Prices and Markets for Crude Oil Fluctuations - myassignmenthelp

Question: Discuss about thePrices and Markets for Crude Oil Price Fluctuations. Answer: Introduction Crude oil is one of the most economically important resources of the world. The economies of many countries are heavily dependent on the production and export of crude oil, while others need to import the oil for energy production and running the transport and other industries. According to a report by Majumdar (2016), oil and gas satisfy more than half of the worlds demand for energies. OPEC, the intergovernmental organization consisting of 14 nations, controls the prices of oil and all the oil trade related activities. The main objective of OPEC is to supervise and regulate the supply of the oil to the consumers and keeping the market stabilized (Griffin and Teece 2016). The price of crude oil has fluctuated significantly in the past two decades. Similar to the prices of any other consumer good or service, the price of crude oil also depend on the demand and supply of it. As stated by IMF (2015), if the price elasticities of demand and supply are low, then the disturbances in either side of the market can lead to sharp fluctuations in the oil price. During the period between 1998 and 2018, the demand for oil has been affected by negative revisions of the global economic prospects, while the supply of oil faced disturbances from armed conflicts, strategic shifts of some parts of the OPEC countries, new discoveries of oil fields and new extraction technologies. In this paper, the economic analysis will be done to highlight various aspects of the crude oil price fluctuations between 1998 and 2018. The reasons for price fluctuations, various aspects of the exchange process, the pattern or trend of the variations, factors affecting market outcomes and its impact on the global economy, and if there is a scope for government intervention will be discussed. Economic analysis Factors influencing crude oil price variations According to a report in Oil and Gas Financial Journal (Ogfj.com 2017), the major factors for crude oil price fluctuations are as follows: Dynamics of demand and supply: In the period between 2010 and 2014, the rise in oil prices can be attributed to the supply crunch from the conventional oil production fields. This resulted in higher income for the upstream organizations and investors. This extra capital was invested for exploration and development of new and unconventional sources of energy, like the shale and tight oil. Success in those ventures led to a fall in the conventional oil prices in 2015 and onwards. World economic growth: Since, the demand for oil is dependent on the growth of many important industries in a nation, such as, electricity, transportation, shipping and manufacturing, hence, the global growth in the industries resulted in higher demand for the oil, which has caused the prices to soar high (Sodeyfi and Katircioglu 2016). Appreciation of USD: The oil trade is done using the global currency, that is, the USD. The USD has appreciated significantly during this time, resulting in increasing the cost of oil imports and decreasing the price of exports. OPEC policies: To stabilize the oil market, OPEC has decided to cut down production of oil, with effect from January 1, 2017 and this is expected to help the price move upward slightly in 2018. Geo-political events: This is an important factor that can affect directly the supply and distribution of oil across the globe. World crisis in the oil producing countries not only increase the price of the oil, but such events can also result in loss of output, disruption of supply, and inefficient market. For example, Arab Spring, that is, unrest in Libya, Tunisia and Egypt, is to some extent responsible for the oil price hike in 2011-2012 (org 2015). It has also been highlighted that, the oil futures contracts on the goods market determine the prices of crude oil, which implies that commodity traders have the power of controlling the oil prices. Since 1974, this trend is still continuing. The regulatory authorities, such as the OPEC, can only affect the bidding decision of the traders but they cannot set the price in the market (Kilian and Murphy 2014). OPEC controls the supply to keep the prices at $70 a barrel, but during the time of excess supply and declining price in 2015, it let the price fall because it would not lose money till the price is $20 a barrel (Ogfj.com 2017). During 2011 and 2014, the shale oil production of the USA had doubled, which contributed the fall in oil prices in 2015 and onwards. Trend of price fluctuations It has been a significant rise in the crude oil prices since 1998. In that year, the average price for a barrel was only $12.28, while in 2012 it was $109, almost a 10 fold increase. Although the price dropped since then, but it never went down at the level it was near the 2000s. The major reason identified for this huge jump in the prices of crude oil is that, the resources of easy-to-get oil are exhausted and only the hard-to-get oil resources are left, such as, the continental shale in the North Sea region (Cobb 2012). New technologies and more capital investment are required to carry out the exploration and production activities in those regions. At the same time, the rate of