Transportation Cost Fluctuation Due to Changing Crude Oil Prices - Essay Example

Transportation Cost Fluctuation Due to Changing Crude Oil Prices Transportation is considered one of the key sectors of economy as it facilitates the movement of goods, people, and animals from one location to another. For instance, for a person, good or animal to move from New York to Washington, they must use at least a mode of transport such as rail, vehicle, train or ship. Consequently, for an individual to move from the U.S. to the UK, he or she must use either air or ship as a means of transport to reach the destination. Most of the modern modes of transport used usually depend on oil as a source of energy. Oil used in the transport industry comes in the form of petrol, diesel and other forms of petroleum products. Apart from the transport sector, other sectors of the economy such as industries also depend a lot on oil as a source of energy. In fact, over the past decades, there has been a steady increase in global demand for oil due to globalization and industrialization taking place all over the world. Worldwatch Institute (8) notes that a substantial growth in energy demand in the world has began especially with China and India, which has the largest human population. He notes that from 2002 to 2004, world global demand increased by 5.3 percent with that of China alone increasing by 5.8 percent. Oil demand in other Asian countries increased by 5.8 percent combined. The increased demand is mainly attributed to the ever-increasing industrialization. Worldwatch Institute also reports that from 2002 to 2004, the US demand for oil increased by 4.9 percent, 10.2 percent with UK realizing a 6.8 percent increase. Other developed countries like Germany and Japan realized a drop in oil demand by 1 percent and 2.6 percent respectively. This prices are however not stable as they keep fluctuating depending on global demand. For instance, an increase in the oil demand usually leads to an increase in petroleum prices. Worldwatch reports that the increase in global demand for oil between 2004 and 2005 saw an increase in petroleum price from about $30 per barrel to $60 per barrel. Such a price fluctuation in oil price in turn affects the transport fares. The level to which fuel price fluctuations as affected by global demand for oil, which in turn affects transport costs can only be explained using supply and demand theories. This paper will discuss how fuel price fluctuation is affected by global demand for oil, which in turn affects the transportation cost. Surface Transportation Policy Project (1) argues that apart from the latest increase in gasoline prices, transportation cost mostly go unnoticed by an average America. This is despite the fact that an average American household spent close to 19.3 per cent per dollar in transportation in 2001. The report found out that it is the second largest expense category, which is three times more than heath care adding close to $7,633 per household every year just to get around. The survey found out that it is only housing that exceeds transportation in terms of expenditure. He notes that in recent years, transportation consume a larger share of family budget. As such, the proportion of household expense grew from below 10 percent in 1935 to close to 14 percent by 1960 and a further 20 percent since 1972 to date. It was also observed that the growth of expenditures on transport closely followed the decline in transit use leading to an emergence of sprawl development (Surface Transportation Policy Project 1). This explains the principle of demand, which states that the higher the price of a product, the lower the quantity demanded, and the lower the price, the higher will be the demand for a product or service. In this case, the law of demand plays out in that the increase in household expenditure lead to a decrease in transit use which in turn lead to emergence of sprawl. This shift was due to the fact that it the only next cheapest alternative to the transit as a means of transport. Surface Transportation Policy Project (1) reports that as public investment in transport started to concentrate more on putting up road reserves and highways, individual spending on transport increased. At this point few transportation alternatives other than driving available to a number of families, more than half of American population revealed having transportation means available. He argues that high cost of transport has become an essential expense. Out of the total funds spent yearly on transportation, a big chunk of about 47 percent is usually spent on new and second hand vehicle purchase. Other overhead costs includes, motor and Gasoline oil, maintenance, insurance and other related expenses, which constitute another 47.9 percent of all transport expenditure. Surface Transportation Policy Project (1) notes that operating and owning a car or truck in US, costs an average American $7,233 annually. This comprises close to 95 percent of total expenditures on transport. In comparison with those high costs, a survey found that public transportation is much cheaper. For instance, a survey conducted by Bureau of Transportation and Statistics (BTS) looking at commuter cost reveals that Americans who commute by personal cars spent $1,280 annually in 1999. This is in big contrast to what an American who uses public transport spent, which in this case was only, $765 annually. This is just a commuting trip. However when all the other costs are added such as non-work trips, public transportation is thus economical and more cost effective which can save an individual or family thousands of dollars. Surface Transportation Policy Project (2) argues economic disparity also exist with regard to a barrier to homeownership. In this case, it notes that for both middle and upper-income households, transportation cost is usually taken for granted. However, this is in contrast with the poorest American households where the high owning and car maintenance cost may put owning a house beyond reach. Home ownership in this case is seen as the most pragmatic way of creating wealth. The ever-increasing transport cost over the past years due to fluctuating prices of oil has become a common phenomenon that economics has to grasp with. This is attributed to the increase in global demand for oil. This has mainly been seen to result from high growth in industries all over the world with China, India and US being the highest consumers of world oil. As the