Question

The shale revolution has increased the oil and gas flow in America tremendously. The International Energy Agency has predicted that the United States would become the world's largest oil producer by \(2020,\) leaving Saudi Arabia and Russia behind. a. What is the effect of the shale revolution in the U.S. on the world price of oil? b. How does the change in the world price of oil affect the quantity of oil produced by members of the OPEC with a comparative advantage in producing oil, the quantity it consumes, and the quantity that it either exports or imports?

Short answer

The shale revolution increases U.S. oil supply, lowering global prices. OPEC's oil production and consumption decrease, and they may adjust exports, potentially reducing them overall but could try to increase exports to maintain revenue.

Step-by-step solution

Understand the Shale Revolution

The shale revolution refers to the technological advancements in extracting oil and gas from shale formations. This has significantly increased the production of oil and gas in the U.S.

Determine the effect on World Oil Prices

The increase in oil production in the U.S. due to the shale revolution leads to a higher supply of oil in the global market. According to the law of supply and demand, an increase in supply while other factors remain constant leads to a decrease in the price of oil.

Impact on OPEC Oil Production

OPEC (Organization of the Petroleum Exporting Countries), especially those with a comparative advantage in oil production, would see a reduction in the quantity of oil they produce. The fall in world oil prices makes it less profitable for them to produce the same quantity of oil.

Consumption Within OPEC Countries

With a decrease in income from oil exports, OPEC countries might have reduced national income, potentially decreasing the domestic consumption of oil because of lower economic activity within these countries.

OPEC Exports

With decreased domestic production and consumption, OPEC countries might export less oil. However, lower prices might lead them to attempt to maintain revenue by increasing their export quantity, despite lower prices, if possible.

Key concepts

World Oil Prices

The world oil prices are affected by a variety of factors, among which supply and demand play a crucial role. When the United States increased its oil production significantly due to the shale revolution, this created a larger supply of oil in the global market. According to economic theory, an increase in supply while demand remains relatively constant generally leads to a drop in prices. In this scenario, the world oil prices decreased because there was more oil available than there was previously. Lower global oil prices can have widespread economic implications, influencing everything from fuel costs to production expenses in oil-dependent industries.

Reduced oil prices can also lead to varied reactions from different stakeholders in the oil market, including consumers, producers, and governments. Consumers might benefit from lower fuel prices, while oil-producing countries might face economic challenges due to reduced revenue from oil exports.

OPEC Oil Production

OPEC, short for the Organization of the Petroleum Exporting Countries, plays a significant role in the global oil market by coordinating and unifying petroleum policies amongst member countries to ensure stable oil prices. Due to the shale revolution in the U.S., the increase in global oil supply has forced OPEC members, especially those with a comparative advantage in oil production, to adjust their production levels. With world oil prices dropping, it's less profitable for these countries to produce as much oil as before.

As a result, many OPEC countries might reduce their oil production to avoid excess supply and try to support prices. This strategic reduction is intended to stabilize the market and maintain an acceptable income level despite lower prices. The balance OPEC seeks between production and global oil prices is a delicate one, influenced by numerous geopolitical and economic factors.

Comparative Advantage

The principle of comparative advantage explains how different countries or entities benefit from specializing in the production of goods or services for which they have a lower opportunity cost compared to others. Many OPEC countries have a comparative advantage in producing oil because they have abundant oil reserves, favorable geographic conditions, and established infrastructure for oil extraction and refining.

However, when the U.S. increased its oil supply through the shale revolution, the global oil prices fell, impacting the profitability of oil production for OPEC countries. These nations now face a challenge: despite their comparative advantage, lower prices make oil production less lucrative. They must adapt by possibly diversifying their economies or finding ways to reduce production costs further, ensuring that they can sustain their comparative advantage in a changing market.

Global Oil Supply

Global oil supply represents the total amount of oil available for consumption worldwide. It is influenced by production levels in key oil-producing countries and regions, technological advancements, geopolitical factors, and energy policies. The shale revolution in the United States has significantly increased the global oil supply by adding a substantial amount of oil to the market.

This surge in supply has caused a shift in market dynamics, challenging traditional oil powerhouses like OPEC. Increased global supply typically results in lower oil prices, prompting oil-exporting countries to rethink their production strategies to maintain revenue. Additionally, the long-term stability of global oil supply depends on factors such as sustainable production practices, investment in new technologies, and global energy policies targeting renewable sources to mitigate environmental impact.