The Causes of Oil Price Rise - Essay Example

Oil Price Rise: A Literature Review of the Causes Department Oil Price Rise: A Literature Review of the Causes Introduction In the 20th century, world started integrating on economic ground. The century saw one of the fastest growths in the history of mankind. Terms like World Economy started making headline. Most of the nations especially from the western world made full use of this revolution by harnessing their resources with advance machines and equipments. Transportation got a boost with the advent of railways and airplanes. The world is totally different than what it was around 100 years back. The main reason behind this economic ride and development has been nothing but using fuels as a source of energy. The world moved itself from using wood to coal and finally to oil or better to say petroleum. It is this petroleum over which this industrial revolution bloomed. With very few nations producing oil but being required by the whole world, Oil has been one the most sought after commodity with oil producing countries having their coffer flushing with dollars. Changes in oil prices have caused great impact on the performance of the world economy. It has its association with almost each and every period of recession and inflation (Barrell, 2004, p. 2). Oil shocks of 1974 and 1979 brought an economic slowdown with it. But since 1980, its price remained steady till 2003 when prices started increasing and is currently hovering around $55 -$58 per barrel. The condition is so precarious that it can cause a new oil shock. A 4 percent fall in global shortfall in daily supply could result in 177 percent rise in oil prices i.e., the prices will have a dramatic rise from $58 to $177 (National Commission on Energy Policy [NCEP], 2005, p. 2). Literature Review Delving deep into the issue of price rise, a number of causes came into focus. The list of reasons starts with restrained production policy of OPEC nations. Organization of Petroleum Exporting Countries or OPEC nations has reversed the upward trend of oil production since 1999 (International Monetary Fund [IMF], 2000, p. 4). Before that rate of increase in oil production was kept at the pace in accordance with the rise in demand. But the Asian crisis of 1997 made further dent in oil prices which got diminished to $11 per barrel. This fall compelled all oil exporting countries irrespective of being a part of OPEC or not to reduce production so that further decline in oil prices is avoided (IMF, 2000, p. 4). This decision started causing effect from late 1999 with oil prices got doubled by the end of the year while the production was forced to fell below consumption causing a deficit. Global reliance on OPEC nations for petroleum is also very important in this scenario. Around two-thirds of global oil reserves are concentrated in Middle East members of OPEC. Relatively new and outside Middle East resources are small and are very expensive to develop (Organization for Economic Cooperation and Development [OECD], 2004, p.1). With OPEC's policy of maintaining lower excess capacity often fails to meet the issue of raising supply in the event of unexpected disruption. This low quantity has made the market more volatile and is highly sensitive to short term supply changes. OPEC has become important that the market pays full attention to it irrespective of the case that it is in the state of action or inaction (IMF, 2000, p. 6). OPEC nations, with the motive to maximize the profit and earn as much dollars as they can, have made a policy of artificially restricting the supply of oil (Hoguet, 2005, p.1). Though OPEC publicly says that it will behave responsibly and will do its best in maintain the oil price at the level which will not hurt the chances of growth of world economy. Analysts have predicted that a rise of $10 in the price of petroleum per barrel will reduce the growth of world economy by 0.3 percent (Hoguet, 2005, p.3). But OPEC's Long Term Strategy Document shows something else. Instead of giving some certain projection to the volume which they will produce to keep the price of petroleum away from steep hike, the document adds more to the uncertain nature to the petroleum market (Mitchell, 2006, p. 12). Disappearance of surplus capacity by these nations is adding more to the uncertainty factor raising a big question of their ability to absorb the uncertainties of supply and demand (Mitchell, 2006, p. 12). Way back in 1980, a US Congress Report had stated that the OPEC oil price is the cartel price which is believed to be much higher than the price that should be charged to this oil thirsty world (Congressional Budget Office [CBO], 1981, p. xix). With OPEC not in a mood to behave responsibly, other factors are adding more to the problem of price rise. World is no more a safe