Changes in the Global Market for Crude Oil - Essay Example

Analysis of Changes in the Global Market for Crude Oil and Analysis of Changes in the Global Market for Crude Oil Introduction The changes in oil prices are determined by the forces of demand and supply. This is the case whether the political decision are made to minimize the production of oil by oil producing countries. OPEC has been a significant force in controlling the oil quantity supplied in a day and thus control the supply of crude oil in the market. This is the economic behind increase and decrease in the price of oil. A decrease in the supplied result to a rise in the prices of oil. Moreover, the law of demand require that an increase in the supply of oil produced in the day should lead to a decline in prices. This essay looks at the historical of price changes in the oil industry and the influence of market fundamentals. James Smith shares a perspective of trends in the oil prices and takes back to the spell between 1874 and 1974. He argues that during this time the prices of oil were characterized by a stable market (Smith, 2009). During the time, a barrel of oil ranged between $10-$20 (Smith, 2009). This period can be explained to have had a stable supply of crude oil that was accessible even to the remotest nations of the world. Therefore, given the market was with no movement, the price elasticity of demand was insignificant and thus the stable prices. After the ‘golden era,’ the world has experienced insurmountable boom and burst in the economies. The world achieved tremendous progress in the early 18th Century. During this time, the prices of crude oil were relatively low given that the supply was steady. However, the price of oil have increased since and resulted in the worst crisis in the world. The world experienced the great depression in mid-18th century. This was a result of decreased production of crude oil as a result of the war in the Middle East. And given that price elasticity of demand a minimum reduction in supply lead to an increased rise in the price of oil. The 1970s saw the price range between $12 to and $ 53 per barrel and shoot to $ 75 per barrel in 1981 (Smith, 2009). In the subsequent years, the prices continued to drop until it lowest at $12 per barrel in December 2008. However, in July the same year the price has risen to $ 145 (Smith, 2009). At the end of the same year had the price at $40 for a barrel (Smith, 2009). Smith cites a number of economic circumstances behind the trend in prices. There are a large number of factors that prompt changes in the global market for crude oil. The 20th century has witnessed increased and declined consumption of oil at the same time. James Hamilton cites oil demand propelled by emerging economies such as China while there was a decline in consumption in developed economies like United States, Canada, Europe, and Japan (Hamilton, 2014). The spell between 20th and 21st Century saw an increase in consumption each year at 440,000 barrels per day. Since 2005, there emerged a decline in consumption of oil in developed economies with recorded increase in consumption in developing economies (Hamilton, 2014). Hamilton argues that the developing economies guide the demand for oil. The decline in consumption in developed economies was as a result of significant loss of income as a result of the financial crisis. However, the decreased demand ought to have brought the prices of oil down, but they skyrocketed every year. Hamilton argues that it was not the decreased income that led to decreased demand for oil in North America, but people shied away because of high prices (Hamilton, 2014). These economies sought alternative hydrocarbons as sources of energy (Hamilton, 2014). These substitutes are considered cheaper though of low quality compared with oil. Hamilton spares some attention at the rate of production of crude oil over time. There has been a component of festering world production of unpolished oil. The resultant decrease in supply increases demands soaring prices hence. The hike in prices would reduce consumption in developed countries. The stagnated production is credited to an amount of factors in the global market. Geopolitical turbulences in oil producing nations affected production. Libya suffered a setback in 2011 in an attempt to oust Gadhafi from power. There were reduced exports hence the cut in supply. The nation suffered labor disputes after the upheaval hence reduced production. Persistent conflicting between warring militias did not help the situation (Hamilton, 2014). Geological limitations have played a significant role in the global market for crude oil. Saudi Arabia controls a third of oil production globally (Hamilton, 2014). It exerts deliberate control on exploitation and supply of this product. It works to ensure good returns to the investors in the industry (Ruhl & Naumov, 2014). A cut in supply increases demands thus increased prices. The prices attract suppliers who consequently increase the amount of supply in the market (The-Economist, 2014). Time after that creates room for stability as the price finds equilibrium. Figure 1 Shift in demand and supply curves (Smith, 2009) A cut in the supply of crude oil by producers prompt the demand to rise. This is demonstrated by the shift in the demand curve from