Organisation of Oil Producing and Exporting Countries - Assignment Example

Answer a The word ‘downturn’ in this extract refers to slowdown or meltdown of global economy because of turmoil and recession. Indeed, the downturn occurred due to reasons such as collapse of sub prime property mortgage scheme in USA and debacle of financial markets in USA, Britain and other developed nations. The negative growth or economic contraction in developed nations was a result of steep fall in aggregate consumption that in turn impeded growth in developing nations that depend on advance economies for trade and commerce. Answer 1-b OPEC is an abbreviation of Organisation of Oil Producing and Exporting Countries which has twelve members in total namely Saudi Arabia, Iraq, Iran, Kuwait, Qatar, United Arab Emirates, Venezuela, Ecuador, Libya, Nigeria, Angola and Algeria. It should be pointed out that OPEC countries are among the major oil producing and supplying nations, which enjoy almost over 65 per cent of world’s proven oil reserves, nearly of 40% total production and around 55 per cent in world’s oil exports (Breitenfellner et al, 2009). OPEC, having secretariat in Vienna, is referred to a cartel because of this members mutually decide about changes in their oil production and supply to nations worldwide. In addition, they opt to constrict supply to escalate international oil prices and thus reap additional profits on exports of crude oil. On the other hand, OPEC members, especially Saudi Arabia, have also increased supply in past (1992 Gulf war) to control shortages. Answer 2-a Oil demand has very low price elasticity or in other words, the inelastic demand because oil is used for energy generation, industries, transportation and cooking. Indeed, the oil supply also has very low price elasticity because it is difficult to extract, produce and refine as heavy plant machinery and investment is needed to accomplish these objectives. There were, indeed, many factors that led to first peak oil (crises in 2008) and finally in steep reduction in world oil prices. The first major reason was the fact that demand increased heavily due to growth in International trade after elimination of trade barriers and decrease in custom tariffs and duties. This not only led to growth and expansion in advance economies but also in developing nation of Asia, Middle East, Eastern and Central Europe, especially China, India, Pakistan, Malaysia, Indonesia, Saudi Arabia, Turkey, Thailand, Hungary and others etc. The world oil demand skyrocketed and touched 85 million barrel mark in 2007 – 2008. Oil then became expensive because buyers were ready to pay more for acquisition of oil contracts in international commodity markets. On the other hand, the supply side remains almost stagnant in 2005 - 2007 because of conflicts in Nigeria, US military involvement in Iraq, frequent natural disasters in Gulf of Mexico, and most importantly, the exhaustion of ‘Ghawar’ oil field in Saudi Arabia (world’s largest oil producer supplier). The supply of oil observes very disappointing growth during 2005 – 2007 that resulted in supply shortfalls in later years while demand skyrocketed during that period (Hamilton, 2009). Oil Supply elasticity reduced further (around 0.05) because of difficulty in production, and supply in total was estimated to be 84 - 86 million barrels but there had been periodic fluctuations. Consequently, prices started increasing and touched new peak of $147 in July 2008. Another reason was use of oil as financial asset in commodity markets where oil was not traded for personal use; rather it was purchased and stocked by investors in anticipation of higher prices after strong demand and weak supply. Fourth, the dollar was although stable against world’s major currencies, however, it had become weaker against world’s major oil currencies such as Pound and Euro that pushed oil prices upward. In short, all above factors lead to oil price escalation in 2008. (Behr, 2009) Since then, the oil prices starting coming down and fell to just $40 or by 74% within 6 months. Indeed, the reason being the fact that domestic oil consumption had been decreasing in USA because of extremely higher prices that in turn hampered US economic growth. In addition, the rise in oil prices increased the costs of power generation, manufacturing and transportation that in turn increased the aggregate business costs and products became expensive. At the same time, surge in inflation due to peak oil prices increased households’ budgets while reducing their real incomes. Overall, decrease in aggregate consumption in USA and other developed nations led to closure of industries that later substantially reduced global oil demand. Oil prices started coming down because of falling demand and stagnant supply and eventually touched their 4-year low of $40. Answer 2-c 1) Higher oil prices increase the costs of energy generation that in turn increase total electricity bills and transportation costs (shipments, delivery etc) incurred by businesses. Expensive power and transportation followed by increase in salaries of workers lead to surge in total manufacturing and services costs thereby reducing profit margins of businesses. (Lynch, 2009) 2) Businesses increase market prices to pass on the impact of higher production costs to consumers. Consequently, the consumption of products (all necessities) with inelastic demand either remains same or observes slight decrease while the demand of luxuries and services with highly elastic demand observes a downward because of price escalation. In this way, aggregate demand reduces keeping all other factors such as income, market size, future expectations, tastes and preferences constant. In short, businesses record decline in their total sales and in net profits. 3) The rise in inflation due to rising costs of products decreases real incomes and purchasing power of consumers that in turn reduced economic activity. The aggregate demand and supply of products reduce as a result thereby reducing the amount of tax revenue to government. State authorities then record financial problems and as a result, budget for public sector development programme. In short, government is being unable to spend money for welfare and prosperity of society and people. (Power, 2009) Answer 3 Indeed, UG government has to take various steps to ensure economic recovery from recession. Indeed, the major reason behind economic contraction in UK is reduction in aggregate demand (AD) of products due to reduction in purchasing power and in money supply. In fact, potential consumers although have willingness to spend but they are cash starved and thus unable to meet their purchase requirements. Overall, demand of products at each price level has reduced in UK. In order to rectify this issue, UK government has to increase its open market purchases (G) thereby increasing the money supply in the market. As a result, the financial and goods markets will perform better and number of transactions will increase. Cash starved consumers and institutions will