IEEJ： March ©IEEJ 2024
Special Bulletin
A Japanese Perspective on the International Energy Landscape (679)

March 7, 2024

Lessons learnt from the History of Market Adjustment in the World Oil Market
Ken Koyama, PhD
Chief Economist, Senior Managing Director
The Institute of Energy Economics, Japan
Oil prices have strangely remained stable. When the Gaza Crisis began with Israel’s
counterattack in response to Hamas's surprise invasion in October last year, oil prices rose, including
Brent, which topped $90 per barrel. Amid a widespread recognition that there would be no major
disruption to oil supply in the Middle East despite the escalation of the Gaza crisis and the spread of
the Israel-Hamas conflict and others, however, the Brent has stayed in the $80-85 range sinceNovember, with the West Texas Intermediate hovering around $80/bbl. Occasionally, crude oil prices
deviated from these central levels. For the past four months or so, however, crude oil prices havebasically remained stable, at around $80/bbl. In particular, crude oil prices have remained extremely
narrow fluctuations since early February. The Brent has stayed within a small range of $80-84/bbl.
What are the factors behind the stability? The first conceivable factor is that the supplydemand balance is stable in the absence of major destabilizing factors. The second is that a kind of
equilibrium situation exists as destabilizing factors offset each other. Since early 2024, global oil
demand has continued to increase steadily. Although outlooks for oil demand growth in 2024 differ
greatly by respective outlook sources, their average comes to around 1.5 million barrels per day. At
the same time, however, U.S. and other non-OPEC oil production is smoothly expanding. Non-OPECoil production growth is expected to be comparable to the average demand increase. Against thisbackdrop, market participants are aware that downside risks for oil demand include sluggish demandamid a global economic slowdown and a Chinese economic slump, while upside risks include thepotential impact of deterioration in the Middle East situation. A conceivable reason for the oil pricestability is that there is a kind of equilibrium between demand and supply factors or between upsideand downside risks. This means that there are no major eminent market-moving factors.
Another important factor behind the oil price stability is the role played by the presence of
the OPEC-plus group of oil-producing countries and their oil supply and demand adjustments. The
group, which consists of the Organization of the Petroleum Exporting Countries led by Saudi Arabia
and some major non-OPEC oil-producing countries such as Russia, has increased its presence as asupply-demand adjuster in the international oil market since late 2016. The group of oil-producing
countries dependent on oil export income adjusts supply and demand in order to protect or support
crude oil prices. The OPEC-plus group’s representative oil supply and demand adjustments include
the largest coordinated production cuts in history from May 2020, which came in response to a crude
oil price crash caused by the COVID-19 pandemic. The group has been expected to adjust supply anddemand not only to protect prices, but also to suppress price hikes or lower prices. It is still fresh in
our memories that amid crude oil hikes since the second half of 2021 and their acceleration under theUkraine crisis, there were calls around the world for Saudi Arabia and other countries with hugesurplus production capacity to increase production in order to lower crude oil prices. Even when crude
oil prices rise significantly, the presence of supply-demand adjusters such as the OPEC-plus groupincreases significantly worldwide.
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The OPEC-plus group, which is now making headlines as a supply-demand adjuster in theinternational oil market, was launched with the "Declaration of Cooperation" between oil-producing
countries in late 2016, as noted above. It is a young group that was created less than 10 years ago. Ina sense, however, the long history of the international oil market is a history of fighting against pricefluctuations, or a history of how to devise mechanisms and initiatives to avoid the negative effects ofextreme price fluctuations. It can be said that the impact of fluctuations in crude oil prices on theeconomy and industry is so significant that there is a sense of urgency and seriousness that something
must be done about such fluctuations.
There is also a question of why crude oil prices fluctuate so much. A traditional analysis of
the oil market has pointed out that the short-term price elasticity of both oil supply and demand issmall. Demand for oil (such as gasoline) as an essential commodity does not immediately decline evenif oil prices rise by 10% or so. Even if oil is expensive, we have no choice but to buy and use it. Rising
prices may not immediately boost oil production (apart from the exploitation of surplus production
capacity). Investment may be made in response to price hikes, leading to a supply increase later. Under
these circumstances, prices are prone to large fluctuations. Conversely, high prices maintained over acertain period of time may stimulate supply (conversely, low prices may discourage investment). Overthe medium term, high prices may structurally lead the supply-demand balance to loosen (and viceversa). It also happens that price fluctuations go too far cyclically. Another important issue is who andhow to manage the surplus production capacity that has always existed in the market. The oil market
has always had the potential to see an excessive oil supply and an oil price crash if the management
fails to work.
That is why there has been a recognition that surplus production capacity should be managed
to adjust supply and demand in the international oil market. Historically, some market participants
have played roles in managing surplus capacity. Since the inception of the international oil market in
the second half of the 19th century, its history has been marked by volatile crude oil prices. In responseto early crude oil price fluctuations, Standard Oil Co. dominated and controlled the market. After thedismantling of Standard Oil, oil majors concluded the Achnacarry Agreement to divide the market andadjust supply and demand. As crude oil production in Texas expanded rapidly, the Texas Railroad
Commission was launched to allocate oil production quotas and adjust supply and demand to avoid
any oil price crash. Reportedly, OPEC later referred to the commission’s approach. As oil supply
expanded rapidly due to the development of huge oilfields in the Middle East after World War II, the"Joint Control" of Middle Eastern oil by the giant oil majors known as the "Seven Sisters" played an
extremely important role in stabilizing the market through supply and demand adjustments. Themajors mutually held equity stakes in major Middle Eastern oil production operating companies formutual surveillance and joint control, contributing much to stabilizing the international oil market in
the 1950s and 1960s.
OPEC, which was created to counter the Seven Sisters, regained sovereignty over oil
resources and became the prime mover of the international oil market in the 1970s. However, thisforced OPEC to replace the oil majors as a supply-demand adjuster. It has continued to serve as anadjuster until today. OPEC's production coordination has continued to have difficulties over theestablishment of member countries’ production quotas. In order to increase the effectiveness of supplydemand adjustment under such circumstances, Saudi Arabia has sometimes taken on the role of aswing producer to adjust supply and demand (reduce production) on its own. However, this role was
too much of a burden for Saudi Arabia, leading the oil kingdom to restore its market share in a mannerthat invited a crude oil price crash in 1986. The history of OPEC production adjustments has continued
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beyond the 1990s. The inauguration of the OPEC-plus group added a new page to history. In the faceof an unprecedented increase in U.S. shale oil production since the mid-2000s, OPEC alone became
unable to effectively serve as an oil supply-demand adjuster and chose to cooperate with Russia,
another major oil-producing country.
Interestingly, we can see that an existing production adjustment system either fails orrequires a new one when its burden becomes too great. It is not clear at this point how long the current
OPEC-plus framework will continue and function, but history seems to provide some implications forthe future of the framework.

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