BPEA | 1986 No. 2

Lessons from the 1986 Oil Price Collapse

1986, No. 2

IN the first half of 1986 crude oil prices fell to about $12 a barrel, back to their level of 1974 and, when adjusted for changes in the general price level, close to the real oil price that prevailed in 1973 just before the first OPEC price increase. This paper reviews the 1986 oil price collapse, discusses why it came as a surprise, and assesses what it means for oil prices in 1986-87 and beyond. The first section of the balance of the paper presents an overview of the 1970-86 world oil market: price, demand and supply by region, and output and revenue for OPEC. The next section reviews the record of expert opinion since the first big price increases in 1973-74, paying special attention to the 1980-81 World Oil study by the Energy Modeling Forum (EMF) and to the results from a series of polls of energy analysts since 1981 by the International Energy Workshop. The third section presents an explanation of the 1986 price collapse, together with a simulation of the choices facing OPEC for 1986 and thereafter. The fourth section examines the question of what should have been expected for 1985-86, going as far back as 1980. Included there are econometric estimates of oil demand functions for the United States and five other countries of the Organization for Economic Cooperation and Development (OECD). The paper concludes with a discussion of the outlook for the world oil market.