sophisticated technology, to enhance their energy security, !sian
countries have neither the financial resources nor the unifying institutions to deal with
energy security issues. #onfidence building measures among the !sian countries is a
prere7uisite for the creation of technology9oriented alternatives for solving the
enormous energy problems the entire region will have in future.
To some it all up we can say that the attempt of the ;nited *tates of !merica and it>s
allies to influence the oil mar/et is one of the major causes for the political turmoil in
various oil producing nations in the middle east. The $ major oil spi/es and the current
oil shoc/ all had a political scenario attached to it with the ;nited *tates of !merica and
it>s allies involved in it someway or the other.
TECHNICAL APPENDIE
-? BARGAINING BET+EEN THE OPEC AND G<3
$%
We consider the following pay9off matrices+9
F"KM 2

:roduce ! :roduce -
F"KM & :roduce !
:roduce
:ay off matri'9&
. F"KM 2
Wor/ alone enter consortium
F"KM & Wor/ alone
nter consortium
Here we use 2 pay off matrices, pay off matri'9&
and pay off matri'92 to analyBe a typical bargaining game between 2 players. *uppose 2
firms, Firm & and Firm 2 are launching & of 2 products (! and -), which are perfect
complements of each other. From payoff matri'9& it is evident that firm & is at a
comparative advantage at producing !. such that if both the firms produce !, firm & will
do so at a much lower price, garnering much higher levels of profit. However from the pay
off matri' it is evident that the best scenario for both the firms is the case when firm & will
produce ! and firm 2 will produce - that is the situation depicted in the top right corner of
the matri'.

0? AD<AS MODEL AND THE PHILLIPS CURDE
We use the !ggregate 8emand (!8)9!ggregate *upply (!*) model to analyBe the inflation
in "ndia. The !8 curve shows the relationship between 7uantity of goods and services
demanded and the price level of the economy. "t is downward sloping as shown in Figure &.
The !* curve shows the relationship between the 7uantity of goods and services supplied
and the price level of the economy. The !* curve is upward sloping as shown in Figure &.
!s prices and wages are stic/y and there e'ists wor/ers misperceptions and imperfect
information in the short run, the !* curve is positively sloped. However in the long run
such imperfections are not present hence the !* curve is vertical.
%5,0 05,05
15,%5 0,%0
&5,&5
&5,25
25,&5 %5,%5
$0
*upply shoc/s are shoc/s which alter the cost of producing certain goods
and services in the economy. *upply shoc/s may be of 2 types when more of a good can be
produced at less costs it is called a favorable supply shoc/. "f the costs of producing the
goods rises substantially it is called an !dverse supply *hoc/. The oil shoc/ is an e'ample
of an adverse supply shoc/.
We will further analyBe the effect of the adverse supply shoc/ on the "ndian conomy using
the !89!* curve and the :hillip>s curve.
$1
!n adverse supply shoc/ such as the supply shoc/ caused due to the oil mar/et leads to a
leftward(outward) shift of the !* curve as shown in Figure &.Hence the price level of the
economy rises from :Q to : 5 . Hence there is an increase in the :rice level of the economy
by :Q:
5
. This increase in the price level is the level of inflation in the economy. The
"ndian economy e'perienced an inflation of close to &2H due to the recent oil shoc/. The
level of output also falls from @Q to @5 due to the oil shoc/.
P8illip% urC( #!#l.%i% o, i!,l#$io!
We use the :hillips #urve to show how an adverse supply shoc/ such as the oil shoc/s. The
e7uation of the :hillips #urve is as follows+9

e
= S v u u b
n
+ ) ( b[5 V..(&)
Where
=
rate of inflation.

e
O e'pected rate of inflation.
u = level of unemployment.
u
n
O natural level of unemployment.
v = supply shoc/.
For an adverse supply shoc/ vR5
a favorable supply shoc/ v[5.
!n oil shoc/ is an adverse shoc/ hence vR5, the cyclical level of unemployment (u 9 u )
remains unchanged, the e'pected level of inflation
e
remains unchanged. Hence from the
:hillip>s e7uation shown in (&) it is evident that this supply shoc/ will lead to an increase in
the value of the inflation rate

. We depict this in Figure9& shown below

Figure & shows the trade off between the inflation rate

and the level of unemployment

u. the initial :hillip>s curve is labeled :
&
. !fter the supply shoc/ the :hillips curve shifts
upwards to :
2
as shown in the figure. Hence at the same level of unemployment an
adverse supply shoc/ leads to an increase in the level of inflation.
9? ACCUMULATION OF REDENUE THROUGH TAEES
! simple mathematical model can e'plain how governments of most countries accumulate
a substantial amount of revenue by imposing large amounts of ta'es on oil imports. *ince
the demand for oil is inelastic (absolute value price elasticity is less than &), the demand for
oil is not substantially affected by higher prices.

