Oil Price Volatility – Old and New

Commodity prices are notoriously volatile, and oil is no exception. The structural volatility of commodity prices is a key reason why the economic development literature has concluded that specialization in commodity exports is not a valid recipe for development. The negative effect of volatility is linked to the fact that prices, and consequently revenues, may become unpredictable, foiling the possibility of rational investment and fiscal policies. Such long-term volatility – qualitatively different from short-term volatility, which occurs in a predictable pattern – constitutes a clear dilemma for commodity producers and users alike.

In the case of oil, price volatility was extreme in the early stages of the industry (at the end of the nineteenth century), until the market power of the leading players (initially, the Standard Oil Company in the United States; then the “Seven Sisters,” controlling, through interlocking interests in upstream consortia, the bulk of global oil reserves), succeeded in maintaining “market discipline” for an extended period of time (about 1900 to 1970). “Market discipline” prevented cheap Middle East oil from rushing to the market in excessively large volumes, which would have brought prices down to levels at which oil produced elsewhere in the world would have been driven out of the market. Instead, prices were kept sufficiently low and stable to progressively displace other primary fuels, and the share of oil expanded rapidly.