Crude Oil Prices: Market Supply and Market Demand
Abstract
The primary purpose of this paper is to understand how supply and demand factors contribute to a consistent decline in crude oil prices across the globe. Furthermore, the paper seeks to understand the impact resulting from the fall in the U.S and the global economy and implications of the same. In the introduction, the paper starts by acknowledging the importance of crude oil to the world economy and the fact that it is an ordinary commodity whose price is influenced by the market forces. Oil prices are renowned for their instability in the market, an aspect that is influenced by various factors which are not discussed in the paper, as the study focuses on two issues, which include supply and demand factors. In the article, it is evidenced that oil has a critical role in the economic development because all sectors of the economy depend on energy, with 34% of it produced from crude oil.
In the second section of the paper, the study focuses on understanding the various issues that result from a decline in crude oil, which is both negative and positive. The study appreciates the fact that a drop in oil prices will lead to substantial development in universal GDP and a momentous fall in inflation. However, the impact is different for developed and the developing countries with an emphasis that it impacts positively on producing states while adversely on others such as the United States. Furthermore, it is evidenced further that the decline helps reduce the price of non-oil commodities across the globe, such as food, due to a general reduction in the production costs. Finally, the paper concludes that oil prices are influenced by a range of aspects of demand and supply, which play a substantial role. The study concludes that oil has a critical role in the growth of global economy and that the low price of the product has more benefits than harm to the development of the global economy.
Introduction
The crude oil industry plays an indispensable function in the elaboration of the economy in various countries and the global economy in general. However, some of the significant issues identified to significantly influence decline in oil prices include demand and supply aspects, although there are other emerging drivers in the market. It is imperative to appreciate the fact that the oil market is faced with a lot of complexity issues. Historically, the decline in the commodity prices was severely experienced in 2008 when the price per barrel fell from $147 to $30 per barrel (Lütkepohl & NetŠunajev, 2014). A fall in oil prices leads to a recession in some cases as most countries’ economies depend on the commodity for its growth such as in Canada. However, to understand how supply and demand factors contribute to the fall in oil prices around the globe, it is imperative to know the positive contribution of the commodity to the world economy. Different researchers assert that although various aspects influence oil price around the world, demand and supply are considered as core issues. The paper discusses at length the economic shock realized due to of a change in crude oil prices over decades in the global economy.
Oil is precious merchandise in the global economy and is renowned for its significance in energy fabrication and influence on economic growth in different parts of the globe. Both consumers and producers of the commodity are affected by the change in oil prices, and as per 2008, it was evidenced that 34% of world energy was produced from the product. According to the International Energy Agency (IEA), it is evidence oil is expected to offer over 30% of global energy. This trend is projected to grow higher in the future, an issue that implies oil as a key to the growth of different economic sectors such as agriculture (Al Dulaimi, 2014).
Trend
The decline in oil prices has existed since 1990 and was more severe in 2008 when the price of the commodity was halved, causing an economic recession in the U.S. However, different developments such as the expansion of effective policies have been enacted to help control the price of the commodity in the market. The recent fall in oil prices experienced in 2015 is considered as the third largest impact to be experienced over the last three decades. Moreover, supply and demand factors are historically renowned for influencing decline in oil prices, although in the recent past, there are other emerging factors. Apparently, supply factors are considered to have an enormous impact on the reduction in the oil prices experienced over the past few decades and were expected to influence price even in the future. However, the low prices are considered to have substantial implications on global economic growth and the likely cause of inflation in various countries. Moreover, a weak demand level of the commodity has acute pressures on the oil exporters, and if the situation is not managed early, it is expected to set back the economic growth.
Low oil prices have different impacts on different regions as it leads to a shift in the real income experienced by people, which affect both the fiscal and monetary policies of a country. In oil-importing states, such as the developing nations, a fall in oil prices enhances economic enlargement and a drop in inflation as the price of the non-oil commodities is expected to fall as well. However, for the case of oil exporting countries, the situation is different and leads to adverse effects on the economic growth of a country, with a significant loss in trading and the fiscal revenue as well.
