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Posts Tagged ‘buffer stocks’

OPEC deal pushes up oil prices

OPEC members agreed on 30 November 2016 to reduce their total oil output by 1.2m barrels per day (b/d) from January 2017 – the first OPEC cut since 2008. The biggest cut (0.49m b/d) is to be made by Saudi Arabia.

Russia has indicated that it too might cut output – by 0.3m b/d. If it carries through with this, it will be the first deal for 15 years to include Russia. OPEC members hope that non-OPEC countries will also cut output by 0.3m b/d. There will be a meeting between OPEC and non-OPEC members on 9 December in Doha to hammer out a deal. If all this goes ahead, the total cut would represent nearly 2% of world output.

The OPEC agreement took many commentators by surprise, who had expected that Iran’s unwillingness to cut its output would prevent any deal being reached. As it turned out, Iran agreed to freeze its output at current levels.

Although some doubted that the overall deal would stick, there was general confidence that it would do so. Markets responded with a huge surge in oil prices. The price of Brent crude rose from $46.48 per barrel on 29 November to $54.25 on 2 December, a rise of nearly 17% (click here for a PowerPoint of the chart)..

The deal represented a U-turn by Saudi Arabia, which had previously pursued the policy of not cutting output, so as to keep oil prices down and drive many shale oil producers out of business (see the blog, Will there be an oil price rebound?)

But if oil prices persist above $54 for some time, many shale oil fields in the USA will become profitable again and some offshore oil fields too. At prices above $50, the supply of oil becomes relatively elastic, preventing prices from rising significantly. As The Observer article states:

It is more likely that a $60 cap will emerge as the Americans, who stand outside the 13-member OPEC grouping, unplug the spigots that have kept their shale oil fields from producing in the last year or two.

… The return to action of once-idle derricks on the Texas and Dakota plains is the result of efficiency savings that have seen large jobs losses and a more streamlined approach to drilling from the US industry, after the post-2014 price tumble rendered many operators unprofitable. Only a few years ago, many firms struggled to make a profit at $70 a barrel. Now they can be competitive at much lower prices, with many expecting $50 for West Texas Intermediate – a lighter crude that typically earns $5 a barrel less than Brent.

OPEC as a cartel is much weaker than it used to be. It produces only around 40% of global oil output. Cheating from its members and increased production from non-OPEC countries, let alone huge oil stocks after two years when production has massively exceeded consumption, are likely to combine to keep prices below $60 for the foreseeable future.

Webcasts
OPEC Cuts Daily Production by 1.2 Million Barrels MarketWatch, Sarah Kent (30/11/16)
How Putin, Khamenei and Saudi prince got OPEC deal done Reuters, Rania El Gamal, Parisa Hafezi and Dmitry Zhdannikov (2/12/16)
Fuel price fears as OPEC agrees to cut supply Sky News, Colin Smith (30/11/16)
OPEC Confounds Skeptics, Agrees to First Oil Cuts in 8 Years Bloomberg, Jamie Webster (30/11/16)
Game of oil: Behind the OPEC deal Aljazeera, Giacomo Luciani (3/12/16) (first 10½ minutes)
Russia won’t stick with its side of the OPEC cut bargain CNBC, Silvia Amaro (1/12/16)

Articles
Oil soars, Brent hits 16-month high after OPEC output deal Reuters, Devika Krishna Kumar (1/12/16)
OPEC reaches a deal to cut production The Economist (3/12/16)
Opec doesn’t hold all the cards, even after its oil price agreement The Observer, Phillip Inman (4/12/16)
Saudi Arabia discussed oil output cut with traders ahead of Opec Financial Times, David Sheppard and Anjli Raval (4/12/16)
The return of OPEC Reuters, Jason Bordoff (2/12/16)
‘Unfortunately, We Tend To Cheat,’ Ex-Saudi Oil Chief Says Of OPEC Forbes, Tim Daiss (4/12/16)
After OPEC – What’s Next For Oil Prices? OilPrice.com (2/12/16)
The OPEC Oil Deal Sells Fake News for Real Money Bloomberg, Leonid Bershidsky (1/12/16)

