Oil Market Dynamics and 2016 Outlook by Bluford Putman - Article Example

“Oil Market Dynamics and 2016 Outlook” By Bluford Putman

The article “Oil Market Dynamics and 2016 Outlook” is highlights a detailed discussion on the supply and demand in the oil market. The author starts by noting that over the recent past, the oil market has experienced “a powerful downward price adjustment” which was sustained throughout the period 2015 (Putnam, 2016). According to the author, there are several long-term demand and supply forces in play and the short-term response factors that make it hard to solve the problem of the decreasing oil prices globally. On the supply side, the author notes that there are technology driven improvements in reference to the extraction techniques that have ignited the production boom in the U.S back in 2016. On the demand side, the author notes that there is a big shift in the global growth environment emanating from the emerging market boom in the early 2000s to the slow growth after the 2008-2009 Great Recession (Putnam, 2016). The two persistent demand trends include continued advancement in the transportation of the fuel efficiency and the slow global growth. The supply trend on the other hand is grounded in the technological improvements pace that are linked to the continued reductions in the extraction costs.

This essay will discuss the demand and supply in regards to the oil, including the determinants of both (as briefly mentioned in the article). Additionally, the paper will cover the price elasticity of the demand, the income elasticity, total revenue and the surplus.

Demand can be described as the relationship between the quantity that is demanded and the price for the particular good or the service. The reason for the continued decrease in the price of the oil can be linked to the law of demand and supply. The global oil supply has continued to increase faster than the demand. With the discovery of new technologies for the extraction of the oil, the trend is unlikely to be reversed in the near future. On the demand side for instance, extended periods of the relatively higher oil prices leads to the consumers shunning their vehicles that are not fuel efficient. People and the businesses pay more attention to the conservation of the energy owing to its cost. This leads to the reduction of demand of oil and this creates a consumer surplus as shown in fig 1 and 2 below. On the supply side, the higher oil prices leads to the more drilling projects and innovations in the new technologies and efficiencies (Putnam, 2016). As such, many of the projects that were previously not viable at the lower prices become viable. These activities lead to the increase in the supply.

According to the article, the slow global growth is a major reason behind the low price of the oil (demand side). For instance, China is decelerating. Russia and Brazil are in recession. Majority of the emerging markets are struggling to grow. In the mature markets, such as the United States, japan and Europe, the best that can be recorded is the real GDP growth of about 2% (Putnam, 2016). In essence, the period of the strong commodity demand in the 2000s that was supported by the 10% real GDP growth in countries such as China is gone with little prospect of return (Putnam, 2016). As such, the impacts of this is sluggish growth in the demand for the oil and, consequently a decrease in the price of the oil. Therefore, this has an effect of creating a consumer surplus since now consumers can afford to buy oil due to relatively lower prices as demonstrated by fig. 2 below.

Also on the demand side, fuel efficiency also play a critical role. Crude oil is 70-75%a transportation fuel in regard to the uses of the refined petroleum products. The continued surge toward the greater fuel efficiency is not only impressive, but also a continued drag on the demand growth for the crude oil. The elasticity of demand for the oil with reference to the real GDP growth is in fact a declining path in the long-run (Putnam, 2016). Thus the technological advancements in the transportation sector means that the elasticity of demand for the crude oil with regard to the economic growth is declining. Electric vehicles are being introduced as the means of transportation adding up to the stagnation of the oil prices.

On the supply side, the article asserts that further advancements in the technology with regard to the oil extraction leads to the reduction of the costs thereby allowing more production from the lesser oil rigs (Baumeister, Christiane, and Lutz, 2016). The positive advancement in regards to the technology allows the oil companies to produce more outputs with similar input. A reduction in the cost of the extraction of the crude oil will lead to the decrease cost of the production. This means that the firms will be supplying more making the supply curve to shift to the left. As a result, the price of the oil will decrease and the quantity supply will increase. Therefore, this creates a producer surplus with consumer demanding the same quantity at the same prices as shown in fig. 4 below.

The geopolitical situation is another main determinant of the supply part of the oil. For instance, the conflicts in the Middle East, particularly those involving Iran and Saudi Arabia are the major distractions to the supply of the oil (Robertson, 2016). Additionally, the expectations and fears by the oil producers in order to be able to optimise the profits also affects the supply of the oil. The oil producers may hoard the oil, thereby leading to the scarcity in terms of supply.

The market for the oil is very unpredictable. In the short-term, both the supply and demand are highly inelastic. For instance, irrespective of the price of the petrol, your car cannot switch to the other fuel. In this case, a large change in the price of the oil only results in a small impact on the demand. This leads to a short-term demand curve as shown below in figure 4. Although oil supply and demand is inelastic in the short term, in the long term, it can be remarkably elastic (Putnam, 2016). For instance, if the long-term expectations for the oil prices increase, then both the supply and demand curves will shift to the right and left respectively.

Consumer surplus can be defined as the benefit that the consumer gain from the goods. This is represented in graphical format in figure 1 and 2 below at prices P0 and P1.

(a) Consumer Surplus at Price P0

(b) Consumer Surplus at Price P1Fig. 1

Fig. 2

Producer surplus on the other hand is the price of the good minus the marginal cost of producing that particular good. This is represented in graphical format in figure 1 and 2 below at prices P0 and P1.

(a) Producer Surplus at Price P0

Fig. 3

(b) Producer Surplus at Price P1

Fig. 4

The oil prices are very volatile in the short-term owing to the fact that supply and demand are inelastic. This is because the limited supply of the oil will make the supply curve to shift to the left, leading to the sharp increase in the price. In regard to demand, the prices are volatile because of the lack of the perfect substitutes to oil, as such, the increase in the demand for the oil will lead to the shifting of the demand curve to the right consequently leading to the sharp increase in the prices (Andreoli, 2016). However, in the long run, the supply and demand is elastic because the future alternatives provides the potential for the increased supply and the reduced demand.

Conclusion

The article has mainly concentrated on the analysis for long period of the low crude oil prices. The author has pointed out that the slow growth that is attributed to the aging demographic challenges and the technological advances in the fuel efficiency are the main factors affecting the demand side of the supply and demand of the oil. On the other hand, the technological improvements in the extraction of the oil, geopolitical factors, and producer expectations, among others impact the supply side of the demand and supply for the oil. Generally, the demand and supply of the oil is expected to continue to grow owing to the fast rate of the industrialisation, technological advancements, and the increasing population worldwide (Putnam, 2016). With most parts of Europe in recession and the US oil production on the rise, it is expected that the supply of the oil will continue to rise. However, despite the invention of the new alternatives sources of the energy such as solar energy, biodiesels, among others, the demand for the oil is still expected to grow in the future.