place. The menace of terrorism is affecting every one. It's no longer a problem of Africa and Asia. People in New York and the people in rich countries like United Arab Emirates are equally vulnerable. This factor is responsible for current price rise but also the same in future. West Asia or Middle East has got a very bad name because of alleged support to terrorism by some oil producing nations of the region (US Department of State [UDS], 2006, p.126). The world is so much apprehensive about the possible terrorist attacks that in the year 2001, George L. Perry of Brookings Institution talked about three hypothetical but bad scenarios of oil supply disruption due to the attack of terrorists in Middle East. In the first scenario, it has been stated that terrorists manage to get control of 8.1 mbd. of Arab oil production. It doesn't include the supply by Saudi Arabia and its core group of UAE, Kuwait and Qatar but it includes that produced by Iraq. In the second case, even Saudi and its core OPEC nations think of disrupting the supply because of its extremist's leaders and public anger getting alleviated due to renewal of Israel - Palestine conflict. It will shave off another 7 mbd. oil from the market. And finally the worst case when entire Arab oil of 21.7 mbd. comes under the control of extremists. The rise in prices will become steeper and steeper with a possibility of being $161 per barrel in the third condition (Perry, 2001, p. 6). The way terrorist attacked World Trade Centre in the year 2001, possibility of happening of none of the above stated three conditions can be denied. More troubled the West Asia, the worst is going to happen in Oil market with a fear of price gaining new heights. The recent attack of Israel over Lebanon has added more to the confusion and it appears that Israel - Palestine conflict will never have any solution. Islamic Republics of west Asia are bound to bow according to their people's demand of taking pro Palestine approach and will do politics of Oil and threat of disruption of supplies. Now the market fluctuates even in case of any rumor or anticipation of another Middle East crisis. Countries in West Asia are not very good neighbors and the Shia- Sunni factor adds more to already troubled region. The war between Iraq and Iran in late seventies and early eighties had already sent oil shock waves with unprecedented rise in oil prices in 1980 (UDS, 2006, p. 132). The Islamic revolution in Iraq in the year 1979 also played havoc. The alienation of Iran from western world and its unpredictable behavior over issues like countering terrorism and Nuclear Proliferation is also a fear factor. The more US and its allies will try to punish Iran through UN, the more it will alienate from the western world and may use oil as a key to show its importance. Leaving out the Iran, and looking into the importance of Iraq, the current Iraqi government has failed to contain the situation under control despite the presence of US marines. There is a civil war like condition and pipelines and oil wells have always been a target of terrorist groups. This has led to regular disruption of supplies from Iraq which contributes around 2.5 million or even 3 million barrels a day (CBSNEWS, 2006). IMF in its paper has also paid much attention to short - term political developments and problems along the production-consumption chain, which receives little attention when buffer is full but now they are adding more to price uncertainty. They can be like Countries' request for payment in euros rather than dollars; escalation of conflict between Israel and the Palestine and threat all these posses to in disrupting the oil supplies (IMF, 2000, p. 12). Transportation bottlenecks have emerged as new problems. Commercial Truckers may pressurize the governments to cut petroleum taxes causing a spike in the price of gasoline for a short period. The same problem may start with pressure on tanker fleet as changing geographical consumption of demand (OECD, 2004, p.3). Crime and political condition have its own effect on global oil prices. These factors are very much responsible for the conditions in Nigeria creating new set worries. Nigeria is always under threat of recoup with militants regularly attacking oil rich delta region (Business Week, 2006). Oil workers from America and Britain are being kidnapped by armed militants. With dozens of oil workers from south oil region being held as hostages since the beginning of this year, the increased violence has caused reduction in Nigeria's normal production of 2.5 million barrel daily production by 25 percent (International Business Times, 2006). Militants have taken dozens of oil workers working in the southern oil region hostage since the beginning of this year. The violence has pared about one quarter from Nigeria's normal 2.5 million