Supply and Demand of Oil and Relationship to Global Economy - Research Paper Example

Supply and Demand of Oil and Relationship to Global Economy Introduction The existing energy sources in the United States are vital to the economic development and progress. In line with this, a significant increase on the demand for energy would mean the need to increase the energy supply coming from different sources of energy. To increase the available energy supply in the United States, the U.S. government decided to spend US$500 billion each year in the development of energy sources alone (U.S. Department of Energy, 2009). As of January 2010, the market price of crude oil was $77.62 per barrel (MSNBC, 2010) as compared to $25 per barrel back in 2003 (William, 2008). Last June 2008, the prices of crude oil reached as high as $142.99 per barrel (Frei, 2008). With the continuously increasing prices of oil per barrel, not only does the cost of transportation increases but also the prices of major commodities like rice, wheat, sugar and other food including other non-food products (Southern States News, 2008). Using the basic laws of supply and demand, economic factors that significantly affect the changes in the market prices of crude oil as well as the negative social and economic consequences of the crude oil inflation will be tackled in details. After discussing the impact of supply and demand over the increase and decrease in the market prices of crude oil, the researcher will seek to identify and enumerate all options that will enable our countrymen to counteract the social and economic threat that is highly associated with the high prices of crude oil. Economic Factors that Affects the Changes in the Market Prices of Crude Oil The trend in the demand and supply of energy can be affected by external factors such as: the prices of global energy sources, the U.S. and the global economic growth, availability of advanced technology, as well as the future public policy decisions in the United States and in other countries. On top of these economic factors, the U.S. latest legislations and regulation against the emission of air pollution and greenhouse gasses could also affect the future’s energy sources (Energy Information Administration, 2008). As a general rule, the market price for crude oil increases when demand for oil is more than the available supply in the market. On the contrary, market price for crude oil decreases when supply for oil is greater than the market demand. (See Figure I – Supply and Demand Curve when Supply of Oil is Scare below; Figure II – Supply and Demand Curve when Supply of Oil is Abundant on page 4) Figure I – Supply and Demand Curve when Supply of Oil is Scare Figure II – Supply and Demand Curve when Supply of Oil is Abundant Shortage and surplus of oil can occur in the global market up to a point wherein the demand and supply curve meets at the equilibrium point. Basically, the market equilibrium price and quantity is the point where the quantity supplied is equal to the quantity demanded. The said equilibrium point changes when there is an imbalance between the demand and supply. For example: If demand for oil is above the supply level, the price of oil in the global market will automatically increase up to a certain point where a new equilibrium point will be created. On the contrary, if the supply for goods is more the demand level, the market price of goods is expected to decrease. Changes in the supply and demand curve will cause significant changes in the market equilibrium point (U.S. Energy Information Administration, 2010 b). (See Figure III – Global Market Equilibrium Point on page 5) Figure III – Global Market Equilibrium Point In economic point-of-view, shortage of oil occurs when the demanded quantity of oil in the global market is more than the available supply. It means that a surplus will occur when the supply of oil available in the global market is more than the expected demand. Considering that supply of oil in each country is highly dependent on the global market price, a shortage of oil is possible in the U.S. local market in case the market prices of oil in the global market shoot up. Likewise, government intervention in another country is also possible to affect the supply of oil in the U.S. market. A good example wherein government intervention in another country could lead to shortage of oil in the U.S. market is the case of Yom Kuppur War back in 1973 wherein several Arab OPEC nations stopped selling oil to the United States as a sign of protest to the support of the U.S. government which was extended to Israel in the Arab-Israeli “Yom Kuppur War” (U.S. Energy Information Administration, 2008). Other than the Arab Oil Embargo, other significant historical event that leads to shortage of oil in the global markets includes: (1) the Iranian Revolution or the Iran-Iraq War during the last quarter of 1978; (2) when OPEC intentional decided to produce less oil in order to increase the market prices of oil (1980); (3) when Saudi Arabia hold back the production of oil in 1986; and (4) when Iraq invaded Kuwait in 1990 causing the market prices of crude oil to increase among others (U.S. Energy Information Administration, 2008). All of these economic factors had significantly decreased the supply of oil products in the global markets causing the prices of oil to increase accordingly. Negative Social and Economic Consequences of the Crude Oil Inflation As a negative economic consequence of the Arab Oil Embargo, the United States experienced a temporary shortage in the supply of oil. Back then, the domestic price of oil within the U.S. market increased overtime. Other than creating the Strategic Petroleum Reserve (SPR), the Congress passed the Energy Policy and Conservation Act [EPCA] of 19751 in order to increase the overall oil production by awarding price incentives to oil producers. In reality, the sudden increase in the world market prices of oil products has significantly affected billions of people not only in the United States but around the world. Given that a lot of developed and developing countries around the world are heavily relying on the use of oil products as its major source of energy, millions of businesses around the world especially those who are in the manufacturing sector are badly hurt with the continuously increasing oil prices in the world market. Oil is one of the major energy resources that most countries need in order to support their economic development. In line with this, changes in the monetary exchange rate has a significant role in producing different degree of economic impact as a result of the sudden increase and decrease in