Macroeconomic Outlook for Oil Prices Owing to Unrest in the Middle East - Essay Example

Article Summary Reuters.com posted an article with the “Oil spike likely to cut EIA oil demand forecast” on March 7, This article wasabout the cut that the US government’s energy forecasting agency is likely to do with its estimated global oil demand this year due to the spike in prices of oil brought by the unrest in the Middle East. 2. Introduction The U.S. Energy Information Administration's (EIA) outlook to be released on Tuesday is the first of three world oil demand forecasts this month that will factor in the recent rise in crude prices. The Organization of Oil Exporting Countries (OPEC) releases its forecast this Friday, followed by the International Energy Agency's oil demand outlook on March 15. The EIA forecast comes as world oil prices race past $100 a barrel to 2-1/2-year highs and U.S. drivers face gasoline pump prices zooming toward $4 a gallon (Doggett 2011, 1). Studying economics is very essential for us to understand several issues like the world oil demand and its rising price raised by this article. These issues affect not only our own life but also the whole economy as well. For us to fully understand these economic issues, we have to study how the economic concepts like supply and demand work. These concepts will help us analyze how the oil markets work and how oil supply and demand is determined in the markets. 3. Analysis A. Scarcity and Opportunity Costs Scarcity or the state of being limited is one of the important concepts in studying economics (Mankiw 2004, 10). It is also the main reason for having economics. This means that economics exists because of the scarcity that is present in our economy. We use resources like oil to satisfy our needs and wants. But problems arise because these resources are scarce while our needs and wants are unlimited. So, in order to solve economic problems like this one, we have to develop a system of priorities. This is where choices, alternatives or substitutes and opportunity cost come in. As oil is one of these limited resources in our economy, we have to allocate and use it efficiently. Otherwise, we have to think of other alternatives or substitute for it and make trade offs. The values of these trade offs are represented by the opportunity costs. Because every time we use one of our resources, we incur the opportunity cost of using the other resources. So if for example, we choose to use oil as source of energy instead of thermal or wind, we are trading off thermal or wind for oil as source of energy. Economics is also about cost and benefit analysis. This is because when we try to solve our economic problems and make choices, we look at it through economic perspective by comparing the costs and benefits of our choices. By using oil for energy source means that its costs and benefits are favorable over the other alternatives, thermal and wind sources. B. Market, Demand and Supply Just like any good in the market, oil demand and supply are affected by several factors in the market. Any change in its demand and supply will affect its price and its impact will be felt by the whole economy as well. 1. Market Market is simply a mechanism or arrangement which brings buyers or demanders and sellers or suppliers of a good or service into contact with one another (McConnell and Brue 2002, 49). In this article, we will be analyzing the oil market, meaning the mechanism or arrangement where the exchange happens between the buyers and sellers of oil. Buyers or demanders are the ones who are willing and able to exchange their money for oil. On the other hand, sellers or suppliers are those who are willing and able to exchange their product which is oil for money. 2.Demand The report cited that the EIA forecasted demand for oil is usually in the middle of OPEC and EIA demand outlooks. Demand refers to the quantities of a specific good or service that people are willing to purchase at any given price during a specified time period, given other things being constant (Miller 2004, 99). When taken singly, it is referred to as the individual demand but when these individual demands are summed up it will result to the market demand. In another article, Turner and Sheppard (2010, 1) cited that non-OECD’s demand came from mainly China. China’s oil demand is an individual oil demand but if China’s oil demand will be added to the oil demands of India, Middle East and Latin America, we will have the global oil demand. CHINA’S OIL DEMAND INDIA’S OIL DEMAND MIDDLE EAST’S OIL DEMAND LATIN AMERICA’S