barrel daily production. According to Shell around 500,000 bbl/d of its company's production has got affected as a result of militant action. Further disruption caused more increase in quantity under shut-in condition (Energy Information Administration [EIA], 2006, p. 4). The problematic condition that Venezuela is posing is more of political in nature with current regime being radical leftist. Its production is steady with quantity being 2.5 to 2.8 million barrel per day. But when this figure is compared with what it used to produce pre strike in 2002, it is very much less. The oil production projects were previously managed by foreign companies but now by Venezuelan State Oil Company causing a fall of production by 50 percent [EIA, 2006, p. 4). The irresponsible nature of Venezuelan government is very much visible form the fact that despite of fears of disruption due to fight in Nigeria, the country went on decreasing its oil production by 50,000 barrels a day (Townhall, 2006). The Chavez regime is performing over time for an anti-west or anti-US foreign policy. With regular threat of disrupting supplies to US despite the fact that US is the largest buyer of its oil, Venezuela causes a new headache to the always fluctuating oil market. Moving on to the oil consumption pattern and the changes in fuel consumption due the rise of new economic giants from Asia, the economic renaissance in world's two most populous country namely China and India has opened two new big oil consumers. In the last two decade, China has transformed itself into world's factory while India is gaining new heights through its service industry. These countries have a combined population of around 2.5 billion and their rising economy have made them major oil consumers because of rapid industrialization process and growing people's purchasing power. Looking into the pattern of the change in consumption in these two countries, these developing countries have seen rapid growth with a growth rate being 7-9% in China while India growing at a rate of 5-7% per annum (Economic and Political Weekly, 2005, p. 3). These countries growth in fuel consumption has been so high that total fuel consumption of OCED countries has been reduced to 62 percent in the year 2003 from a high of 73 percent in 1973 (Barrell, 2004, p. 5). These countries have both consumers and producers sucking a large quantity of oil and have made the demand of oil at an all time high level (BBC, 2006). They are not just big consumers but are also wasting a great amount of fuel. Oil Intensity i.e., primary oil consumed per unit of GDP, is much higher than that of OECD nations. Taking the case of India, it takes two and half times as much oil as developed nations per unit of GDP (International Energy Agency [IEA], 2004, p. 11). In the same way, China and other developing nations of Asia and Africa are equally fuel hungry with very poor use of technology that harnesses oil for energy generation. The use of traditional fuels has now been replaced by modern petroleum fuels for both commercial and industrial processes. So large consumption of fuel by developing countries are making the situation grimmer in oil market and pushing the prices to reach new heights. With process of industrialization still in infancy, these countries are paying less attention towards technological research and developing better technology for efficient use this scarce commodity. Low fuel prices in late 90s and in the beginning of 21st century led them to use less efficient machines and are now the same machines have become major oil guzzlers. Recent rise in prices has also been because of Hurricanes Katrina and Rita. They have caused severe disruption of Oil and Natural gas production facilities in the Gulf of Mexico. This added more woes to already short supply of fuel oils to US and pushing more to the oil prices (National Institute of Economic Review [NIER], 2005, p. 19). The factor which was insignificant till the recent price rise was development of new shores for oil production. The low fuel prices made companies and countries to concentrate on this issue. But the price rise has now compelled to renew the world view towards development of new oil rigs and aggressively pushing research and development process of technological improvement of getting energy from renewable sources like wind and sun. But the delay has already made its effect. The prices have increased more rapidly than any technological breakthrough. As a result more dollars have to be shelled out not only for purchasing oil but also developing technology. The energy requirement of new Asian giants i.e., India and China will have to be fulfilled through electricity produced through nuclear reactors. But apprehensive western world are delaying the technology transfer and even if they agree to