The Oil Price

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1. Describe how the oil price has changed since 1960. Identify in particular the extent to which the 2008 oil price was exceptional. (One other factor which is not considered in the case study is the affordability of oil).

In the year 1960 the Current Oil prices were £1.314 and the Real Price was £1.314(Appendix 1). Overtime the price of Crude Oil has increased at a frequent rate because the importance of oil has increased for fuel for transport and is a major output to the chemical industry (Figure 2). The economy of today is mainly based around the consumption of oil which is justified by the fact that the world consumption by fuel 2008 is 34.8% Oil, (Figure 1). So therefore prices rise overtime as the value of money falls with inflation, so Oil prices will rise. However Current Oil prices have decreased in 2008 leading to a wider affordability of Oil that is stated in (Appendix 1).

Exchange rate levels have increased overtime (Appendix 1) and as prices rise, the demand for Oil will increase as a result, so Oil would be more expensive. During the 1960's prices of Oil were stable the price increased after 1973 (Page 2, 3rd paragraph). Then after 1986 the price decreased sharply and has been low since that time so therefore, Average incomes have risen just as quickly as the price of Oil leading to the greater affordability of Oil.

2) Why has the demand for oil been increasing?

The demand for Oil has been increasing because the importance for Oil has been increasing, it supplies over one third of the world's energy (Page 1, 2nd paragraph Case Study). It is a major output to the chemical industry and that literally all manufactured items part of the chemical industry including packaging are made from Oil (Page 1, 2nd paragraph CS). Oil is used for a range of things such as transport, heating, lighting and air conditioning so therefore the demand for Oil has been increasing over a period of time (Page 3, paragraph 4 CS). The demand has been increasing because the lower the price the greater the quantity demanded (Page 3, 3rd paragraph Case Study). Examples of the demand increasing are that as income rises so will oil consumption, people will travel more, consume more and so the demand would increase expectedly, this is measured by income elasticity of demand (Page 4, 6th paragraph CS). Also the demand for Oil has been growing more quickly in LEDC countries because in low income countries with higher income demand would increase for energy use goods such as cars, air conditioning, energy efficiency would be lower and with high manufacturing industries oil consumption would increase as result.

3) How is the increase in price of oil likely to affect the demand for oil in the short term and the long term?

The effect on demand in the short term would be that demand would fall less than in the long term. In the short term the price of Oil rises by 10% and the demand would fall by 0.8% in the short term whereas in the long term if the price rises by 10% the demand would fall by 6.4% in the long term (Page 4, 2nd paragraph Case Study). This shows that in the long term the effect of a change in price would be more significant in the long term than in the short term (Page 4, CS). Therefore the demand is likely to change if the price of Oil increases in the long term. The reason why this would be the case is because in the long term thanks to lower population growth and higher use of services in richer economies, industrialisation of the developing world, this will add to the demand of oil based products, developing nations would want the cars and goods that western countries have used for decades(intelligentinvestor.com.au/articles/283). So therefore this will be a unique reason for the increase in oil demand in the long term.

4) Explain why the effect of the price on demand differs between the short term and the long term.

The effect differs between the short term and long term because substitute goods in the short term have very high prices and this could contribute to the switching of Oil substitute goods to other sources (Page 4, 3rd paragraph CS). In the long term substitute goods would then increase in demand, so therefore the demand for the original oil would decrease, overtime. The price of demand would differ because in the short term the price elasticity of demand was -0.08% and in the long term the price elasticity of demand was 0.64%. So therefore if the price of oil rises by 10% the demand would fall by 0.8% in the short term and in the long term the demand would fall by 6.4% (Page 4, 2nd paragraph CS). The theory for the difference on the effect of the price of demand is that in the short term, price elasticity corresponds to the change in demand right after the change in price occurs (www.math.tau.ac.il/elasticity). On the other hand price elasticity in the long term corresponds to the change in demand a long time after the price change (www.math.tau.ac.il/elasticity), therefore price elasticity differentiates due to the time which a price change occurs.

5) Describe the trends in the production of oil since 1965.

The trends in production of Oil since 1965 have been that OPEC production has increased much more than Non-OPEC production (Figure 6). This is because Oil production is in the hands of state owned oil companies, it is therefore owned by the government. Production of Oil production is run by Russia, Soviet Union countries and the Organisation of Petroleum Exporting Countries (OPEC) (Page 7 paragraph 2). These countries produce 54.2% of Oil and have 75.9% reserves. The trends in production are that OPEC production has had lower prices than Non-OPEC (Figure 5). In OPEC countries oil is much more important than in Non-OPEC countries. The effect of an oil price rise in Non-OPEC countries is much more marginal and there is some increase in output but is generally small (Page 8). The current price has increased from 0 to 100 from 1965 to 2008, (Figure 5), this shows that with higher rates of Oil production the current price has been increasing in parallel to the increase of Non-OPEC production. Another trend is that Oil production is needed to provide exports to pay for imports, but with large Oil prices the countries economies have been booming as a result

