Summary: Two shocks to the market for oil – the coronavirus pandemic and a breakdown in the partnership between Russia and the Organization of Petroleum Exporting Countries – have resulted in a surplus and lower oil prices. It is expected that the surplus will not soon be drained away.
Classroom Application: When there is a simultaneous decrease in demand and an increase in supply in the same market each change will lower the equilibrium price. But the net impact on the equilibrium quantity is uncertain; a decrease in demand will cause quantity to decrease while the increase in supply will cause quantity to increase.
Questions:
- Draw and label a graph illustrating the demand for and the supply of oil. Indicate in the graph the location of the equilibrium point. Explain why it is a mistake to state that at this point: “the demand for oil is equal to the supply of oil.”
- Refer to the graph you drew for the previous problem. In the graph illustrate the impact of a decrease in demand and an increase in supply. Briefly explain why the net effect of these two changes on the equilibrium quantity of oil is uncertain.
- From the article: “The world is swimming in crude oil, and the glut won’t drain away any time soon.” Describe the relationship between quantity demanded and quantity supplied when there is a glut in the market for oil.
- Assuming that there is no additional change in either the supply of or demand for oil, what adjustment(s) would eliminate a glut of oil?
- The article refers to “contango” which refers to oil traders buying oil at a low price in order to sell the oil at a higher price at a later date. Would this type of transaction be considered an arbitrage transaction? Briefly explain your answer.
- In the article the chief investment officer of Massar Capital Management stated: “Even in December, we knew that this year’s supply was going to overrun demand…It’s gone from bad, to very bad, to extraordinarily bad.” For whom is this change “very bad”? For whom would this change be very good?
- In the article the head of commodities strategy at Société Générale stated: “The…reason…why you get this steep contango is that you have to incentivize people producing oil to store the oil now, as opposed to sending it out into the market.” Why would contango result in people storing oil rather than “sending it out into the market”?
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