The Economic and Political Factors Behind the High Prices of Oil - Research Paper Example

Thesis: The economic factors and political factors are both behind the high prices of oil. Introduction: People use a lot of things that make life easier. All of those things save time for people who need to do their jobs and take care of their families. When people wake up in the morning, they turn on the lights, take a shower, prepare breakfast and then they use their cars to go to their desired destinations like schools, universities or jobs. Everything in their life needs energy. Some of the energy is from electric power, and other energy is generated by thermal energy. People might think gasoline prices today are very high. But they probably do not know the reason behind the high prices. Oil is taken out of the ground, deep from the ocean floors, from underneath ice or other places where workers risk their lives. They need a drill and dig in to the earth’s surface miles and miles below. Once the oil is found, it takes a long time to transport them, with expensive ships, and then convert them into gasoline through various processes. Trucks transport these converted gasoline to the petrol stations which involves high amount of money for transportation, and the gas stations have to have expensive equipment for storing them. This is also one reason for the high price of oil and has to be conserved accordingly. There are several reasons that make oil prices so high which have increased dramatically over a period of time. There are few main factors behind the high oil prices. They are. Political factors, economic factors and other factors like OPEC which are the reason behind the high oil prices. There is a lot of debate about which factors are the biggest reason or if are they equally responsible for the high prices. Sometimes, these factors work in combination with each other to raise prices even higher. Causes for high prices: There are few factors that cause increase in the price of petrol. It is very essential to understand these factors and find a solution to keep the factors under control. The price of oil is very essential in international trade and also for the growth of the nations. Economic Factors: There are various factors that affect the price of oil. The economic factors that affect the oil prices are weak of the US dollar and supply and demand. These factors are controllable factors. Weak US Dollar Berman states that some analysts blame high oil prices on the weak US dollar. Theoretically, a weak dollar only means that a barrel of oil cost more in the United States and the countries that base their currencies on the US dollar. (Pg23) The purchasing power when a currency becomes weak, the nation either imports the same amount of product at a higher cost or a lower amount of foreign commodities for the same cost, which causes difference in the standard of living of people and also change the saving and investment rates of the people and the nation. US dollar as a weak dollar makes other currencies get dearer and the dollar gets cheaper. The weak currency has a lower purchasing power so the commodities denominated in terms of that currency must now offer higher prices for the same amount of goods and services. Oil prices per barrel are valued in terms of dollars. “The US dollar is frequently used as the invoicing currency of international crude oil trading. Hence, the fluctuation in US dollar exchange rate is believed to underlie the volatility of crude oil price and especially its forecasting accuracy.”(Zhang, Fan, Tsai, Wei. 973). Most of the international transactions happen in dollars. When the dollar value goes up or down, it directly affects the oil price as the international trade of oil happen in dollars. “Reports the impact of devaluation of US dollar on the purchasing power of Organization of Petroleum Exporting Countries (OPEC) Joint effort of OPEC to push up the US dollar”. (Bahree and Tanner, online). So, when dollar gets cheaper, the value of oil per barrel get lower and thus becomes more attractive for nations with stronger currencies to buy large quantities which in turn will increase the demand for oil the price of oil barrels starts rising. This is an economic factor that affects the oil prices. Supply and Demand: Oil is an exhaustible natural resource and has reserves in very few nations of the world and hence the supply of oil is inelastic in nature. Few observations indicate that the price of crude oil is an important gateway for disturbances to the oil supply chain. As large number of countries throughout the world are developing or at the verge of getting developed, there has been increase in demand for oils. The price of oil increases with increase in demand for oil. One of the most important economic reasons that have resulted to a soaring up of oil prices since last decade was when India and China turned out to be two of the ten high importers of oil in the world. When there is limitation in supply of oil, it increases the demand of oil resulting in the price hike. “Fossil fuels possess very useful properties not shared by non-conventional energy sources that have made them popular during the last century but unfortunately they are not renewable. Since the oil crisis of 1973, considerable progress has been made in the search for alternative energy sources.”