global demand for oil goes up, the prices of the fuels also goes up, which in turn results, into an increase in transport cost. This is in line with the law of demand, which states that, an increase in demand of a product, leads to decrease in the prices of the product while a decrease in price of a product leads to an increase in the quantity demanded. This is so because when there is high demand for a given product, the many buyers will tend to compete to buy the product making the seller to adjust her prices. On the other hand, when the demand for the product is low, prices will also have to drop, as there are few buyers in the market. This explains why an increase in demand for oil leads to an increase in fuel prices (Cowie 34). Supply The low of supply on the other hand states that as the quantity of goods supplied increases, the prices of the products decreases. This is so because, when there is plenty of products in the market than the demand, sellers in the market will compete for the few buyers in the market leading to a reduction in prices of the same products. With regard to transport cost, it is evident that at some points in the year when there is economic boom and the supply of oil is not interrupted implying there is plenty of oil in the market, the prices of other goods also falls leading to a fall in transportation cost. Likewise, when there is very low supply of oil may be due to disasters, hording or wars, leads to an increase in fuel prices in the market. This is then translates to an additional cost in the transport sector which in most cases see an increase in transport costs (Cowie 35) Income is another factor that influences oil prices in the market in demand point of view. Cowie (38) notes that other things remaining constant, a general increase in income would make many people to use transport services thus increasing its demand. On the other hand, a decrease in income would lead to a decline in demand for transport. Graphically, an increase in demand will be shown by a shift to the right with a decrease being shown with a shift to the left. As the demand for transport increases, this will in turn lead to an increase in transport fares since there would be many people scrambling for the available transport means. On the other hand, any decrease in income will see demand for transport services dropping, this leads to a drop in transport fares as there would be no enough people to be transported due to financial constraints. Part Two: Quantitative Analysis Surface Transportation Policy Project notes that transportation expenses pose a lot of burden to low income families, which in turn inhibits wealth creation (2). It reports that the poorest American households which constitute about 20 percent of households with an annual earning of less than $13,908, spent close to 40.2 percent of their salaries on transport. Out of this, money spent on transport by American poorest families, 95 percent is devoted to private vehicles expense. However, communities with car in mind usually give lower-income households no other alternative. To meet life’s daily challenges American household including the poorest rely on a car as a means of transport. For instance, a report by BTS found out that the poorest working American households spend close to 10 percent of their salary on transport, to and from work. This compares with only 2 percent for those earning $45000 and above annually and about 3.9 percent of working class (Surface Transportation Policy Project 2). This shows economic disparity, which regard to individuals earnings. In the transport sector, one factor that is bound to change with time is the cost of oil. When the cost of crude oil fluctuates in the international market, it affects the prices of oil-based products in various jurisdictions. By extension, such changes in the price of oil-based products affect the cost of transport. When, for example, the price of one barrel of crude oil in the international market steadily rises from $40 to $60 dollars, for example, in the international market, the costs of petrol, diesel, grease, engine oil, and lubrication oils used in the transport sector will definitely increase. Better stated, the small rise in the price of crude oil in the international market will be factored in various production and service activities to an extent that the final petroleum-based product that reaches the consumer will have its unit cost increase quite significantly. This significant increase in the products will be wholesomely reflected in the significant rise in transportation costs and fares. In the United States of America, the price of petroleum products such as gasoline is stabilized with the help of price controls and the introduction of more fuel from the country’s oil reserves in case of need. What this means is that when the supply of oil from OPEC countries is cut or reduced for whatever reason which under normal circumstances would trigger a sharp rise in fuel prices, the country opens its oil reserves to boost the supply of the petroleum products. This in turn controls the prices of petroleum fuel maintaining its stability. The cost of oil in the U.S. and beyond is often affected by speculation. When for example, U.S. nationals predict that there is bound to be a shortfall in the production of crude or petroleum products, they may end up rushing for the product in a bid to secure more of the commodity. This sudden rise in demand in turn causes the price of petroleum products to rise in a manner that reflects the arguments postulated by the demand and supply theory. Similarly a fall in the demand of the commodity will see the price fall in line with the supply and demand law. The changes in fuel prices and by extension transportation costs affect various players in the national and global markets. Workers who board public transport on their way to and from their places of work are affected by changes in fuel prices and transport costs. Members of public travelling to various places by public or private means are similarly affected by the changes. The same changes affect the aviation and maritime industries to an extent that passengers have to pay higher fares to access transport services. Yet again, those who pay freight charges as they have their goods transported from one location to another are affected by fuel price changes. In this category include importers of products who rely on water transport and manufacturers that have to ferry their goods by road or air to