6. Consider why world oil production does not seem to respond to changes in oil prices.

Oil production does not respond to changes in Oil prices because In Non-OPEC countries the price elasticity of supply of oil is low and that increases in price will not lead to significant increases in output (Page 8, 1st paragraph). It is difficult to find a relationship between the price and production of Oil because of the large fluctuations of Oil prices there is no expected change of the production of Oil in response to the Oil prices (Figure 5, Case study). Also buying Oil does not directly affect the price, so there would be less of a correlation but however there can be an indirect effect because high prices of Oil could affect both prices and production of Oil

Oil's produced in countries with economic and social problems such as the Middle East and could affect supplies and price (Page 9, 3rd paragraph). Since 1983 oil production has grown and with output stagnated since 2005, an increase in OPEC production has fluctuated much more throughout the period (Figure 6 Case Study). In the future the delay of the production of Oil would lead to high prices and influence future decisions on Oil

7. Explain why the price of oil was so high in 2008.

The price of Oil was high in 2008 due to factors of the supply and demand curve for Oil. The price of Oil has been increasing because there was availability of natural gases. From 1985-2005 there was increasing availability of natural gases, contributing to low prices. In the short term the price rise is short term and is recent (Case Study, The price of oil). One theory is that the recent dollar decrease has driven investors to commodities as an inflation hedge. Another explanation is that Global oil supplies are much tighter and that an increase in demand will outpace new production growth for many years to come. Energy subsidies distort the market, this can cause high consumption, (nytimes/2008/6/21/business), Oil consumption was at 34.8% in 2008 more than any other energy source). Therefore the substition effect will have more of an impact in the short term than and will have a stronger impact in the long term. The other factor is that there was high surging demand from China and India and a stop of Oil supply from Nigeria and Iraq. From another source the data shows that Global demand was down and supply was up.

8. Why did the price of oil fall after July 2008?

The price of Oil decreased after 2008 because of the shrinking economies internationally due to the result of the 2007-08 recessions and also a stronger US dollar, so therefore there was huge oversupply of oil as a result. Oil fell by around 30% on July 11th due to high prices and slowing economic growth. Also global demand outran supply forcing Oil prices to decrease in the 2nd half of 2008 (Bloomberg.com/news). The reason for the decrease of prices is because of the fact that the slowing down of the economy caused demand for fuel to decrease. One source says that the oil price boom of 2008 might have had an effect on the crisis caused after July (blogs.wsj.com/economics). Another factor may have been that demand was high and that prices of oil were high as well so prices of oil began to decrease in order for many people to afford it (answers.Yahoo). The price fall may have come because the value of black gold caused further reductions it has fallen around $20 a barrel. With high prices and slow economic growth this has driven have driven oil demand to fall. Demand elasticity is therefore showing full effect.

9. Will the price of oil remain high?

I believe that Oil prices will remain high because demand is strong and there would be subsidies that would continue to increase in correlation of the oil. If supply of Oil is constant then Oil prices would be expected to remain high (seekingalpha.com). The price of Oil will remain depending on supply and demand. Expectations of future oil prices are down to speculation. High prices of oil futures would influence expectations of future prices. However decreasing in supply and demand could affect prices as well as future recessions and alternatives of other energy sources (Case Study the price of oil). Brazil's energy plant says that oil prices will remain high depending on the current conditions in the economy. They say that if conditions change which is if supply is higher than demand, low interest rates and if there are returns on investment in future markets (thaindian.com/newsportal/world-news). Gordon Brown said in 2008 that oil prices will remain high but that high prices would have an impact on families with the lowest income (telegraph.co.uk/news). The former Labour secretary also said that oil prices will remain high and that crude oil prices could reach $70 a barrel in the near future.

References

  • http://www.intelligentinvestor.com.au/articles/283/The-case-for-oil.cfm?articleID=2035633
  • http://www.guardian.co.uk/business/2009/oct/26/oil-prices-production
  • http://blogs.wsj.com/economics/2009/04/03/did-the-oil-price-boom-of-2008-cause-crisis/
  • http://www.thaindian.com/newsportal/world-news/brazils-energy-giant-says-oil-prices-will-remain-high_10067094.html
  • http://www.redorbit.com/news/science/444456/oil_prices_will_remain_high_former_labor_secretary_says/index.html
  • http://www.math.tau.ac.il/~fibich/Manuscripts/elasticity_JAMS.pdf
  • http://useconomy.about.com/od/commoditiesmarketfaq/p/high_oil_prices.htm
  • http://www.bloomberg.com/apps/news?pid=20601085&sid=aph4v20TXX6E&refer=europe
  • http://www.nytimes.com/2008/06/21/world/20.html
  • http://www.telegraph.co.uk/finance/newsbysector/energy/2793753/Oil-price-falls-as-US-gasoline-demand-wanes.html
  • http://www.telegraph.co.uk/news/newstopics/fairdealfordrivers/2042595/Gordon-Brown-High-oil-prices-will-remain.html
  • http://seekingalpha.com/article/171384-oil-20-a-barrel-or-200
  • http://seekingalpha.com/article/81979-oil-s-supply-and-demand

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