Demand and supply factors
As revealed by research studies, it is evident that the world oil supply is surpassing the demand level for the product for some reasons as will be explained in the study. From the first quarter of 2012, it was evidenced that supply of oil was more than the demand level in the market. However, supply increases at a significantly higher rate as compared to demand, an aspect that has led to a fall in the oil prices. Some of the key issues that led to a greater supply of oil from the exporting countries include the use of hydraulic fracturing to tap the resource, leading to low production costs of the commodity unlike in the past. Previously, the producing countries were renowned to limit the production as a strategy to increase demand for the product in the market so as to experience an increase in oil prices. However, the case is different nowadays as the Organization of Petroleum Export Countries (OPEC) has regulated the practice that involves limiting production to allow the free supply of the product into the global market. In the long-term, the demand level for oil is expected to increase, an aspect that is renowned to escalate the oil prices in different parts of the world. The observation is subject to positive economic growth in both the developed and developing countries that use oil in running almost all of their economic sectors (Kaufmann, 2016).
Collectively, consumers of oil dictate the demand level for the product in the market, and therefore, have a great impact on the prevailing prices of oil in the marketplace. However, suppliers are typically concerned with the production of oil and tend to embrace various strategies so as to create intentional shortages, an attribute that will contribute to the price increase. Apparently, both demand and supply factors have an influence on oil prices in the global market, and firms in the oil industry use price indicators to manage their resources. Therefore, the price concept helps control the behavior of managers in the sector, an aspect that significantly dictates the market forces of oil products (Kilian, 2009).
During periods of high oil prices, people tend to limit their operational activities to help cut down on costs. For example, some individuals will tend to avoid driving vehicles that consume a lot of fuel. For the case of business institutions, they will tend to reduce their operations, an aspect that will contribute to reducing their expenditure level. However, high prices influence oil production in a positive way in that when the prevailing prices for the commodity are high; people will tend to invest more in the business and embrace better techniques that will enhance production capacity.
A case in place is the 2007 and 2014 cases that experienced huge prices for oil, which was almost $100 per barrel, an issue that attracted massive investment in the industry (Kang et al., 2014). New companies ventured into the business in expectation to benefit from the firm and utilized new strategies such as fracking and oil sand that significantly contributed to increased oil production. Furthermore, the increase in demand level did not meet the supply level due to various factors, an issue that contributed to the decline of the oil prices by almost a half. In the period of 2008 and 2007, major economies such as the U.S and China, which consume a lot of oil globally, experienced a recession, an aspect that significantly reduced the demand level for oil (Baumeister & Peersman, 2013).
Crude oil prices are influenced by a wide range of factors which are understood to have a lasting impact on the flow of oil to the market such as geopolitical and other weather-related aspects. Such issues as asserted by various scholars develop uncertainty on the future supply and demand of the product, making the stakeholders set vulnerable prices. Such shocks in the oil market make the consumers pay more for the products as they often have no alternative energy sources. Some of the key disruptors of oil supply in the market include political upheaval as experienced in Libya, Iraq, and Nigeria over the years, creating a market shock that contributes to the rapid price increase. The market participants, therefore, take advantage of such disruptions and using the historical data on the same, they often predict the possibility of the future confusion with their personal impact hence creating market shock so as to increase the price of the commodity. On the other hand, the weather has a significant role to play in the disruption of the supply of oil to the market, creating a shortage of the product which makes prices shoot up drastically (Kaufmann, 2016). An example in place is the 2005 incidents where the hurricanes led to significant reduction in the supply of oil and other natural gases including the closure of most refineries, an aspect that significantly created a shortage in the provision of the product.