(Mirza, Ahmad, Harijan and Majeed, Pg.1111) Stock market down The down trend in the stock market causes rise in oil prices. Rise in the price of oil increases the cost of the other products. There is a demand caused for all the commodities which are an out come of the problem in transporting products as there is lack of fuel. The cost of production also increases as there is a rise the in cost of transport which leads to price hikes of finished goods which causes inflation. As the inflation rate goes up, there is a negative impact caused in the stock markets. People avoid investing in stocks and shares. This conclusion has been drawn from the Fisher theory, which says that the nominal rate of return of an asset has two components, the unanticipated inflation rate and the real rate of return from the assets. So, with an unchanged nominal rate of return, a higher rate of inflation will lead to a lower rate of real return from the assets and ultimately the equity holders earn lower rate of dividends in real terms. The investors respond to this by selling their shares and stocks which lowering the stock prices resulting in the stock market slow down. “Oil companies are allowed to rise or drop retail prices by 8 percent from a government set benchmark. Despite the price spike on the international market, Chinese government hasn't adjusted the prices since mid-May because the government is concerned that the price increase may undermine its efforts to cool down the economy. The rapid growth in demand for oil products has forced Chinese refineries to run at top rates, leading to a crude oil import surge.”(China Chemical Reporter, online) Political Factors: Apart from the economic factors, there are also political factors that cause high oil prices. Oil being is one of the greatest resources for a nation; it also brings good revenue to the governments. It is also used in all the activities and there is a high level of consumption y all the nations. Hence most of the nations aim at having a good reserve of the resources. The politics between countries make political factors as the cause of high oil prices. Sudan War: Sudan is a country with rich oil resources. They give them the huge military benefit. Hence they planned to develop their country with their own natural resources and were falling to be a united Sudan. There was always a clash between the northern and southern part of the nation. This Civil War is being fought over the revenue from oil. There are three different groups of militant forces who all have weapons. The government is also involved in the fighting, so in total, there are four groups involved in the Civil War. Until a stable government is created and maintained, the violence will continue. Before unrest stops in this area, the prices of oil will continue to be affected. (Patey, 1000-1002) The war in the nation caused tension to the oil companies and oil districts. This caused a rise in the oil prices. During the 1980’s the price of a barrel of oil was nominal. There was more peace in the Middle East region than today. American went to Iraq and initiated the war; the country was not able to produce the same amount of oil as earlier. Moreover, the region became even more dangerous. The risk of terrorism attacks increased. In fact, the war in Iraq damaged a lot of buildings, hospitals, and streets. To reconstruct the country, Iraq needed to produce more oil, unfortunately the war made this impossible. They were forced to import oil from other countries, such as Saudi, Kuwait and United Arab Emirates. The huge amount of demands and the fact that the country and its need to be reconstructed affected the oil price marked dramatically. In fact, this unfortunate situation helped Oil producer’s cartel OPEC to limit their production. This could now be blamed on war and the possible risks of terrorism attacks. (Emmott, 47) Iraq war in 2003 The war on Iraq by American had oil as the major reason. Iraq is one of the richest countries in oil resources. The war in Iraq hiked the price of oil to great extent. Oil is at the sensitivity of the crisis between the US and Iraq. Main powers have fought in order to control this source of riches and power. Oil is indubitably a concern, and that the United States has used military force in the past for energy purposes, these precedents fail to explain the current military operations in the region. There is strong evidence that major oil companies no longer favor war in the Middle East, because they prefer stability and predictability to periodic spikes in the oil price that result from war and political convulsion. (Ismael, Zadeh. 295). All of them were keen to achieve power over Iraq's oil, lost with the nationalization. The history of the world oil industry is a history of power; the resources in the country made America wage a war against Iraq. Attaining Iraq will give the power to America to use that resources .Hence it is one of the political issues for oil crisis. Other Factors affecting oil prices Apart from the economical and political factors, there are other factors like monopoly of OPEC which causes high oil prices. Organization of Petroleum Exporting Countries (OPEC) OPEC is an organization consisting of thirteen countries that produce and export oil. Oil is the main product and the force behind the economies of these nations. The money made from selling this oil to importing and consuming countries supports the majority of the population in these nations, which totals approximately 585 million people (OPEC, Online). Monopoly of the OPEC: After the Second World War, the oil conserves in the USA were exhausted to a large extent due to the high usage of oil for the military power which resulted to an inclination towards the Middle-East for a regular oil supply. OPEC is a cartel that was formed between the oil producing nations of the Middle-East, in the 1960’s. In terms of oil production and controlling the world's greatest sovereign wealth, Abu Dhabi is said to be at the top of their game, defying the predicted worsening global conditions. With the oil abundance, maximized advantages, and strategic foreign relations, they will continue to lead in technological sectors. There have been proposals to diversify the source for economic revenue in Abu Dhabi. (Davidson, Pg.59). Majority of the nations depended on them for oil supply which gave them a monopoly situation. There is no other organization which competes with the OPEC and hence they have a price advantage. ” Saudi Arabia has announced that the new oilfield will push up Organization of Petroleum Exporting Countries' (OPEC) total spare capacity to about 8% of world oil consumption. The Khurais field has the capacity to produce 1.2m barrel per day of Arabian Light crude, and is the final element in Saudi Arabian Oil Co.'s (Saudi Aramco) plan to increase its capacity to 12.5m barrel per day by end-2009.” (Global agenda, 7) The OPEC enjoys