ABSTRACT
Oil is of vast importance in the Middle East, and its impact on the region has been magnified by the volatile character of global oil prices. Many commentators emphasize political factors or fundamental resource shortages to explain the periodic dramatic price increases, although in fact the industry’s history is as full of dramatic price declines. The classic economic explanation for the industry’s unstable character is in P.H. Frankel’s 1946 Essentials of Petroleum. He argued that the oil industry lacks the usual self-adjusting mechanism in which price increases quickly lead to more supply and less demand; instead, supply and demand adjust very slowly to price changes because of the uncertain results of exploration, the high overhead costs at all stages of the industry, and the unresponsiveness of demand in the short run to price increases. Frankel’s thesis has only been strengthened by the growth since 1946 of oil nationalism, that is, political movements demanding greater control over the industry by the producing-country governments. The initial impact of that nationalism was to depress oil prices: uncertain how long their concessions would last, oil companies had an incentive to raise output. After nationalization, the bias has been toward higher prices. Having taken over from the oil companies, governments could more effectively act as a cartel to restrict output, thereby putting a floor under prices. Meanwhile, their exclusion of potential investors impeded the expansion of output in the most promising areas, thereby limiting the usual process that puts a ceiling on prices.