various locations. Practically, changes in fuel prices which ultimately may affect fuel prices affects all people in one way or another. Even those who do not have products or who are not moving from one place to another get affected indirectly as they pay higher prices for the goods that they buy after higher transportation costs are factored into their wholesale and/or retail prices. While the rise in fuel prices is a curse to many, consumers especially, it is often a blessing in disguise to transport service providers in some cases. The service providers in some cases exaggerate the situation to their advantage by charging exorbitant prices that are not commensurate with the rises experienced in the cruse oil markets, all factors held constant. The ever rising fuel prices is an issue of great importance in the transport sector considering that it affects virtually every individual in a nation; either directly or indirectly. The fluctuation in fuel prices is subject to several factors, most of which are beyond individual control. When Organization of the Petroleum Exporting Countries (OPEC) member states feel threatened in one way or another, they reduce their output of oil which causes a shortage in the supply of the vital commodity that is oil as noted by Mabro (352). This shortage in turn sees the price of oil per barrel shoot upward as players bid higher for the product in the market. In view of the supply of demand theory, when the supply of oil increases in the market, the price of the commodity will tend to drop, the opposite holding true as noted by Paul (64). On the other hand, equilibrium in the oil market occurs when supply and demand of the commodity, in this case oil, are in balance Jenkin (159). The figures below show the demand and supply graphs. Fig 1: Demand-Price relationship Courtesy of Investopedia From figure 1 above, it is clear that when price increases from P3 to P2 to P1, the quantities demanded reduce from Q3 to Q2 to Q1. Thus, the relationship between demand and price is inversely proportional. In relation to fuel prices, when demand goes up, the prices of the commodities go high even as the supply sides go low. Fig 2: Demand-supply curve Courtesy of Wikipedia As can be seen from figure two above, when the demand for fuel moves up, the quantity that needs to be supplied to meet the demand also goes up. The price of the commodity is also positively affected to an extent that a higher price applies. Generally, as the price of fuel increases, the transport operators also report to the price change by increasing transport cost. However, this does not necessarily mean that an increase in fuel prices leads to an increase in transport cost. Instead, most operators especially of public transport take advantage of the fact that demand elasticity is very low. As a result, people will still have to travel from one point to another despite an increase. This is illustrated in the demand curve below (fig 3). The equilibrium points lie at the intersections of the demand and supply curves. Y Fuel Price Pi Pii qi qii Global demand Quantity X Fig 3: Fuel prices and market demand Conclusion The law of demand and supply plays a lot in the transport industry. The law states that when the demand for a commodity is high, the price of the commodity rises. On the other hand, if the supply of a commodity is high, its price in the market dips, other factors held constant. The cost of fuel in the international market to a large extent affects the prices of fuel and petroleum products. When the price of fuel in the international market rises, for example, the costs of refined fuels similarly go up. This rise in price of fuels instigates a rise in transportation costs. When transport costs rise, passengers, business people, and car owners all feel the brunt of the change as they have to pay more to get mobile. On the other hand, when the prices are lowered, the aforementioned stakeholders of the transport industry will probably enjoy a reduction in the cost of transportation even as petroleum products have their prices lowered. Although most stakeholders suffer from fuel price increases, petroleum dealers may experience gains in respect of the same especially if the prices that they charge for the commodity is higher than what it ought to be under fair conditions. The issue of rising fuel costs is paramount to every economy as it affects almost the entire population of a nation. When fuel prices go up and therefore transportation costs are adjusted upwards, the prices of goods also tend to rise as the transport costs are factored into the equation. While controlling the cost of transport may be a complex issue, the government may institute fuel price controls to ensure that nationals enjoy lower transport costs and lower commodity prices. Yet another strategy that may be employed in maintaining transport costs is by storing huge volumes of the commodity for use during emergencies or crises. Work Cited Cowie, Jonathan. The Economics of Transport: A Theoretical and Applied Perspective. New York: Tailor & Francis. 2010. Print. Jenkin, Fleeming. "The Graphical Representation of the Laws of Supply and Demand, and their Application to Labour," in Alexander Grant, ed., Recess Studies, Edinburgh. ch. VI, pp. 151-85. Edinburgh. 1870. Print. Mabro, Robert. Organization of Petroleum Exporting Countries. Oil in the 21st century: issues, challenges and opportunities. Oxford Press. 2006. Print. Paul, Samuelson, "Reply" in Critical Essays on Piero Sraffa's Legacy in Economics. Cambridge University Press. 2000. Print. Surface Transportation policy Project. Transportation Costs and the American Dream: Why lack of Transportation Strains the Family Budget and Hinders home Ownership. Special report. 2003. Print Worldwatch Institute. Biofuels for Transport: Global Potential and Implications for Sustainable Energy and Agriculture. London: Earthscan. Print. Xxx The first part should be five to seven pages, typed and double-spaced. It will identify and describe a transportation issue of importance: included in this description is the economic theory composing the issue. Five to seven sources should be presented and discussed (i.e. a literature review). The second part should be five to seven pages, typed and double-spaced. It will comprise a quantitative analysis of the issue identified in the first part: how and why the issue is important (who is affected and how?). The analysis should be a critical assessment of both sides of the issue. Read More