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Oil Markets Q1: Some hate it and some love it, but regardless of how you feel oil is still a key part of our daily lives. The average individual uses about 20 barrels of oil each year, equivalent to about one and a half swimming pools. Since it is such a major part of our expenses, oil is a product where, when price changes, we really notice. In 2008, China's expansion sparked a long period of high prices. In this case, you will analyze what has happened to these prices over time and the impact this has had on oil producers from the lens of producer theory. To simplify, let's assume that the oil market is perfect competition. A. What will occur in the long-run for this market? Show this on the new graph below. MC ATC 70 65 60 56 Price Barrel (5) AVC 35 30 25 20 15 10 2 6 8 10 12 14 16 18 20 22 24 26 28 30 20 40 00 80 100 120 140 160 180 200 Millions of Barrels/Day Millions of Barrels/Day The period of high prices indeed incentivized private firms to search farther than ever before - in the Arctic, Brazil's pre-salt fields, deep waters off Angola, and Canada's oil sands to ever expand the supply of oil. Investors encouraged this activity, rewarding future growth as much as profitability. Oil prices have been quite volatile. Recently, from mid-2014 to early 2016 oil prices plummeted from $110 a barrel to around $27. This sharp decline has been due to a number of causes. A key cause was when sanctions were lifted for Iran; a new producer entered the market with large quantities of oil. In addition, growing fears about action on climate change, coupled with the emergence of alternative-energy technologies, caused producers to pump as hard as they can, while they can. B. Use the producer theory model from above to show the impact of Iran's entry, assume this brings the market from long-run equilibrium to a price of $27. C. What are the firm profits at this price? In the industry at large, the incentive is to keep producing "as flat out as you can", once investment costs have been sunk into the ground, says Simon Henry, Shell's chief financial officer. He says it is sometimes more expensive to stop production than to keep pumping at low prices, because of the high cost of mothballing wells. He suggested that firms will not pack up so long as prices cover day-to-day costs, in some cases as low as $15 a barrel. It may be uneconomic to drill new deep water wells at prices under $60 a barrel, he says, but once they are built it may still make economic sense to keep them running at prices well below that. Such resilience is used by some to justify why they expect prices to remain "lower for longer"