Data and information
Brent crude prices, daily US Energy Information Administration
OPEC home page Organization of the Petroleum Exporting Countries
OPEC 171st Meeting concludes OPEC Press Release (30/11/16)

Questions

  1. What determines the price elasticity of supply of oil at different prices?
  2. Why is the long-term demand for oil more elastic than the short-term demand?
  3. What determines the likelihood that the OPEC agreement will be honoured by its members?
  4. Is it in Russia’s interests to cut its production as part of the agreement?
  5. Are higher oil prices ‘good news’ for the global economy and a boost to economic growth – a claim made by Saudi Arabia?
  6. What role does oil storage play in determining the effect on the oil price of a cut in output?
  7. What are oil prices likely to be in five years’ time? Explain your reasoning.
  8. Is it in US producers’ interests to invest in new shale oil production? Explain.
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Weaker coffee

Coffee prices have been falling on international commodity markets. In August, the International Coffee Organization’s ‘composite indicator price’ fell to its lowest level since September 2009 (see). This reflects changes in demand and supply. According to the ICO’s monthly Coffee Market Report for August 2013 (see):

“Total exports in July 2013 reached 9.1 million bags, 6.6% less than July 2012, but total exports for the first ten months of the coffee year are still up 3.6% at 94.5 million bags. In terms of coffee consumption, an increase of 2.1% is estimated in calendar year 2012 to around 142 million bags, compared to 139.1 million bags in 2011.”

But despite the fall in wholesale coffee prices, the price of a coffee in your local coffee shop, or of a jar of coffee in the supermarket, has not been falling. Is this what you would expect, given the structure of the industry? Is it simply a blatant case of the abuse of market power of individual companies, such as Starbucks, or even of oligopolistic collusion? Or are more subtle things going on?

The following articles look at recent trends in coffee prices at both the wholesale and retail level.

Articles
Coffee Prices Continue Decline Equities.com, Joel Anderson (17/9/13)
Arabica coffee falls Business Recorder (19/9/13)
Brazil Launches Measures to Boost Coffee Prices N. J. Douek, Jeffrey Lewis (7/9/13)
Coffee Prices Destroyed Bloomberg (4/9/13)
The surprising reality behind your daily coffee: The CUP costs twice as much as the beans that are flown in from South America Mail Online, Mario Ledwith (23/9/13)
Coffeenomics: Four Reasons Why You Can’t Get a Discount Latte Bloomberg Businessweek, Kyle Stock (19/9/13)
Here’s who benefits from falling coffee costs CNBC, Alex Rosenberg (9/9/13)
The great coffee rip-off is no myth Sydney Morning Herald, BusnessDay, Michael Pascoe (23/9/13)
Monthly Coffee Market Report International Coffee Organization (August 2013)

Data
Coffee Prices ICO
ICO Indicator Prices – Annual and Monthly Averages: 1998 to 2013 ICO
Coffee, Other Mild Arabicas Monthly Price – US cents per Pound Index Mundi
Coffee, Robusta Monthly Price – US cents per Pound Index Mundi