OIL DEMAND GLOBAL OIL DEMAND 30 M bpd 10M bpd 12M bpd 5M bpd 57M bpd TABLE 1. Hypothetical global oil demand and individual oil demands of selected countries A fundamental characteristic of demand is that as price increases, its corresponding quantity demanded falls (McConnell and Brue 2002, 52). This negative or reverse relationship between demand and price is also known as the Law of Demand. As consumers or buyers are rational beings, they will prefer lower prices than higher ones to maximize the purchasing power of their incomes. Figure 1. The demand curve for hypothetical oil demands of selected countries Vertical axis shows the price in $; horizontal axis shows the quantity in million bpd But aside from price, market demand is affected and determined by several factors present in the economy. These may include tastes and preferences of consumers or buyers, the number of buyers in the market, the money income of the buyers, prices of related goods and the buyers’ expectations about future prices and economic conditions (McConnell and Brue 2002, 54). Surging fuel costs have caused consumers to reduce driving. Many economists fear they will also cut other spending. That could slow the economy, which would hit oil demand (Doggett 2011, 1). This is also related to the article where Turner and Sheppard (2010, 1) cited that OPEC left its forecast of a 1.05 million barrels per day (bpd) increase in 2011 global oil demand unchanged. The organization has based that estimate to the forecasted slow growth in world gross domestic product (GDP). GDP is used by many countries to measure their economic performance and represent the monetary value of their final output. This only means that the unfavorable economic condition shown by the expected lower rate of expansion in the coming year will affect the forecast demand for oil. Lower rate of expansion also means a lower rate of production. So if the projected world economic expansion in 2011 is at 3.7 which is lower than expected world expansion in 2010 which is at 3.9 , it is also expected that the rate of production in 2011 will be lower than the rate of production in 2010. And because oil is used by many economies in their production activities , its global demand is expected to be affected by the rate of production. Another determinant of oil demand to consider is the money income of the oil buyers. In this case, the GDP is also viewed as the income of the countries who buys oil. Lower income means lower demand. Because income gives the buyer the power to purchase a good or service, demand will depend on the income available to the buyer. So, if a country has a lower GDP, it means that its power and capacity to purchase goods and services like oil will also be lower. This will cause a decrease in the demand for oil in the global market. 3.Supply The other side of the market is the supply side. Supply is the amount of a particular good or service a seller or supplier is willing and able to produce and make available for sale at specific price and time (McConnell and Brue 2002, 58). Individual supply is the quantity that a single seller or supplier produced and willing to sell for a given price and time. The total of all the supply available in a market will be the market supply. From the article, Turner and Sheppard (2010, 1) cited oil suppliers are the members of the Organization of the Petroleum Countries and non-OPEC countries that produces oil. Oil supplied by each country is the individual oil supply but when their oil supplies are taken together, they will form the global oil supply. OIL SUPPLIED BY THE OPEC MEMBERS OIL SUPPLIED BY THE NON-OPEC COUNTRIES GLOBAL OIL SUPPLY 51.92M bpd 29.197M bpd 81.117M bpd TABLE 2. Estimated oil supplied by the OPEC and Non-OPEC countries OPEC reported a higher oil production. Its members with output qoutas alone already produced 26.861 million bpd in July which was 142, 600 bpd more than in June. The organization estimated a total supply of 51.92 million bpd from non-OPEC countries in 2010 and will increase to 52.27 bpd in 2011. The relationship of supply and price is shown by the Law of Supply. It states that as price increases, the quantity supplied also increases. This is because as sellers are as rational as buyers, they will prefer to produce and supply goods and services at higher prices than lower ones. However, there are other factors that affect supply. These include the costs of inputs used to produce the good or service, technology and productivity, taxes and subsidies, price expectations and the number of suppliers in the market (Miller 2004,106 ). Figure 2. The supply curve for hypothetical oil supply of selected countries Vertical axis shows the price in $; horizontal axis shows the quantity in million bpd In the article, Doggette (2011,1) reported that the situation in the Middle East may cause the rise in oil prices. The number of suppliers in the market is one of the determinants of supply. So, in this case, as most oil producers are in the Middle East, the situation may affect their oil production. So, if production rate will be affected, supply of oil will be decreased. The decrease in oil supply will cause the price of oil to rise. 4. Equilibrium When demand and supply are combined together, the point where quantity demanded is equal to quantity supplied is the equilibrium. This condition determines the market clearing price or the equilibrium price, the price that clears the market from any excess supply or excess demand (Miller 2004). Excess supply results to a surplus. It is a condition when the quantity supplied is higher than the quantity demanded at a price set above the equilibrium price. Excess demand results to a shortage or the condition of having a higher quantity demanded than the quantity supplied at a price below the equilibrium price. Figure 3. The supply and demand curves for hypothetical oil supply and oil demand of selected countries Vertical axis shows the price in $; horizontal axis shows the quantity in million bpd In an article, Turner and Sheppard (2010,1) cited that the surplus in oil stocks was forecasted because the demand is at slower rate than the production. So, if the oil suppliers will continue producing oil at the same rate as before, they will be producing more than what the oil demanders are willing to buy from them. This situation will result to a surplus of oil in the market. To at least decrease the amount of surplus and bring the production near to equilibrium, OPEC members agreed to cut their supply by setting output quotas (Workman 2006 ,n.p.). In another article, Doggett ( 2011,1) reported that the spike in oil prices can be attributed to the slow economy. The expectations about the future economic condition cause consumers to cut their spendings including their need for oil for their cars and reduces their driving activities, too. Conclusion Economics help us understand and analyze the issues that may affect our everyday life. Scarcity caused us to make choices and in every trade off that we make, we incur opportunity cost. But because we are rational beings, we always act and behave in an economics perspective by comparing costs and benefits. Prices affect market demand and supply but there are other factors present in the market that can cause changes and can determine market demand and supply. Bibliography Doggett, Tom. "Oil spike likely to cut EIA oild demand forecast." reuters.com. March 7, 2011. http://www.reuters.com/article/2011/03/07/businesspro-us-eia-monthly-oil-idUSTRE72665Q20110307 (accessed April 10, 2011). Mankiw, N. Gregory. Macroeconomics. New York: Worth Publishers, 1997. McConnell, Campbel, and Stanley Brue. MICROECONOMICS: Principles, Problems and Policies. New York: McGraw-hill, Inc., 1993. McConnell, Campbell, and Stanley Brue. Macroeconomics: Principles, Problems and Policies. New York: McGraw-Hill Companies, Inc. , 2005. Miller, Roger LeRoy. Economics Today: The Micro View. Boston: Pearson Education Inc., 2004. Turner, David, and David Sheppard. Reuters. August 13, 2010. http://www.reuters.com/article/2010/08/13/us-opec-monthly-idUSTRE67C1NY20100813 (accessed March 29, 2011). Workman, Daniel. Most Powerful Oil Countries . October 8, 2006. http://www.suite101.com/content/most-powerful-oil-countries-a7584 (accessed March 29, 2011). OPEC sees slow demand, continued supply overhang LONDON | Fri Aug 13, 2010 9:17am EDT http://www.reuters.com/article/2010/08/13/us-opec-monthly-idUSTRE67C1NY20100813 (Reuters) - A surplus of oil stocks will continue for many months as global demand remains sluggish, OPEC forecast on Friday. The Organization of the Petroleum Exporting Countries said that demand for oil will continue to grow slowly for the remainder of 2010 and in 2011, when world economic expansion is projected to be slightly lower than this year's. "Given the current supply/demand outlook, the overhang in inventories is not expected to change significantly in the coming quarters," it said in its Monthly Oil Report. OPEC left unchanged its forecast of a 1.05 million bpd increase in 2011 in global oil demand to 86.56 million bpd versus 2010. It based that estimate, which is low by