Total Kevenue for the government is given by,

TKOpQ7 VVVV.. (&)
:artially diff. (&) with respect to price(p) we get,

TK2 p O 7 S pQ 72 p
TK2 p O 7 \& S (p27)Q 72
p
]
$3
TK2 p O 7 (& 9

(p))
TK2 p O 7 (& S
) ( p
) VVVVVV.. (2)
Where

(p) O the price elasticity of demand

For the oil mar/et the absolute value of the elasticity of demand is less than &. Hence an
increase in price will cause the Total Kevenue(TK) for the government to rise. Hence
governments of most countries especially the developing countries impose vast ta'es on
imported oil to garner revenue.
:? THE DEMAND SUPPLY MODEL AND THE ASSUMED EEIT OF SAUDI
ARABIA AS A RESULT OF POLITICAL FRICTION
*ince the early &635s, the world oil mar/et has been buffeted by the ,:# (The
,rganiBation of :etroleum 'porting #ountries) cartel and by political turmoil in the
:ersian Gulf. "n &63%, by collectively restraining output, ,:# pushed world oil prices
well above the competitive mar/et price, because it accounted for much of world oil
production. 8uring &6369&645, world oil prices shot up again as the "ranian revolution and
the outbrea/ of "ran9"ra7 war sharply reduced "ranian and "ra7i production. 8uring &645s,
the price gradually declined, due to the fall in the demand and the rise in the competitive
(non9 ,:#) supply. However prices remained relatively stable during &6449255&, e'cept
for a temporary spi/e in &665 due to "ra7i invention of Duwait. :rices spi/ed again in
25529255$ due to stri/e in JeneBuela and the war with "ra7 in 255$.
We will consider the prices measured in &663 dollars.
&663 world price O P&4 per barrel
World demand and total supply O 2$ billion barrels per year (bb2yr)
&663 ,:# supply O&5 bb2yr
#ompetitive (non9 ,:#) supply O &$bb2yr
SHORT RUN LONG RUN
+ORLD DEMAND <2/26 <2/:2
COMPETITIDE SUPPLY 2/-2 2/:2

?ow by using these values we find out the short run and the long run demand and supply
curves.

*H,KT K;?
.T TH *H,KT K;? 8M!?8 F;?#T",? - + I O a 9 b:
Where I is the output demanded in the world mar/et
$4
: is the world oil price
a, b are positive arbitrary constants.
The slope of the demand function
P Q 2
O 9b.
:rice elasticity of demand
D
O :2I Q
P Q 2


D
O :2I Q 9b
95.50 O 9b Q &422$
9b O (95.50 Q 2$)2&4
b O 5.51
We now substitute b in the demand function
I O a E b:
2$ O a E 5.51 Q &4
2$ O a E &.54
a O2$ S &.54
a O 2%.54
now we substitute a and b in the short run demand function
I O a E b :
*hort run I
D
O 2%.54 E 5.51 :


.T TH *H,KT K;? #,M:T"T"J *;::.@ F;?#T",? - + I O c S d :
Where I is the competitive supply
: is the world price
c ,d are positive arbitrary constants
the slope of the supply function
P Q 2
O c
:rice elasticity of supply
S
O :2I Q
P Q 2
S O :2I Q c
5.&5 O &42&$ Q c
c O (5.&5Q&$)2&4
c O 5.53
We now substitute c in the supply function
I O c S d :
&$ O c S 5.53Q&4
&$ O c S &.21
c O &&.3%
now we substitute c and d in the short run supply function
I O c S d :
*hort Kun @ S Q --/3: M 2/23 P
*hort Kun total supply is the *hort Kun competitive supply and ,:# supply(&5bb2yr)
Therefore we add &5 bb2yr to the competitive supply e7uation
*hort run total supply O * S S&5
*
T
O &&.3% S5.53 : S&5
S
T
Q0-/3: M2/23
-y e7uating *
T
and I
D
it is verified that the world price is coming to P&4 per barrel.
$6
.,?G K;?( .K)
.T TH .K 8M!?8 F;?#T",? -+ I
D
O a E b :
:rice elasticity of demand
D
O :2I Q
P Q 2
The slope of the demand function is
P Q 2
O 9b

D
O :2I Q
P Q 2

D
O :2I Q 9b
95.%5O&42&$ Q 9b
b O (5.%5Q&$)2&4
b O 5.0&
?ow we substitute b in the .K demand function
IO a E b :
2$O a E 5.0&Q&4
a O2$ S6.&4
a O$2.&4
?ow we substitute a and b in the .K demand function
IO a9 b :
@
D
Q 90/-4 R 2/6- P
.ong9run competitive supply+ *>O 3.34S5.26:
.ong9run total supply+ S Q -3/34M2/07P/
%5
FIGURE
*audi !rabia being one of the world>s largest oil producers
accounting for nearly $bb2yr, which is nearly one third of ,:# production and about &$H
of total world production.
!ssuming that *audi !rabia stops its oil production completely we subtract $ from the total
supply in both the short and long9run supply curves derived above.
Therefore we have+
*hort9run total supply+ SNQ-4/3:<2/23p
.ong9run total supply+ S%Q-:/34M2/07P
The short and long9run demand curves remain unchanged.
7uating 7uantity demanded and 7uantity supplied in the short9run we see+
%&
@%Q SN,
&&.3%S5.53: O &4.3%95.53:
P Q 62
The price therefore more than doubles to P052barrel
"n the long9run, because both demand and competitive supply are more elastic, the $bb2yr
cut in oil production does not support such a high price as in the short9run.
7uating 7uantity demanded and 7uantity supplied in the long run we see+
@D Q SS
$2.&495.0&: O &%.34S5.26:
P Q 0-/36
:rice rises to P2&.30, only P$.30 above the initial P&4 price.
Thus if *audi !rabia does stop its oil production then we should e'pect to see more than a
doubling of oil prices in the short9run. However in the long9run prices will gradually fall
afterward as demand falls and competitive supply rises.
The oil industry is therefore an increasing cost industry with an upward sloping long run
supply curve indicating that oil producers are willing to supply more only at higher prices
in the long9run period. This happens because there is limited availability of easily
accessible large volume oil fields. #onse7uently as oil companies increase output they are
forced to obtain oil from increasingly e'pensive fields.

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