The Recent volatility In World Oil Prices

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Executive Summary:-

This report is a sequel to the recent volatility in world oil prices. It describes the possible causes beginning with improper world consumption information impacting price equilibrium due to inadequate supply; this in turn triggered speculation opportunities for financial investors and speculators to hike the price. Furthermore, global recession contributed to sudden retrenchment in world oil demand and reducing the price to its lowest. Finally, the report concludes with some realistic remedies available that would ease out the fluctuations.

Introduction:-

Crude oil prices always swings in times of demand shortage or oversupply and it has been variable since the price increase of 1970s and 1980s. In middle of 2008, the price of crude oil was at $ 140 a barrel. By February 2009, it stood at $ 34.57 and in recent days, it's been fluctuating around $ 70 a barrel (Figure 1).

Now,

Is the oil price heading towards $150/barrel or $50/barrel?

  • If so, what may be the reasons behind this volatility?
  • What could be the possible solutions?

Possible Causes:-

The following can be considered as the possible causes for oil price responses to the global economy:-

Improper data:-

The crude oil consumption/production information has not improved. When we consider the demand side, the oil consumption data is not certain and they are subjected to revisions with delay in publishing. The data of developing nations like India and China, which are turning out to be the major consumers of oil are less reliable and the problem is becoming shoddier. While on the other side, i.e. the supply side, the OPEC production level uncertainty adds to the oil production uncertainty. Therefore the uncertainty of demand and supply in the oil market has increased volatility due to oil gap and increased speculation.

Speculation:-

Speculation can be considered as one of the main causes of oil price volatility. Future oil price speculation has led to the overshooting and undershooting of spot prices over the recent period. From figure 2, which gives the data on volume of oil futures, it is clearly seen that oil futures have grown tremendously. The average intraday trading volume of oil futures in 2002 was four times the demand of oil per day. While, in 2008 this rose to 15 times the oil demand per day. The above facts can be taken as clear-cut evidence of the financialization in oil market recently.

Global recession:-

Another most important factor which has affected the volatility is the global recession. It is seen that there has been 6 global recessions (Figure 3) within a period of 3 decades from 1970. The first two recessions occurred in 1974-75 and 1980-82 which did not immediately affect the oil price but the other four recessions 1991-93, 1998, 2001 and 2008 had an immediate effect and the price of oil crashed down as it became evident that global economy was falling brusquely.(Figure 1 and figure 3 shows positive correlation between recession and oil price volatility) .The OPEC market power was very much stronger before the 1990's than that of now and it was easier for OPEC to prevent the volatility in the earlier period.

Conclusion:-

Let me conclude off by stating again that the recent bizarre volatility in oil prices is a natural response to an unexpected, remarkable change in global economy. Financial tensions and economic flaw have produced a corrosive opinion which could persist to be a risk to the global position. Even though, the global slump can be shortened with effective implementation of policy actions, consumer's readiness to pay the price for this valuable commodity would always be a factor which cannot rule out oil price volatility.

Solutions and Recommendations:-

The course of price alteration has not been smooth over time. During the recent years, there has been phases when prices declined by a huge margin, only to increase afterwards. Now then, Will these volatilities continue in future? “May be” or “may not be”! Nonetheless, we can implement some policies which could help reduce volatility in oil price and call a halt to the hefty price sways.

In my belief the following recommendations can be considered:-

  • Appropriate, international, and accurate data on the demand and supply of oil.
  • The financial investors and market regulators need to contribute to improve the clarity, implementation, supervision and finally the demand and supply balance, in the international oil markets.
  • Reduce oil consumption by improving energy efficiency.
  • Alternate source of energy need to be the order of the day.
  • Speculation diminution by making transparent dealing over the counter and regulating strict rules to avoid speculation.

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