historical standards, largely on its forecast that growth in world gross domestic product (GDP) would remain lackluster next year -- at 3.7 percent, compared with 3.9 percent for 2010. "The world economy is facing increasing headwinds that will slow the growth momentum going forward," OPEC said. The group cited "recent strength in U.S. consumption" behind a decision to tweak upwards its forecasts for this year's global oil demand. LATEST FIGURES Its current estimate for 2010 is 85.50 million barrels per day (bpd) -- 1.05 million bpd higher than in 2009. The new figure is 100,000 bpd more than it had estimated in July and is identical to the annual increases it forecast for 2011. The organization said: "As in the current year, the growth in oil demand is expected to come from the non-OECD (countries), mainly China, India, the Middle East and Latin America, with demand concentrated in the industrial, transportation and petrochemicals sectors." Harry Tchilinguirian, commodity strategist at BNP Paribas, predicted, however, that the rate of increase in demand would abate. "We see global oil demand falling back (next year) in line with global GDP growth," he said. OPEC raised its estimate of demand for its own crude in 2010 to 28.74 million bpd and in 2011 to 28.92 million bpd, which was about 80,000 bpd higher than its previous assessment. OPEC members' production has been creeping higher. Members with output quotas -- all except Iraq -- produced 26.861 million bpd in July according to the organization, 142,600 bpd more than in June. Including Iraq, production was 29.197 million bpd. The organization's members in July met 52 percent of their targeted 4.2 million bpd in supply cuts, down from 55 percent in June, according to Reuters calculations based on OPEC data. The cuts were agreed in 2008. OPEC estimated that supply from non-OPEC countries would total 51.92 million bpd this year, up 60,000 from its previous estimate, and increase to 52.27 million bpd in 2011. Crude oil prices were little changed following the 6:35 a.m. EST publication of OPEC's report. (Reporting by David Turner and David Sheppard; editing by Jane Baird) Oil spike likely to cut EIA oil demand forecast By Tom Doggett WASHINGTON | Mon Mar 7, 2011 4:17pm EST http://www.reuters.com/article/2011/03/07/businesspro-us-eia-monthly-oil-idUSTRE72665Q20110307 The U.S. Energy Information Administration's outlook to be released on Tuesday is the first of three world oil demand forecasts this month that will factor in the recent rise in crude prices. The Organization of Oil Exporting Countries releases its forecast this Friday, followed by the International Energy Agency's oil demand outlook on March 15. The EIA forecast comes as world oil prices race past $100 a barrel to 2-1/2-year highs and U.S. drivers face gasoline pump prices zooming toward $4 a gallon. Surging fuel costs have caused consumers to reduce driving. Many economists fear they will also cut other spending. That could slow the economy, which would hit oil demand. "I think it is obvious that this could cut into demand," said Phil Flynn, energy analyst at PFGBest in Chicago about the effect of current high oil prices. "This is probably the greatest risk to demand and the economy we've seen in some time," he said. Guy Caruso, energy expert at the Center for Strategic and International Studies think thank and former head of the EIA, said if current U.S. oil prices of $105 a barrel and gasoline at $3.50 a gallon prevail for the rest of 2011, U.S. oil demand would probably fall by 100,000 to 200,000 barrels per day. However, the oil price would drop $5 to $10 a barrel in the short-term, and demand would rebound somewhat, if the Obama administration tapped the U.S. emergency oil stockpile, he said. The EIA last month increased its forecast for global oil demand this year by 140,000 bpd, from the previous month's forecast, to a record 88.16 million bpd. In 2010 oil demand was 86.72 million bpd. The demand forecast from the EIA is usually in the middle of the OPEC and IEA demand outlooks. OPEC increased its forecast last month for global oil demand this year by 170,000 bpd to 87.7 million bpd. The IEA boosted it global oil demand estimate by 120,000 bpd to reach 90 million bpd in late 2011 for the first time. Traders will be watching to see if the IEA revises last month's optimistic forecast that said spare global production capacity and high oil inventories will help to constrain further oil price increases in 2011, a prediction that hasn't yet come true. (Reporting by Tom Doggett; Editing by David Gregorio) Read More