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Economics 14

Lecture 25: Energy Prices

OPEC and the oil market
electricity

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OPEC and the Oil Market

OPEC controls about three-quarters of world oil reserves. OPEC is a cartel: an organization of individual competitors that join to form a single monopolist.

Under competition, the price of oil is P_comp and an individual OPEC member produces q_comp and earns just a normal profit.

With a cartel, joint profits are maximized at P_opec and Q_opec.

Since Q_opec < Q_comp, q_opec must be less than q_comp for each OPEC member each member is assigned a quota, q_opec.

At q_opec, MR > MC profits rise if the country expands production.

Produce at q_cheat, where MR = MC.

But, if all members cheat, total production rises the price of oil falls competitive outcome

Electricity

In California utilities owned both the electricity generators and the transmission lines. Deregulation in 2000 required the utilities to sell their generating capacity. The wholesale electricity market and prices to industrial users were deregulated but residential prices remained regulated.

The wholesale price of electricity rose from $26.56 per megawatt hour in April 2000 to $575 per megawatt hour in April 2001. Utilities could not afford the higher wholesale rates because they could not raise residential rates.

Collusive behavior by natural gas suppliers and electricity generators was responsible for the rapid rise in wholesale prices.

David A. Latzko Business and Economics Division Pennsylvania State University, York Campus office: 13 Main Classroom Building phone: (717) 771-4115 fax: (717) 771-4062 e-mail: web: www.yk.psu.edu/~dxl31