OPEC+ efforts to stabilize the market reduced crude oil price volatility by 50% January 2017 and August 2021
OPEC+’s management of its spare capacity reduced crude oil price volatility by up to 50%, both before and during the COVID-19 pandemic, according to a new study published by experts from King Abdullah Petroleum Studies and Research Center (KAPSARC) in the Energy Journal. This reduction in oil price volatility lowered the macroeconomic costs of adjustment to the pandemic and contributed to higher social welfare.
The study “Oil Market Stabilization: The Performance of OPEC and Its Allies” further highlights that, OPEC+’s market-stabilization efforts appear to have lifted the average price from $18 to $54 during the pandemic demand shock, but to have decreased the average price before the pandemic by $2.50.
The study develops an economic model that calculates the crude oil price that would have prevailed if OPEC+ had not attempted to stabilize the oil market using its spare capacity. The resulting price volatility and average price can be compared to those observed historically, as shown in the table below.
The formation of OPEC+ in December 2016 was a signal event in the history of the world oil market. It established for the first time in OPEC’s sixty-year history an agreement by which non-members would cooperate with OPEC in the effort to stabilize the price of oil. The ensuing pandemic soon posed a great and unexpected challenge to this enterprise, one that tested both the limits of cooperation and the ability to overcome an unparalleled demand disruption.
“OPEC’s role has been critical in reducing price volatility directly— by acting as a swing producer that offsets shocks to supply and demand. Its spare capacity policy is an effective tool to achieve this strategic objective,” noted KAPSARC President, Fahad Alajlan.
Figure 1 shows the monthly spare production capacity held by OPEC and its allies. The dramatic increase in spare capacity observed in May 2020 illustrates the strong action taken by OPEC+ to offset the negative demand shock caused by the pandemic.
The value to the world economy of stabilizing the oil market is substantial. In a previous peer-reviewed study, we calculated that OPEC’s management of its spare capacity annually increased world’s GDP by almost $200 billion,” explains Research Fellow and coauthor, Hossa Almutairi.
Shocks to oil demand and supply are both large and frequent, with many possible causes, including war, natural disasters, labor strikes, economic sanctions, financial crises, technological innovations, changes in economic growth. The economic importance of stabilizing the price of oil derives from the rigidity of global oil demand and non-OPEC oil supplies. Any shock to supply or demand requires a relatively large price adjustment to restore market equilibrium. The negative impact on the global economy of the resulting price volatility is amplified by oil’s position as the leading commodity in international trade.
“The period covered by our study ends in August 2021, but I believe that OPEC+’s market stabilization efforts have consistently continued until today. We will quantify their impacts with our model once sufficient data is available,” stated Axel Pierru, Energy Macro & Microeconomics Program Director.
Oil price volatility is the source of various economic costs borne by both consumers and producers. In the global economy, some of these costs take the form of shocks to revenue streams and prices of production factors that disrupt long-term business planning and delay investment.