Impact of decline in crude oil prices to the U.S and global economies
The demand and supply aspects have a substantial influence on the decline of crude oil prices around the globe, which have both negative and positive impacts on the economic growth. Some of the impacts created by the 2014 price decline include the appreciation of the U.S dollar, spillover effects due to geopolitical risks, and a shift in the OPEC policy issues to regulate the oil price change in the global market.
It is considerable to appreciate the fact that decline in crude oil prices has a vital function in influencing growth and inflation prospects of an economy. Apparently some of the benefits of low prices of crude oil to the global economy are that the concept is expected to increase the entire GDP by almost 0.7-0.8 percent and experience a significant reduction in inflation (Lin et al., 2014). Other impacts created by the decline in the crude oil prices include a significant shift in the income for the residents in both importing and exporting states. The change will lead change in consumer behavior, hence reducing the price of the non-oil commodities in the two countries, which is good for the people.
The shock will be affirmative for the development of international economy particularly developing nations which will experience significant growth. As aforementioned, a swell in the supply of crude oil contributes to a decline in prices as dictated by market forces, an aspect that leads to economic growth and reduction in the inflation rates. The reverse applies to the case of the developed countries such as the U.S, which are involved in both importation and exportation of oil. A significant drop in the oil prices sets back the economic growth of the respective countries due to the loss of revenue as a result of export, and fiscal operations carried in the nations. An example in place is the 2008-2007 recession that saw a significant drop in the oil prices in the United States that forced the U.S to reassess various monetary policies to regulate inflation in the country to avoid risks of losing investors. Another impact of the decline in the crude oil price includes the fact that the countries will experience a substantial capital outflow, loss of the government reserve and other negative externality on the bordering countries (Kilian & Murphy, 2014).
A benefit of experiencing a decline in crude oil prices is that production costs significantly drops across all sectors of the economy, an attribute that makes the prices for the other commonalities such as fertilizers and food staffs to be low. Researchers have indicated their concern that a reduction of the oil prices by a margin of 45% only is enough to increase the quantity of food produced globally by about 10% (Effiong, 2014). Food is the primary commodity purchased by everyone in the society irrespective of their social status hence essential for helping benefit every person in the society. Another impact that results from a fall in the crude oil prices is the change in both monetary and fiscal policies as well as their structural design. However, the decline in the oil prices impacts positively to all countries across the globe as it encourages economic drain of the various energy subsidies and reformation of the tax policies. The 2015 appreciation of the U.S dollar had a varied implication to different countries as it contributed to weak demand in most countries while at the same time increased the supply level of oil from the non-U.S dollar producers. The significant appreciation of the dollar experienced last year in the United States contributed to further decline in the prices of oil commodities across the globe.
Conclusion
Oil is a volatile product as revealed from the above study, and like any other product, it is influenced by the demand and supply market forces. The 2015 decline is the most recent to be experienced and is regarded as the largest drop in the history of oil production in the whole world. The fall in oil prices is caused by a range of aspects that lead to long-term and short-term effects on the international economy. From the study, it is evident that high prices of oil attract massive production as more investors are attracted to invest in the industry, an aspect that increases the overall supply of the product in the global market. Innovation is one of the issues that enhance the production of at a reduced cost, contributing to more supply of the products compared to when the availability of the commodity in the market is limited. On the other hand, it was evidenced too that the rate of growth of supply is more than that of demand, an aspect that makes excess oil in the market to be sold at a low price. Therefore, low demand levels and high supply of crude oil due to intensified production has significantly contributed to the growth of the global economy, particularly in developing countries.
The study further indicates that a fall in the cost of oil has various consequences on the market such as macroeconomic implications, monetary and other policy issues. However, if the same is sustained over a long time, it is believed to result in a reduction in inflation rate among other significant benefits to the global economy. However, negative effects are experienced for the case of the developed countries as they experience reduced economic activities, an aspect that impairs their economic growth. Researchers have however asserted that oil is one of the most difficult commodities to predict future prices as the product is faced with a lot of uncertainty.
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