advantage of profits through their monopoly situation. Other control factors Oil is one of the most important resources in the world and it won’t be feasible at all if its supply is managed by an organization that exploits its powers to serve its own interests. The presence of just one organization and a good treaty between all the nations for supply and price of oil is another reason for high prices. At the same time, it isn’t suitable enough if no organization shoulders the responsibility because in such a situation, oil conservation will be a very difficult task as non force would act to maintain or regulate the oil supply. A possible way-out in such a situation would the formation of another organization consisting of representatives from all major oil-importing nations, so that their voices would be unified and they can create a counter pressure on the seller countries in case they exert any pressure on the former because then in one-way there would be a single buyer and a single seller in the market. In such case, both the parties are bound to listen to the demands of the other. Natural calamity The price rise is also caused when there is a natural calamity. When there is flood or earthquake or any kind of a natural calamity, it affects the mining of these resources and also transporting them to desired locations for transforming in to the usable form. It would also be difficult to import or export oil to other countries. For example when an oil exporting country faces natural calamity, it finds it difficult to explore the resource and undergo the process of extraction. The available oil with the country cannot be transported to the countries which are in bad need of the resource. This will also increase the price of oil. The countries which require this resource will be ready to buy them at any price due to the urgent requirement of the resources. This will increase the demand and decrease the supply hence resulting in high prices of oil. The prices would comeback to the normal position once the country recovers from the problem. But this natural factor can not be controlled like the other factors. The nations can aim at setting up reserves for their future use to avoid these kinds of situations. Conclusion Oil is one of the most important fossil fuels in the world. Like any other product, is expected that oil would also be subject to price swings during periods of supply shortage or increase. But, in most instances it is found that oil prices are more subject to external forces rather than purely economic ones There are other minor factors that cause change in oil prices like the monopoly of OPEC (Organization of Petroleum Exporting Countries). It has often been found that oil price hike is caused by regulations built by OPEC. But this factor is controllable and they can be solved through good control over the organization. However economic factors also play a role in the rise of oil prices. These factors are caused naturally. For example, the present down fall of the share market caused increase in oil price. In a due course of time, the market would comeback to normal trend which will also bring back the normal oil price. The political factors cause problem in exporting or importing oil and thus creating a false demand which increases the oil prices drastically. Because war between nations is planned by the governments, they do not occur naturally. War spoils the living condition of people, wealth of the nations; it causes huge losses to the countries and also utilized power and energy like oil in abundance for their military power. This causes disturbance to the whole world to large extents. Hence this is considered as the major factor that causes increase in oil prices The oil prices can be brought to control by taking careful measures on all factors. A good understanding and treaty between nations are very important for world growth. The OPEC can play a very important role in keeping the price at a reasonable level with out much fluctuations, it must not take any political pressures in to consideration. They must only consider the well being of all the nations and must give many priorities to developing and underdeveloped nations. The united act of all the nations and the OPEC can together bring a positive trend to global improvement and global peace. No war agreements and one common organization to look in to the social benefit of nations will decrease the problems arising due to the instabilities. As oil is an important product which affects the economy of the world, it has to be controlled effectively. There must be appropriate control over the oil price which should allow International growth and help all the nations equally. The policies must be developed in such a way that they help the developing and developed nations. Works Cited Bahree, Bhushan, and James Tanner. "OPEC plan to lift oil prices goes awry." Wall Street Journal - Eastern Edition 225.48 (1995): A2 Berman, Arthur. “The High Price of Oil.” World Oil 229.8 (2008):23. Davidson, Christopher. "Abu Dhabi's New Economy: Oil, Investment and Domestic Development." Middle East Policy 16.2 (Summer2009 2009): 59-79. Emmott, Bill. Foreign Affairs. “Who Wins in Iraq?” Mar/Apt 2007 "High International Oil Prices Hits Chinese Market." China Chemical Reporter 15.25 (Sep. 2004): 4-4. Hossein-Zadeh, Ismael. "The Political Economy of US Wars of Choice: Are They Really Oil Wars?" Perspectives on Global Development & Technology 8.2 (2009): 295-314. Kaufmann, Robert K.; Dees, Stephane; Mann, Micheal, “Horizontal and vertical transmissions in the US oil supply chain,” Energy Policy 37.2 (February 2009) 644 Patey, Luke Anthony. “State Rules: Oil Companies and Armed Conflict in Sudan.” 28.5 July 2007 investing in tragedy Mirza, Umar K. "A vision for hydrogen economy in Pakistan." Renewable & Sustainable Energy Reviews 13.5 (June 2009): P.1111-1115. Academic Search Complete. "Oil to spare." Global Agenda (13 June 2009): 7 OPEC, Organization of Petroleum Exporting Countries Zhang, Yue-Jun. "Spillover effect of US dollar exchange rate on oil prices." Journal of Policy Modeling 30.6 (2008): 973-991. Read More