Analysis of the trends in the consumption patterns of oil - Essay Example

Analysis of the trends in the consumption patterns of oil Introduction Oil is one of the most heavily traded commodities in the world. Fluctuating prices have important effects for oil producers/exporters and the many countries that remain dependent on oil as a key input in their energy, manufacturing and service industries. In this paper, an attempt is made to analyze the trends in the consumption patterns of oil, on the basis of the International Energy Agency (IEA) monthly report on oil market (IEA, 2008). First, the basic definitions of Economics are provided. Then, the trends in the consumption patterns of oil are analyzed. Economics The definition of Economics can be classified into three broad categories, namely: (a) Wealth Economics Definition, (b) Material Welfare Economics Definition, and, (c) Scarcity Economics Definition. Of these three, the Scarcity Economics Definition is the pertinent for the present. According to this, economics is a "science which studies human behavior as a relationship between ends and means which have alternative uses" (Robbins, 1935). The study of Economics is divided by the modern economists into two parts, namely; microeconomics and macroeconomics. In macroeconomics, the economy as a whole is analyzed, while microeconomics analyses the economy in terms of its innumerable decision-making units. Microeconomics: The study of supply and demand inside a market is known as microeconomics. Microeconomics is "the study of particular firms, particular households, individual prices, wage incomes, individual industries, and particular commodities" (Boulding, 1969). Microeconomics offers solution for the problems: what should be produced, how those goods and services should be produced, and, who is allowed to consume those goods and services. It explains the composition of total production- why more of some things is produced than of others. In other words, it analyzes demand and supply for a product or service. Law of demand: The demand for anything at a given price is the amount of it which will be bought per unit of time at that price. The law of demand states that "a rise in the price of a commodity or service is followed by a reduction in demand, and a fall in price is followed by an increase in demand, if conditions of demand remain constant" (Samuelson, 1962). The major factors that influence the demand for a product or service are: price and availability of a substitute good, price and availability of a complimentary good, income, tastes and preferences, price expectations, stock of goods in consumer hands, and, population. Law of supply: Supply is the amount offered for sale at a given price. The law of supply states that "other things remaining the same, as the price of a commodity rises its supply is extended, and as the price falls its supply is contracted" (Boulding, 1969). The supply changes due to: i) costs of production, ii) unavailability of resources (like raw materials for the production), iii) improvement in the means of transportation, communication and technology, iv) political disturbances or war, and, v) the climate, irrigation methods and soil (in the case of agriculture products). Trends in the consumption patterns of oil The availability of oil and its price are linked by the laws of supply and demand. Each day approximately 84 million barrels of oil are extracted from the earth, and approximately the same amount is consumed. The world's rate of oil extraction will begin soon or has already begun to decline, while the demand for oil continues to grow which in turn will produce sharply rising prices for oil. In this study, the Oil Market Report by IEA dated 10th July, 2008 (IEA, 2008) is analyzed. The highlights of the analysis are given below: Microeconomics of oil - Supply and Demand: The oil market is one where small changes to the supply or demand cause large changes to the clearing price. In economics jargon, both oil supply and demand are "inelastic" - they show only a minimal short-term response to changes in price. The demand for oil is increasing due to the following factors: 1. Robust growth in developing economies like Asia and Middle East 2. Weather conditions in the northern hemisphere 3. Indian demand, driven primarily by income growth 4. Economic growth, favorable demographics, very low retail prices and occasional shortages in alternative energy sources leads to oil demand in the Middle East The short-run supply of oil is affected by a series of different factors8: 1. Transportation bottlenecks: Problems with the pipelines that transport oil 2. External shocks: The effects of production shocks such as the unrest in Nigeria's oil fields, the possibility of war between the U.S. and Iran, and the antics of Venezuela's Hugo Chavez 3. Natural causes: Events like a hurricane hitting the oil producing areas in the US Oil pricing: The factors that affect the price of oil in the global market are: Inventory - Oil producers and consumers build a storage capacity to store oil for immediate future needs. They also build inventories to speculate on the price expectations and sale/ arbitrage opportunities. Any change in these inventory levels triggers volatility in oil's prices. Demand and supply - The increasing demand for oil and the almost static supply is another factor that is influencing the prices of oil upwards. Lack of close substitute - While there are substitutes for oil, these substitutes would require a substantial initial investment from the consumers, which is why the oil prices increase. Rise in geopolitical tension such as possible military confrontation between Israel and Iran Oil demand and supply may be inelastic in the short-term, but in the long-term, they are remarkably elastic. Over the long-term, high oil prices will tend to encourage consumers to either reduce energy consumption or shift to other forms of energy. Consumption pattern of oil: For a product like oil, quantity demanded does not change that much in response to the price. A large change in price produces only a small change in demand. However, over the long run, consumers and producers respond to higher oil prices. The increase in oil prices has the following effects on the consumer: Americans are driving less and have switched to buying more fuel efficient cars. British consumers are becoming more cost-conscious: Internet shopping appears to be on the rise, while retail sales in out-of-town centers - which are usually reached by car - are sliding. People change their choice of car, and look to switching to public transport. Many consumers have switched to cheaper unbranded gas oil - ranging from truckers unwilling to purchase more expensive premium grades and utilities to other users seeking to mix gasoil with subsidized kerosene (fuel adulteration is a common practice in India). Conclusion Due to the increase in oil prices, the consumer has to pay higher gas and electricity bills and this means a reduction in his savings. There will be dramatic change in buying patterns for different automobiles with shifts towards smaller, fuel efficient, cars, and hybrids. There will also be an increase in mass transportation use. Over a longer term, people adapt in what housing they want and where they want it, and governments will respond by changing zoning rules and development patterns to facilitate living without the automobile. Thus it is noted that the increase in oil prices leads to highly discernible changes in consumption patterns. Bibliography Boulding, K. E. (1969). Economics as a Moral Science. American Economic Review. 59 (1). p.1-12 Goose (2007). The Economics of Oil, Part I: Supply and Demand Curves. http://www.theoildrum.com International Energy Agency (2008). Oil Market Report: A Monthly Oil Market and Stock Assessment. http://omrpublic.iea.org/currentissues/full.pdf (last accessed on 11.08.2008) Robbins, L. (1935). Nature and significance of economic science. Economica, 28. p 66-81. Samuelson, P. A. (1962) .Economists and the History of Idea. American Economic Review, 52(1). p.1-12. Read More