Business Economics in Energy Industry - Essay Example

?Business Economics in the Energy Industry Introduction This paper examines the global energy industry and takes a look to forecast energy prices by the last quarter of this year. The industry comprises the production and sale of energy in the various forms it takes such as the oil and gas industries, coal, electricity and nuclear industries. It takes a look at the situation of the oil industry in particular. The paper also examines the role of renewable energy sources such as solar, wind and hydropower. Discussion The world has not weaned itself from its thirst for oil despite several warnings made by oil experts that peak oil is upon us (Deffeyes, 2001:3). The largest consumers of fossil fuels are the automobile industry and the electric power generation industry. Major manufacturers of the world also rely mostly on bunker fuels to run their factories. What “peak oil” means is that oil production is now on a downward slope due to declining oil production from rapid depletion of this non-renewable energy source. Oil is also an energy that has security risks involved as its source, chiefly in the Middle East, has been wracked by production disruptions lately. Economic development for the past several decades has been anchored on the assumption of cheap oil supplies but this is not true anymore. Fossil fuels or hydrocarbons have supplied the most of energy requirements for transportation and also for the production of fertilizers, plastics, fibers, pesticides, detergents and even pharmaceuticals (Abdullah, 2005:18). It is quite ironic the automobile industry is only now again reviving electric cars although the technology had been around since the invention of cars centuries ago but shelved due to the availability of vast cheap oil which precluded further development of electric and hybrid cars (Anderson, 2010:4). Market Structure – the oil industry is an oligopoly. It means only a few players are able to control the whole industry which encompasses extraction, refining and distribution of the oil products. This is because entry barriers are very high which need big capital outlays, economies of scale, complex technology and geo-political muscle to explore and drill in some of the most politically-sensitive areas on the planet such as the Middle East and Africa. To date, the only large areas still left unexplored are the large patch of ocean in the South China Sea known as the Spratly Islands group (Deffeyes, 2001:9) and the cold Arctic wastes of the North Pole (Myers, 2011:1). The global warming from climate change had made the ice glaciers retreat which now opened many new inaccessible areas to possible oil and gas exploration activities. Price Discrimination – the oil industry had been charged in the past of this bad practice as it has a complete hold on oil production and sale. There is latent price collusion among the oil producers in which one leading producer can increase its prices at will and then followed by the other producers (OPEC is an example although its pricing power has weaned recently). Other practices include setting the maximum price that the market can bear as producers in oligopolies are price-takers (ability to set the price) especially with oil becoming a diminishing commodity. Industry players are able to do this because of price inelasticity in oil demand in some markets. Government Regulations – the oil industry also stands accused of price gouging in which the players take advantage of price volatility in the international markets to their own advantage. Although many factors determine the gasoline price at the pump, it has been estimated only 85% of price changes are due to changes in demand conditions worldwide. This is further complicated by growing demand from strong powerful economies like China and India. In the United States, Robinson-Patman Act (1936) makes price discrimination an illegal practice. It is rarely enforced due to the difficulties in monitoring volatility and the many factors driving gas prices. Global Business Environment – the industrialized Western economies of the world had just barely gotten out of the world recession caused by the financial crisis brought about by the collapse of the United States housing mortgage market in 2007. Long-term interest rates are a bit higher compared to a year ago but short-term rates are essentially flat due to the credit crunch as an aftermath of the financial crisis. The International Monetary Fund (IMF) saw uneven growth with some re-balancing and persistent risks in some regional markets. The semi-annual economic report of the IMF called World Economic Outlook (WEO) predicts Asia as leading the way out of the recession with the United States in a very mild jobless economic recovery while Europe is now mired in a financial crisis of its own as some member countries of the European Union are on the verge of bankruptcy. The IMF is in middle of crucial talks to arrange a $1 trillion bailout (Thomas & Erlanger, 2011:1) to prevent the so-called PIIGS (Portugal, Italy, Greece, Spain and Ireland) from defaulting on their sovereign debts. The threat has a dampening effect on their economies with a resulting decline in their oil demand as well; only Germany is doing well. Spike in Oil Prices – the recent sudden price increases in oil in the past few months were a passing phenomenon only as there is now a sharp retreat in oil prices (da Costa, 2011:1) which had vindicated the United States Federal Reserve Board to keep its low-interest rate regime for a longer period. The decline in oil prices is due primarily to the weak economic recovery and the US Fed is concerned how to spur economic growth as the threat of inflation is very distant. The unemployment levels have remained high in both Europe and the United States with signs of an economic robustness abating and further complicated by the euro-zone bailout package. Other regions like North Africa, the Middle East, Central Asia and former Soviet states are registering mild economic recoveries only while Japan, although a significant oil consumer is still stuck in economic stagflation since the 1990s and restrained by the tsunami and nuclear crises (ibid.). Price Speculation – the recent rise in oil prices was primarily due to oil speculators in the futures market to manipulate the price for their own profits and then sell the futures later on that is now seen as happening with the sharp retreat in prices because the fundamental demand for oil is simply not there due to a weak economic recovery and high unemployment levels in the major industrialized countries. Only Singapore, South Korea, Hong Kong and Malaysia are having the decent economic growth expected from the rising tigers of Asia but the rest of the world demand is slumping or simply flat. More ominously perhaps, consumer spending and confidence is now on a downward trend which is a recognized marker of an impending US recession (double dip). New Legislation – the Kyoto Protocols and later agreements regarding climate change are now being implemented by the industrialized countries to help offset carbon emissions. Renewed focus on renewable energy sources such as wind and solar power has likewise started to make a dent on oil demand because solar panel prices are getting cheaper worldwide. European Union countries had their carbon offset markets trading since year 2000 as financed by the World Bank (Kollmuss, Lazarus & Lee, 2010:208) which should reduce further oil demand. The troubles at various hot spots of the globe will likewise dampen oil demand as the negative factors could dent the United States manufacturing output to a large extent. Conclusion My prediction is that oil prices will be lower by the last quarter of this year compared to today’s prices. Although the European Central Bank no longer sees a need for bailouts because it claims the Euro-zone is well on its way to economic recovery, the growth is quite patchy at best and limited mostly to Germany and France only (Papachristou, 2011:1). Except for a severe or long winter period, oil prices will not rise back to today’s levels due to reduced demand. References Abdullah, B. (2005) Peak Oil Paradigm Shift: The Urgent Need for a Sustainable Energy Model. Trinidad and Tobago, West Indies: Medianet Limited. Anderson, C. D. and Anderson, J. (2010) Electric and Hybrid Cars: A History. Jefferson, NC, USA: McFarland & Company, Incorporated. da Costa, P. N. (2011) Oil Slump Vindicates Fed Doves. Reuters, [on-line]. 15 May. Available at: http://www.reuters.com/article/2011/05/15/global-economy-weekahead-idUSN1520169820110515 [accessed 17 May 2011]. Deffeyes, K. S. (2001) Hubbert’s Peak: The Impending World Oil Shortage. Princeton, NJ, USA: Princeton University Press. Kollmuss, A., Lazarus, M. and Lee, C. (2010) Handbook of Carbon Offset Programs: Trading Systems, Funds, Protocols and Standards. London, UK: The Earthscan Publications. Myers, S. L. (2011). Cooperation is pledged by Nations of the Arctic. 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