transfer, construction of nuclear reactors will require some time and till then the industry will continue sucking oil no matter how pricey it remain. So the prices have only one directions to follow i.e., upwards fattening the pockets of both OPEC and non-OPEC oil exporters. Conclusion The Oil price is now at around $58-60 per barrel from the figure of $10 per barrel in 2000. Though it is not in a position to touch the figure which was during the period oil shocks of 1979 and 1983 in near future, but if this trend continues the figure will one day cross all limits and may affect the world so hard that a very long period of recession will the economy. Energy production through other sources has not been efficient enough to replace oil as the main source. World is virtually dependent on the OPEC cartel and some other oil exporting nations for fuelling its growth despite well acknowledging the fact that most these oil producing areas are from the one of the most troubled part of the world and always under terrorist threats. These nations are often suspected as major financers of world terrorism but are equally vulnerable to these elements. The need of the hour is nothing but minimization of dependence on oil as a source of energy but again in how many years the phases of transfer from fossil fuel to other source like nuclear and wind will take place. And will the world continue to bleed its hard earned dollars just to quench its thirst of oil How long the oil exporting nations will continue to black mail oil importing nations The way Venezuela and Iran are behaving and continuing their anti-west foreign policy, the situation is becoming more uncertain. The Iran is touching new milestones in defying UN with continued Uranium enrichment for making nuclear weapons, there by creating a new insecure scenario of extremists and fundamentalist playing with worlds' deadliest weapon. This obstinant policy of Iran is because of its role in oil market and the impact over world economy after its withdrawal from world trade. The price is so much sensitive that its fluctuation is as fast as the spreading of rumors. Can anyone predict when will the world free itself from the ugly clutches of oil The oil was the reason behind growth in the past and the same can be said about present. But will it retain its position as fuel of growth in future Will it remain economically viable to fuel growth with petroleum oil or will it act as a necessary evil not only destroying environment but also impeding the world's fledging economic condition of present All these questions are quite unanswerable now, but the way oil prices having been changing and recent attitude of OPEC nations have underlined the fact that Oil will no longer remain the major source of energy. Our machines will have to function on anything but oil. But one question is still hovering, when will that day come and till then References Barrell, R. & Pomerantz, O. (2004, December). Oil Prices and the World Economy, NIESR, London, p. 2, 5. Organization for Economic Cooperation and Development (2004). Oil Price Developments: Drivers, Economic Consequences and Policy Responses, France, p. 1, 3. Hoguet, G (2005). Oil and Controlled Distortions in the World Economy and Their Long - Term Industrial Implications, State Street Corporations, p. 1, and 3. National Commission on Energy Policy (2005, June 23rd). Oil Shockwaves: Oil Crisis Executive Simulation, p.2. Mitchell, J. V. (2006, August). A New Era for Oil Prices, Royal Institute of International Affairs, London, p. 12. International Monetary Fund (2000, December). The Impact of Higher Oil Prices on the Global Economy, Research Department, p. 4, 6 & 12. International Energy Agency (2004, May). Analysis of the Impact of High Oil Prices on The Global Economy, p. 11. Energy Information Administration, (2006). Short Term Energy Outlook Supplement : Why are Oil prices so high, p. 4. Congressional Budget office (1981, February). The Effect of OPEC Oil Pricing On Output, Prices, and Exchange Rates In the United States and Other Industrialized Countries. p. xix. US Department of State (2006), Middle East and North Africa Overview, p. 126 and 132. Perry, G. L. (2001, November), The War on Terrorism, the World Oil Market and the US Economy, p. 6. Economic and Political Weekly (2005, May). Industrial Growth in China and India, A Preliminary Comparison, p. 3. CBSNEWS (2006, November). www.cbsnews.com/stories/2006/04/28/ap/world/mainD8H969Q00.shtm. Business Week Online (2006). http://www.businessweek.com/ap/financialnews/D8L5MU100.htm International Business Time (2006, November). http://www.ibtimes.com/articles/20061103/oil-prices.htm Townhall (2006) http://www.townhall.com/News/newsarticle.aspxContentGuid=fd8a249d-ee49-40be-8d34-d39a50793c5c BBC (2006) http://news.bbc.co.uk/2/hi/business/4922172.stm Read More