Causes of Increase in Oil Prices in Last 36 Months - Essay Example

The paper "Causes of Increase in Oil Prices" is a perfect example of an essay on macro and microeconomics. A major reason for the increase in oil prices in the last three years is speculation in the futures market relative to the oil industry. Since mid-2005, oil marketers have been taking an entrenched position in speculating that the oil industry’s future looked dark. Such circumstances encouraged speculators to adopt measures that would ensure they made sufficient money to meet future demand.

Oil traders have started placing premiums on the prices of crude oil on the basis of instability and uncertainty in the Middle East, which has the largest oil reserves in the world. Moreover, the increasing internal disturbances in countries such as Libya, Iraq, and Tunisia as well as the potential threats pertaining to disruption of crude oil production and transportation in this region and in Africa, have led to increasing in oil prices. In view of these circumstances, speculators started bidding higher for oil, which again raised prices across the world.

  Governments of several oil-producing countries have not been adopting efficient management practices that have adversely impacted the performance of the oil industry in these countries. For instance, oil-producing nations such as Venezuela have been channeling their oil revenues into domestic politicking in order to continue holding on to power. The oil industry in Venezuela and other countries in the Caribbean region have been nationalized and are used by the respective governments to meet their political objectives.

Revenues from the oil industry are used to finance social projects and to subsidize gasoline to citizens. Oil revenues are substantially misappropriated in meeting the costs of political agendas, which reduces oil available in the market and thus there is an increase in prices. The PDVSA is the only oil company in Venezuela that is having a complete stake in the country’s oil functions. In being owned by the state, its management complies with state mandates irrespective of the fact that the company’s long term revenues and profitability suffer a setback.

These governments try to make more money out of the oil business by quoting oil prices at very high levels. In African countries such as Nigeria, the increasing activities of rebels and terrorists have deterred investors from investing in the oil industry (Flower, 2010). Such circumstances deprive the sector of employing advanced technology because of which high production levels cannot be achieved and the resultant short supply leads to higher prices. Increasing use of industrial and automobile equipment, especially in developing countries, has led to increased demand for oil.

The law of demand and supply provides that the price of any commodity will increase if its demand increases at any given supply level. In view of political and economic circumstances, oil producers are not increasing the supply of oil adequately in keeping up with increasing demand. It is thus natural that oil prices will increase. In the last few years, the evolving patterns of industrialization and the use of vehicles has led to the advancement of production processes, which have led to increasing demand for oil.

The global demand for crude oil is increasing steadily, particularly in India and China that are undergoing rapid industrialization and development processes (Gupta, 2005). The economies of China and India are slated to grow the maximum in the coming future and they have already started consuming much higher levels of oil in meeting their energy requirements. Increasing per capita incomes in China and India have considerably increased the demand for automobiles and more and more people now own their own cars (Reynolds, 2005).

In view of the huge middle class in these two countries, which are the most populated countries in the world, it is apparent that the demand for oil will also increase substantially. The US is no longer the biggest oil consumer and cannot dominate the oil industry by demanding preferential oil prices for itself. The OPEC has also transformed into a purely market-based entity and prefers to supply in areas where it gets higher prices. It is known that the price of crude oil is dependent upon the value of the US dollar.

The value of the US dollar has been consistently declining since 2008 across all trading markets because of which the prices quoted in dollars have been increasing. The depreciating value of the dollar is a result of the declining US economy and the cutting down of interest rates. Investors view oil as a commodity that can be hedged against inflation and a declining dollar (Galbraith, 2008). Therefore, it is natural that investors will invest in crude oil in the commodity exchange markets thus increasing prices of crude oil.

It is unfortunate that presently there are no alternative sources of crude oil. Alternatives such as liquefied coal and ethanol have the potential to reduce demand for oil only marginally.