the global market price of oil products. Among the different countries around the world, European countries are among the least affected countries despite the continuously increasing market prices for crude oil because of the high purchasing power of euro. With regards to the issue on exchange rate, economic analysts explain that “dollar dominated” countries such as in the case of the United States are the ones that are seriously facing the negative consequences of paying a higher price for oil and other basic commodities (Iqbal, 2008). Recommended Solutions To avoid facing the economic consequences of uncontrollable oil shortage in the global market, the U.S. Department of Energy decided to rely over the use of biofuels and fossil fuels (Science Daily, 2007). In general, biomass residues include not only urban wood waste products but also forest residues, used papers and pulps, as well as other agricultural residues. As part of producing cellulosic and hemicellulose ethanol, the use of high-tech enzymatic hydrolysis can enable us to process additional plants and other biomass residues into fermentable sugars (U.S. Energy Information Administration, 2010 ). Through the use of Fischer-Tropsch process or other specialized microbes, readily available biomass can be converted into synthesis gas like hydrogen or carbon monoxide and eventually into ethanol as the end result (U.S. Energy Information Administration, 2010 ). This strategy is considered one of the low-cost ways to increase the available supply of fuel-quality ethanol in the U.S. market. With the purpose of controlling the long-term negative economic impact of high market prices of crude oil in the global markets, the U.S. government is currently promoting the shift from the use of gasoline to ethanol on domestic transportation. As a result of the strong government support that has been extended to the local producers of gasohol or E102 in the United States, the total number of U.S. motorist that consumes ethanol has been constantly increasing since 2000 (U.S. Energy Information Administration, 2007). This was made possible because of the significant increase in the local production of ethanol and biodiesel for vehicle consumption. Maximization principle in economics has a crucial role to play behind the success of promoting the biofuel in the U.S. market. As result of implementing the Energy Policy Act of 2005, ethanol consumption is expected to reach 11.2 billion gallons by 2012 (Winters, 2010). Because of the positive acceptance in the local market, local producers of gasohol are planning to increase the ethanol blend from 10% up to 85% by volume for E85 (U.S. Energy Information Administration, 2007). In relation to the increase in the supply of gasohol, local car manufacturers such as Ford, Daimler Chrysler, and General Motors have started producing “flexible-fuel” vehicles like cars, trucks, and minivans that requires the use of E10 and E85 (Flavin et al., 2006). In the long run, significant change in the demand for oil products could eventually result to the decrease in the total annual demand for gasoline and diesel in the U.S. market. Discussion Although the market prices of oil products in the global market could significantly affect the business activities in other non-oil producing countries, the government in each non-oil producing countries has the power to minimize the negative impact of sudden increase in the market price of oil products in the global market. This can be done by creating alternative sources of oil products. There is a trade-off between the use of pure gasoline with the use of E10 or E85. Since the United States could not produce oil supply more than its demand, the use of E10 and E85 is more economical as compared to the use of pure gasoline or diesel. With regards to the cost of transportation, increasing the supply of biofuel needed in the production of E10 or E85 could eventually decrease the domestic prices of fuel in the U.S. market. Aiming to drive down the cost of E10 and E85 in the U.S. market, the U.S. government should support the local manufacturers of biofuel for E10 and E85. Basically, increasing the supply of biofuel for the production of E10 and E85 could decrease the total demand for crude oil in the global market. Conclusion The basic principle behind the law of supply and demand is useful in terms of analyzing the factors that could significantly affect the changes in market prices of oil products. In line with this, the increase in supply of oil more than the demand could drive down the market prices of oil in the global market. On the contrary, a sudden decrease in the supply of oil products in the global market could result to the sudden increase in the market prices of oil. Oil is one of the major energy resources that most countries need in order to support their economic development. However, external economic factors such as the case of Arab Oil Embargo, the Iranian Revolution or the Iran-Iraq War during the last quarter of 1978; the incidence when the OPEC intentional decided to produce less oil in order to increase the market prices of oil (1980); holding back Saudi Arabia’s production of oil; the presence of war in major oil producing countries like Iraq and Kuwait could suddenly cause the market prices of oil products to increase. In line with this, government intervention in non-oil producing countries is necessary to counteract the negative economic consequences of a sudden increase in the market price of oil. It is not a good idea for the local governments to control the domestic prices of oil products since this strategy could result to more serious long-term economic consequences in a country’s overall economic performance. By developing alternative sources of energy other than the use of oil products, there is a better chance for each country to protect themselves from the sudden fluctuation in the global market price of oil. References Energy Information Administration. (2008, March). Retrieved June 6, 2010, from Annual Energy Outlook 2008 (Early Release) : http://www.eia.doe.gov/oiaf/aeo/trends.html. Flavin, C., Sawin, J. L., Mastny, L., Aeck, M. H., Hunt, S., MacEvitt, A., et al. (2006, September). Retrieved June 6, 2010, from American Energy. The Renewable Path to Energy Security: http://images1.americanprogress.org/il80web20037/americanenergynow/AmericanEnergy.pdf. Frei, E. (2008, June 27). Oil Marketer. Retrieved June 6, 2010, from WTI, Brent in new records near $143 per barrel: http://www.oilmarketer.co.uk/2008/06/27/wti-brent-in-new-records-near-143-per-barrel/. Iqbal, S. (2008, April 24). DAWN the Internet. 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