d1 to d2. The cut in supply has an effect of shifting the supply curve from S1 to S2. The resultant of the decrease in supply established a new equilibrium at point q2, P2. Therefore, as a result of supply shock the equilibrium market price of crude oil changes from P1, q2 to P2, q2 as the show in the graph. This explains the how the crude oil price has persistently been increasing from year to year out since 2005. The increase in demand for oil as a result of increased income and population growth is equal to q2-q1. This is the quantity that shift the demand curve to the right. And because the elasticity of demand is not constant, the change in the price of oil is bigger than the change in quantity supplied. Smith argues that the price elasticity of demand varies by region, time and the method used to estimate it. However, he says that the price elasticity of demand is estimated to be -0.05 in the short term while it is -0.30 in the long term. But it required a number of years to calculate making it impossible to have current price elasticity of demand and supply. Figure 2 Figure 2 show the changes in demand and supply of oil over a period of 33 years (Smith, 2009). The data used 1975 as the base year (Smith, 2009). From the graph estimated demand has a long run elasticity of 0.3 while non-OPEC supply have an elasticity of -0.3 (Smith, 2009). The graph demonstrates the volatility of price oil as a result of changes in demand and supply given that the elasticity of demand and supply is not 1. Given that price elasticity for oil = Change in quantity/Change in price Elasticity of demand= (Q2/Q1) x (P1/P2) eD And Elasticity of supply= (Q1 /Q2) x (P1/P2) eS According to Hamilton, an income elasticity of 0.7 is high enough to necessitate an increased production by about 20% (Hamilton, 2014). However, this was not experienced though in the wake of stable prices. The production of crude oil only rose by 3.1% (Hamilton, 2014). Nevertheless, the elasticity of price of oil of about 0.3 has helped the price increase, but while other factors considered (geopolitical disturbance) (Hamilton, 2014). Price volatility is an element that affects the oil industry. The commodity is surrounded by delicate forces of demands and supply that are triggered by other elements of the global economy. In many incidences, the price has always hiked reducing affordability and consequently cutting consumption (Thomson Reuters, 2015). June 2014 had the prices rise to $106 for each barrel of oil? January 2015 has had the prices below $ 50 (Thomson Reuters, 2015). An examination of the size and scope of the oil industry gives an insight into the nature of the changes evident in the oil global market. The supply and demand of the product subjects a lot of stakeholders to delicate circumstances. With more than 70% of oil reserves being in the Arab world, the price of the product will totally depend on the decisions executed by these nations. The recent drop in prices is affecting economic environments in the vast parts of the world with reports of narrowing divergence ii MENA sovereign credit trends (Reuters, 2015). Smith cites economic growth in world major economies as a driving force in the trending oil prices (Smith, 2009). Industrial revolution is calling for energy sources to run these industries thus creating an avenue that increases demand for oil. Increased income in the hands of investors is earning them buying power even when prices are beyond the reach of others. Geopolitical issues, role of OPEC and other elements may result in reduced supply of the product and given the elasticity of the prices of oil the price of the product will increase as supply decreases. The supply curve shifts inside from S1 to S2. Increased oil prices attract suppliers, ceteris paribus. There is amplified supply of the product making the supply curve to shift outwards. A state of equilibrium is realized when the quantity necessitated equals the quantity supplied. In conclusion, the world will continue to experience unstable oil market condition as a result of increases forces that interfere with a smooth oil production. The crisis in the Arab world where most of the world get their energy from pose a great danger to the cost of living given the supply shock. REFERENCES Hamilton, J. D., 2014. The Changing Face of World Oil Markets. [Online] Available at: econweb.ucsd.edu/~jhamilto/IAEE_2014.pdf [Accessed 23 Feb 2015]. Reuters, 2015. Fitch: Oil Price Fall Narrowing Divergence in MENA Sovereign Credit Trends. [Online] Available at: https://www.google.com/search?q=trends+in+oil+prices-+reuters&ie=utf-8&oe=utf-8 [Accessed 23rd Feb 2015]. Ruhl, C. & Naumov, A., 2014. Energy in 2013 – Taking Stock: Highlights from the 2014. [Online] Available at: http://www.iaee.org/documents/2014EnergyForum4qtr.pdf [Accessed 23rd Feb 2015]. Smith, J. L., 2009. World Oil: Market or Mayhem?. Journal of Economic Perspectives, 23(3), pp. 145-164. The-Economist, 2014. Why the oil prices are falling. [Online] Available at: http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4 [Accessed 23rd Feb 2015]. Thomson Reuters, 2015. Global crude oil prices - changing market dynamics. [Online] Available at: http://www.zawya.com/story/Global_crude_oil_prices__changing_market_dynamics-ZAWYA20150222074242/ [Accessed 23 February 2015]. Read More