benefit from increase in money supply and will start making their routine purchases. According to economic theory, the upward shift in IS (investment – saving) curve after increase in government purchases will also cause an upward shift in AD curve while LM curve remains constant. Consequently, total output and economic activities will increase thereby resulting in better cash flows and improved real purchasing power. In addition, if government of UK reduces number of taxes (T) on businesses and consumers, the costs of manufacturing or production will reduce and overall price level for all goods and services will fall. The reduction in prices will increase real income of consumers i-e the amount of goods and service their money income can buy (having constant nominal income). Consequently, consumers will make more purchases that will cause an upward shift in aggregate demand of products. Similarly, producers will also want to produce more in anticipation of improvement in economic conditions and greater sales volume. Answer 5 The price of oil is impacted from various factors including global demand, oil supply, role of speculation, position of US oil stocks and fluctuations in dollar exchange. Indeed, I would like to through light over two major factors that are Oil demand and supply. Indeed, demand has increased over last 10 years because of phenomenal double digit growth in world most populist Asian countries namely China and India that are now among top ten consumers of oil. The industrial growth and increase in per capita consumption of oil in these nations have increased their imports from international commodity markets where supply remains relatively stagnant due to reduction in new annual oil discoveries and depletion of oil resources in Indonesia and Saudi Arabia. Similarly, Iran and Iraq has sufficient potential to increase supply, yet they can’t because of lack of capital resources and technology required to extract and refine crude oil. As per rule of economics, the fewer units but more buyers result in combat among parties thereby pushing oil prices upward. Answer 6 The oil has highly inelastic elastic demand and supply. According to various industry analysts and economic pundits, the price elasticity of demand of oil is between 0.05 – 0.10 while, the supply elasticity of oil is also below 0.10 as calculated by experts. Answer 7 Quite unequivocally, OPEC is a cartel where member countries mutually take production and supply-related decisions. OPEC members forecast future oil demand, dollar exchange rates, economic growth in advance and emerging economies, new developments in environmental protection policies and their impact on oil demand. Having done the above, the members evaluate and analyse the determinants of demand and then adjust their production and supply to stabilize oil prices across the globe. OPEC intentionally reduces supply and control production in the short run so that supply does not run too far ahead of demand and prices remain high. (Kilian, Rebucci and Spatafora, 2008) Answer 8 As far as the structure of oil industry is concerned, it should be noted that it is an oligopolistic industry dominated by nations with greater oil reserves and production capacity. Indeed, most of the OPEC members from Middle East and Africa are oil dependent economies that heavily rely on revenues from oil exports to boost their economy. The income from oil is then spent to meet government budget expenditures, on public sector development projects including infrastructure, utilities and construction as well as to finance imports of scarce resources. In contrast, oil is a basic need of all nations and is imported to meet domestic demand from residential, commercial and industrial consumers. Oil is used as a raw material in power generation plants to produce electricity, in private automobiles, industrial machinery and production plants, generators and for transportation of products in domestic and foreign markets (rail, road, air and sea). Obviously, higher oil prices impacts all aforementioned sectors by causing inflation and reducing aggregate consumption in an economy after decrease in real incomes and consumer purchasing power. The developing nations are adversely impacted because they import oil for their energy production. Unlike developed economies that have extensive resources at their disposal, in fact, developing countries do not have sufficient alternative energy sources such as natural gas, water, nuclear energy, wind mills and solar plants that aggravate their economic prosperity and growth. In addition, the negative growth in economy results in lower tax revenues to governments that later add to financial problems. Answer 9 “Economic boom” refers to the growth and expansion of primary (agriculture), secondary (manufacturing) and tertiary (services) sectors that in turn leads to an increase in trade and commerce. Recently, the ‘Boom’ had been observed in the world during 2002 – 2007. The word “Economic Recovery” is used when world observes the beginning of end-of-recession and improvement in global economy. In fact, the aggregate production, consumption and trade that reduced during recessionary cycle starts increasing and new business opportunities are created. Answer 10 The word Credit Crunch refers to liquidity and financial crises where cash available for spending on goods and services is much lesser than cash required. The world also faced Credit Crunch situation in 2008 – 2009 after debacle of financial markets in USA and in the world. Indeed, the reason behind it was failure of sub-prime mortgage scheme in 2008 that brought heavy losses to banks and other financial institutions which invested in failed mortgage scheme. In short, banks run of cash when they did not receive a large of installments from consumers that in turn created a shortfall of money or credit crunch in the entire economy. Sources: Francesca Steele (2009) “High oil prices threaten economic recovery” Times Online Power, Helen (2009) “High oil prices push manufacturing costs up” Times Online BBC News (2009) “Fuel cost causes driver cutbacks” BBC UK BBC News (2009) “Q&A: Volatile oil prices” BBC UK Lynch, Russell (2009) “Oil prices sends manufacturing costs up” The Independent Grady, Sean (2009) “Opec agrees to keep oil output unchanged” The Independent Savage, Michael (2009) “The Big Question: Does Opec have too much power, and is it to blame for the high price of oil?” The Independent Arnott, Sarah (2009) “Rising oil price could stall recovery, warns Opec” The Independent David Prosser (2009) “Opec members playing the same old games” The Independent Hamilton, James (2009) “Causes and Consequences of the Oil Shock of 2007-08” University of California Behr, Timo (2009) ‘The 2008 Oil Price Shock” Global Public Policy Institute Paper No. 1 Available at http://www.gppi.net/fileadmin/gppi/GPPiPP1_Oil_Prices_2009.pdf Kilian, Lutz, Alessandro Rebucci and Nikola Spatafora (2008) “Oil Shocks and External Balances” Available at http://www-personal.umich.edu/~lkilian/oil030908.pdf Read More