Questions

  1. Why have wholesale coffee prices fallen so much since 2011? Are the reasons on the demand side, the supply side or both? Illustrate your answer with a supply and demand diagram.
  2. What determines the price elasticity of demand for coffee (a) on international coffee markets; (b) in supermarkets; (c) in coffee shops?
  3. Why has the gap between Arabica and Robusta coffee prices narrowed in recent months?
  4. Identify the reasons why coffee prices have not fallen in coffee shops.
  5. The cost of the coffee beans accounts for around 4% of the cost of a cup of coffee in a coffee shop. If coffee beans were to double in price and other costs and profits were to remain constant, by what percentage would a cup of coffee rise?
  6. How would you set about establishing whether oligopolistic collusion was taking place between coffee shops?
  7. What is meant by ‘hedging’ in coffee markets? How does hedging affect wholesale coffee prices?
  8. Explain the statement “If they have hedged correctly, Starbucks and such competitors as Green Mountain Coffee Roasters (GMCR) are likely paying far more for beans right now than current market rates.”
  9. What are “buffer stocks”. How can governments use buffer stocks (e.g. of coffee beans) to stabilise prices? What is the limitation on their power to do so? Can buffer stocks support higher prices over the long term?
  10. What are “coffee futures”? What determines their price? What effect will coffee future prices have on (a) the current price of coffee; (b) the actual price of coffee in the future?
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Olive oil and the fallacy of composition

A bumper olive crop in Spain would seem to be good news for Spanish olive growers. But the effect has been a fall in the prices of olives and olive oil. With 43% of the global supply, Spain is the world’s largest olive oil producer and changes in Spanish output have a big effect on the world price.

Premium extra virgin olive oil has fallen to its lowest level (even in nominal terms) since 2002. Today the price is around $2900 (£1850) a tonne in the wholesale market; in May 2006 it peaked at nearly $5854 – double today’s price.

And while this is bad news for Spanish farmers, for farmers in countries without bumper harvests, the low prices are even harder to bear.

The problem is being exacerbated by a fall in demand in many countries currently suffering recession, such as Greece, Portugal and Italy – all big olive oil consumers. Although olive oil prices have fallen, it is still more expensive than various substitutes. Many people are thus buying these cheaper alternatives, such as sunflower oil, especially for cooking.

What is more, cheaper substitutes for olive oil are increasing in supply. Take the case of rape seed oil in the UK. As the Mail Online article, linked to below, reports:

“UK rape planting is thought to have hit an all-time high this year as British farmers take advantage of the high prices being demanded for rapeseed – base ingredient of many vegetable oils and other edible oils.

Much of the UK crop is used by the local food industry, although some analysts are predicting strong UK yields will give farmers the opportunity to export more to Europe. Because of rising export demand, oil users in the UK claim there is little to indicate the price they are paying for rapeseed oil will drop substantially in the near future.”

The market for olive oil is global. Crop yields in one part of the world, both of olives and of substitute crops, affect global prices and hence growers’ incomes worldwide.

Webcast
Debt hit countries suffer from olive oil price dip Euronews (28/5/12)

News articles
Olive oil price slides as glut hits southern Europe Gulf News, Javier Blas (29/5/12)
Farmers feel squeeze as olive oil price slips The National, Gregor Stuart Hunter (29/5/12)
Olive oil surplus adds to economic pain in Spain The Week (29/5/12)
Olive oil price fall brings further pain for Spain, Italy and Greece The Telegraph (28/5/12)
Pass notes No 3183: Olive oil Guardian (28/5/12)
More Storage Aid for Virgin Olive Oil Olive Oil Times, Julie Butler (17/5/12)
Yellow Britain from the air: Rapeseed’s relentless march across the country pictured in vivid colour as farmers cash in after price of crop’s oil soars Mail Online, Sean Poulter (29/5/12)

Data
Commodity Prices Index Mundi
Olive Oil, extra virgin Monthly Price – US Dollars per Metric Ton Index Mundi

Questions

  1. Identify the factors that have contributed to the fall in the price of olive oil. Illustrate the effects on a demand and supply diagram.
  2. Explain what is meant by the fallacy of composition and how it relates to a price taker, such as a farmer.
  3. How do the price elasticities of demand and supply of olive oil help to explain the magnitude of the price fall?
  4. What developments in other vegetable oils are affecting the olive oil market? What determines the magnitude of these effects?
  5. What actions have been taken by the EU to support the olive oil market? Is this the most appropriate policy response?
  6. Why are Middle Eastern olive producers unable to compete on cost with the major EU producing countries?
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