The New Global Oil Market: Understanding Energy Issues in the World Economy

By Siamack Shojai | Go to book overview

Chapter 4
Oil Pricing

J. Cale Case

How much should a barrel of oil cost? This is an often-asked question that has no easy answer. Oil is a strategic and valuable resource. It is frequently associated with supply uncertainty. The question of whether or not we are running out of oil is one of major concern.

Economics has focused on natural resource availability since its inception. Early writings on the possibility of world resource production being unable to keep pace with a growing population led to economics' designation as the "dismal science." 1 However, despite centuries of predictions that we are running out, most natural resources, including oil, are still in plentiful supply. Real prices for extractive natural resources have, almost uniformly, declined with time as improvements in the technology of mining, refining, and utilization have occurred.

This chapter considers how the price of oil is determined--it discusses the relevant economic theory of oil pricing, analyzes the the empirical evidence regarding pricing tendencies, and concludes by speculating on future price trends.


OIL PRICING: THE THEORY

This section begins with a discussion of supply and demand analysis and considers theoretical opportunity cost models that predict increasing resource scarcity. The traditional model is expanded to allow for improving technology, market failures, and uncertainty.


Supply and Demand

Market prices for any commodity represent the product of two forces: supply and demand. Supply is a function that describes how much of a good or service

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