The World Oil Market - Assignment Example

The World Oil Market 1. Describe the world oil market. The oil industry is a fast-depleting one, the prices and current production rates of which is largely determined by the Organization of the Petroleum Exporting Countries (OPEC) and a few other countries which are non-OPEC members. Oil is the largest strategic resource in the global and international market. In international trade, various forces hold power over the world oil supply, which include temporary, cyclical, and permanent factors. The world oil market features volatility and uncertainty in prices because it is intrinsically slow to respond to changes in supply and demand. Tight balance between supply and demand can lead to high prices that cause both higher expenditures for consumers and higher incomes for producers. In economics, exhaustible resources generally follow the rule that the rate of growth must equal the rate of interest in order to reach industry equilibrium. However, due to the unpredictable character of future oil supply and demand conditions, oil prices do not generally follow this rule. Most of the time, it exhibits backwardation wherein future prices are lower than current ones. Future demand is hard to predict because it is difficult to foresee changes in energy technologies and it takes years for consumers to switch to other resources should prices go off the roof. On the other hand, investment is expensive and risky and it takes a while before production supply turns to high capacity. Oil prices also behave unexpectedly since the market is responsive to speculative pressures, operational constraints, and political conditions. 2. Analyze the impact of the recent hurricane, which hit the gulf of Mexico and destroyed New Orleans, on the price of oil. Use demand & supply diagram(s) to support you answer. The Hurricane Katrina, by reducing gasoline supplies (which is chiefly derived from crude oil), became one dramatic factor that caused oil prices to skyrocket in 2005. The storm reduced oil production, transportation and refining capacity--it paralyzed major oil and gasoline pipelines that carried supplies down from the Gulf Mexico and took down offshore oil platforms. Power outages also caused problems in oil and natural gas distribution in many areas. The large drop in supplies caused oil prices to rise. Additionally, consumer expectation contributed to the demand component. With the hurricane retarding oil production and restricting supplies, they expected prices to rise. They immediately increased the demand by buying gasoline, hoping to fill up their tanks before prices start to rise. Reduced supply and increased demand caused oil prices to increase dramatically, as shown in the graph below: 3. Analyze the structure of the world oil market & identify what kind of market structure it has. The world oil market structure is oligopolistic, since the market is dominated by a limited number of suppliers. An industry is said to be oligopolistic if few supply the majority of the output and if those suppliers are interdependent. In oil production, about 50 percent of the output and 70 percent of the reserves are controlled by a cartel. Production is handled by both public and private sectors. However, oil production is just one aspect of the market—converting and refining it to other consumer products is another facet of the total world oil industry, one which has its own dynamics and regulations. Worldwide supply and demand determines oil prices, with great influence from OPEC. On the supply side, OPEC provides most of the world's supply and normally acts as a semi-cartel, influencing oil prices by maintaining excess capacity. It also tries to maintain oil prices at its target level by setting quotas or production limits for its members. On the other hand, non-OPEC suppliers have generally limited reserves and typically behave as price takers. OPEC's policy in recent times is to control crude oil inventories and reserves in consuming nations in order to balance the market. 4. Use separate demand & supply diagrams to show the impact of each of the following events on the price of oil i) war in Iraq ii) Economic growth in China and India iii) Fuel protests which create uncertainty in the minds of the public about the availability of petrol. 5. Why is demand for oil inelastic in the short run but not in the long run? The demand for oil tends to be inelastic in the short run for several reasons. First, oil products have few substitutes. Since consumers have limited alternatives to choose from, price fluctuations do not have significant effect on their buying patterns. Second, oil and its derivatives are considered as a necessity by most, therefore, many are willing to sacrifice other goods to spend more on it should prices increase. Consumers are also slow to react to price changes in the short run since change in consumption and lifestyle patterns take time. However, in the long run, the demand becomes more elastic. Consumers can adjust by looking for alternatives and developing strategies for adjusting their lifestyle. Energy suppliers can also adjust to upward movements in prices by having the opportunity to develop alternative sources of energy in the long run. 6. What might be the long-term consequences of oil becoming a scarce resource? Using the principle of supply and demand, diminishing oil resources (supply) will likely increase oil prices. However, the recent economic consensus is that the impact of higher oil prices on the global economy will likely be limited. More efficient utilization of resources, improved monetary policies, flexible labor markets, and richer financial markets is believed to prevent the world economy from suffering like it did during the oil shocks about 30 years ago. However, uncertainty about the repercussions of oil being a scarce resource is a reality since in the long run, demand is difficult to predict—future developments and innovations and the degree as to how the economy can adjustment is subject to speculation. Bibliography Allen, Mark, ed. Oil Market Developments and Issues. International Monetary Fund, Policy Development and Review Department. 1 Mar. 2005 Berkmen, Pelin, Ouliaris, Sam and Hossein Samiei. The Structure of the Oil Market and Causes of High Prices. International Monetary Fund Research Department. 21 Sept. 2005. 30 Apr. 2006. . Energy Information Administration. A Primer on Gasoline Prices. U.S. Department of Energy. 30 Apr. 2006 . Joyce, Christopher. "The Global Oil Market." In All Things Considered. National Public Radio. 4-7 Mar. 2002. 30 Apr. 2006. . Morse, Edward L. Global Oil Market Outlook: Demand Issues. 14th Annual Energy Outlook and Modeling Conference. Energy Information Administration, U.S. Department of Energy. Washington, DC. 27 Mar. 2006. Murray, Bruce. "Oil and economics: Cutting through the spin." FACSNET. Apr. 2003. Foundation for American Communications. 30 Apr. 2006 . Pirog, Robert. "World Oil Demand and its Effect on Oil Prices." In CRS Report for Congress. Congressional Research Service, The Library of Congress. 9 Jun. 2005. Ponomarev, Dmitri E., Backus, David, and Luis Cabral. "The Petroleum Market: 1970- 2001." In Firms and Markets Mini-Case. New York University Leonard N. Stern School of Business. 28 Aug. 2002. Rogoff, Kenneth. "Oil and the Global Economy." In Ministry of Petroleum and Mineral Resources. 11 Nov. 2005. Harvard University. 30 Apr. 2006 . Weisman, Jonathan. "Energy Production A Katrina Casualty." The Washington Post. 30 Aug. 2005, natl. ed.: D01. Read More