production is important, irrespective of the size of the oil reserve. In the two decades, from 1998 to 2018, the demand for oil has increased more rapidly after 2000s, leading to sharp price volatility, and its role in transportation is still critical. The rate of consumption increased exponentially until 20 05 when the advancement of technology has brought revolution in every aspects of life and in the industries (Bodenstein, Guerrieri and Kilian 2012). Figure 1: Average crude oil prices, 1998-2018 (Source: statista.com 2018) It is seen from the chart that, the oil prices were increasing over the years but the sharp increase and price fluctuations started to happen since 2008. While the oil price came down in 2009, it came to a peak in 2012 with $109.45 per barrel, which suddenly came down to $40.68 in 2016. It has been increasing again since then. Hence, it can be seen that prices of oil were more or less stable during the period of 1998 to 2004 and it experienced sharp fluctuations afterwards. The OPEC has changed its strategy for defending the market share than the price by producing more oil at lower prices. The oil prices surged very high since 1998 due to an unexpected international economic boom, especially, from the emerging economies like China and India, and the oil producing countries failed to meet the sudden rise in the demand. In 2007, the traders increased inventories in anticipation of further rising demand and this made the oil prices to shoot up in 2008 (Kilian and Murphy 2014). The fall in oil prices occurred due to increase in supply from the new oil fields. Advanced technologies in the USA have led to increased production from the oil fields of the USA and other countries have also contributed in increasing the oil supply (Sodeyfi and Katircioglu 2016). Welfare implications and government intervention Since oil is one of the most important sources of energy to the world and determinants of economic growth, the volatile nature of its prices affects almost all types of industries as well as exchange rates. There are few aspects, by which the oil prices affect the exchange rate and market. In terms of purchasing power parity (PPP), when the demand and supply dynamics results in increased oil prices, the currencies of the oil-dependent countries depreciate due to high inflation (Brahmasrene, Huang, and Sissoko 2014). Hence, it affects the exchange rate of the countries as well as the level of international trade. A sudden rise in oil price is usually compensated by labor adjustments and hence, there is a structural impact on the employment (Le Coq and Trkulja 2015). Currency devaluation for the oil importing countries leads to a fall in the exchange rate, influencing them to create import substitution and export expansions, such as, in the case of Russia. The commodity composition nee ded to be diversified in Russia to improve the international trade. The welfare implications follow from the above discussion. As the oil price affects the exchange rate and currency valuations of the nations, it will have an impact on the economic growth. During the oil price rise, the wealth is transferred to the oil exporting nations (in USD terms) and is reflected as the improvement in the current account balance and export revenue in domestic currency (Wang and Chueh 2013). This appreciates the currency of oil exporting countries and depreciates the currency of oil importing countries. Thus, the government of the nations should intervene in keeping the system stabilized. The prices of oil should be maintained at a rate where all the countries could afford it and inculcate the growth. Conclusion According to Oil and Gas Financial Journal, 80% of the fuel for the worlds transport system including all types of transportation is derived from the petroleum, while the number is 93% in the USA. As oil is one of the major sources of energy for almost all industries in an economy, volatility in the crude oil prices has a major impact on all the economies of the world. In past two decades, due to the uncertainty in demand and supply side factors, the crude oil price has not only increased significantly, but also fluctuated majorly. This had impacts on the businesses of the oil producing companies; and on the exchange rate and currency values of the oil exporting and importing countries. The oil exploration technology has improved over the years, new and difficult-to-explore oil fields were discovered, OPEC had taken decision about not curtailing the production, global economic growth has happened, USA has started oil production and has been contributing considerably, and high importa nce is given to the alternative, that is, renewable energy sources. All these factors have contributed in oil price volatility over the years. Measures have been taken to stabilize the market, and to regulate the production and supply of oil to all the economies of the world. However, the oil exporting countries are benefitted when the prices are high and the importing countries are benefitted during the lower price. To keep the global economy stable and influence an equal growth, the government intervention is necessary in controlling the global crude oil price. References Bodenstein, M., Guerrieri, L. and Kilian, L., 2012. 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