Identify and Explain the Economic Factors Behind the Closure of the Clyde Oil Refinery

Shell planned to close its oil refinery operation, one of Australia’s seven operating refineries at Clyde, source of ten per cent of Australia’s needs and convert it as a fuel import terminal. Shell will import products to replace output from Clyde (Murphy 2011). As there are a small number of firms in the industry, it is an oligopoly market. In this essay, the economic factors, costs and the impact on competitiors behind the closure of Clyde refinery will be identified and analysied.

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Firstly, for the economic factor behind the closure of Clyde refinery, it is facing strong competition from new “mega- refineries” in Asia. These competitors ramp up the output as production of oil.

From Diagram 1 (The Pennsylvania State University 2006), when supply increases from S1 to S2 as a result of imports, the quantity supplied will eventually increase from q1 to q2 while the price will fall from p1 to p2. The lower the market price of oil, the less total revenue received by the firm. The consequence of over- supply is that the profit margin has been plummeted.

Diagram 1

Moreover, the profit margin falls while the production cost of oil refinery such as raw material and regualtion fee increases. As an oligopoly, Shell cannot increase its price to meet the cost. Otherwise, the customers will switch to the competitors that sell homogenous products with a lower price. Other firms will not follow as they hope to increase their market share by taking the customers of firm that increased its price.

In Diagram 2, the firm that increased price goes up its elastic demand curve and loses market share. It will quickly realize that it is losing market share and quickly return its price to that of its competitors.

Diagram 2

The result of increased total cost and reduction of market price is that the Clyde refinery reaches at a shutdown point, the market price of oil falls below the minimum point of the average variable cost curve.

From Diagram 3 (Frost and Taylor 2009), the market price equals marginal cost at a quantity where total revenue (Price X Quantity) is less than variable costs (Average Variable Cost X Quantity)

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