Introduction
For numerous decades, oil has been an important source of the commercial energy throughout the world. The oil industry has always been a vitally crucial industry due to its contribution to the global economy. For this reason, oil is in high demand at all times. Just like the other commodities, the price of oil is determined by the market forces of supply and demand. The oil price fluctuations greatly affect the national economies differently. For instance, while the net exporters of oil suffer economically when the prices decline, the economies of the net importers benefit. Consequently, as one of the largest oil exporters in the world, Russia is currently experiencing difficult economic times due to the recent decline in the global oil prices. In Russia, oil-exporting plays an imperative role in its economy. The oil exports will greatly influence Russia’s GDP and the resulting change in oil prices will determine the global demand for Russia oil.
Oil Price and GDP
Russia has established her worldwide position on its vast energy potential. In essence, Russia is one of the world’s key players in oil production. In 2009, Russia accounted for 12.5% of the worldwide oil output. Russia has a number of main oil production areas. Among these regions include Yakutiya, Komi Republic, Western Siberia, Sakhalin, Irkutski, Ural-Volga, and Arkhangelsk. Ural-Volga and Western Siberia are the most significant oil production centers as they account for 22.1 percent and 63 percent of Russian oil production respectively. In the recent times, the production of oil in Russia has not been constant. For instance, in March 2015, the production of crude oil in Russia declined to 10050 BBL/D/1K from 10150 BBL/D/1K in the previous month. The following graph shows the production of crude oil in Russia between July 2014 and April 2015.
Source: www.trendingeconomics.com
Russia exports the bulk of her oil to Europe owing to its geographic closeness. There has been an increase in oil demand in many parts of the world especially in Asia, which has contributed to the expansion of the Russian market on the Asian continent. In the previous couple of years, the exports of crude oil from Russia to Asia has been rising while the exports to Europe have been declining. Oil plays a vital role in Russia’s economic development. As a result, oil is a crucial resource for Russia. In essence, the Russian oil industry contributes significantly to its economy. The revenues from oil exports provide sound financial sources for economic growth. The Russian oil industry is an essential economic sector and the leading source of state budget revenues. The oil revenue makes a substantial part of the Russia’s national budget hence oil prices have a significant impact on the economy. The oil corporations in Russia form an important part of her most active and recognized firms in the foreign markets. The domination of oil in the Russian government revenues is primarily mirrored in her export mix. In particular, oil and gas are the leading exports from Russia.
Russia depends on energy revenues for its economic development. In essence, natural resources such as oil make up a significant share of exports in Russia. It is worth noting that oil exports play an important role in Russia’s economic growth, as well as development. Throughout the 2000s, the gas and oil production in Russia accounted for below 10 percent of her GDP as suggested by the official figures. The income generated by the sale of oil in Russia has always been the basis for socio-economic condition stabilization. The high oil prices have little direct influence on Russia’s GDP growth. Nevertheless, the Russian economy is vulnerable to the oil price swings. The Russian government budget raises with the increase in prices of oil and shrinks with the decline in oil prices. Gas and oil account for about a quarter of GDP in Russia, roughly a third of tax revenues, and around a half of her exports earnings. Consequently, the Russian government spends significantly on important national investments such as social programs, defense, and infrastructure when oil prices are high. In contrast, the decrease in oil prices adversely affects the Russian economy.
Oil Price Change and World Demand for Russian Oil
The deteriorating oil prices can have some indirect effects on the oil-exporting economies. Thus, the major changes in the price of oil globally have a major economic impact on oil-exporting countries such as Russia. The market forces of demand and supply determine the price of oil. The demand and supply concept is rather straightforward. As the demand for oil declines, the price is expected to fall. On the other hand, the increase in demand for oil raises the price of oil. In the short run, the demand for the oil is fairly inelastic, implying that the changes in the oil price have a small impact on the quantity of oil demanded. Additionally, the changes in oil prices in the short-run do not spur the new supplies of oil. During the short-run, the quantity of oil is relatively fixed hence a shift in demand causes huge changes in the price. In the case of elastic demand, a small increase in the oil prices makes the consumers cut their purchases and, as a result, decrease the quantity demanded.
The variations in oil prices have an impact on the demand for Russian oil. The rapid expansion of economic activities in different countries of the world raises the demand for oil in the oil producing countries. As an oil exporter, Russia benefits from the increasing global demand for oil. Russia accounts for roughly 20% of the oil consumption in Europe. For this reason, the changes in the prices for oil have a significant impact on the demand for Russian oil. Firstly, the increase in the price of Russian oil reduces the world demand for Russian oil. The rise in the prices of oil decrease the demand for oil within the oil importing countries and, as a result, deteriorates the position of the balance of trade in the oil-exporting country. The importers look for affordable oil in other oil-exporting nations when the Russian oil price upsurges. Ideally, the rise in price for oil impacts how the Russians and the overseas buyers consume the Russian oil and formulate their budgets. Consequently, the rise in the price of Russian oil affects the economic activities of the countries where it exports her oil.
In essence, oil price increases adversely affect the industrial production of countries that import oil from Russia. As a result, these states keep on demanding less oil from Russia until when the prices go up. However, a large impact on the quantity of Russian oil demanded due to the rise in her oil prices occurs only during the long-run. In the short-run, the demand for the Russian oil is fairly inelastic, implying that the changes in the oil price have a small impact on the quantity of Russian oil demanded. The fall in the quantity of Russian oil demanded as a result of the rise in oil prices leads to a collapse in the production of oil within Russia. One of the reasons that caused a fall in the production levels of Russian oil to only 10% of the world’s total production by the year 1995 was a collapse in the industrial production that lead to a lower demand for oil. Thus, this implies that the increase in the prices of Russian oil leads to a decline in the production of oil owing to the fall in the industrial production in countries that Russia exports her oil.
On the other hand, the fall in the price of Russian oil raises the world demand for Russian oil. Just like in other commodities, there is an inverse relationship between the price of Russian oil and the quantity of oil that importers are willing and capable to demand. Thus, the world demand for Russian oil is high when the prices are low. When Russia reduces its oil prices, the importers from various parts of the world demand more. Ideally, the fall in oil prices promotes the industrial production in the oil-importing countries around the world. The industrial production in these countries facilitates their economic prosperity and, as a result, they demand more oil from Russia since they have the capability. Nevertheless, despite raising the world demand for Russian oil, the plummet in oil prices has adverse impacts on the Russian economy. The fall in the oil price is considered bad news in oil-exporting countries. In essence, the drop in Russian oil might lead to the collapse of its economy. Russia greatly depends on oil as its major source of revenue. Thus, the fall in oil prices would result in the collapse of the Russian economy in spite of the rise in demand.
Model
The impact of price changes on the global demand for Russian oil can best be analyzed by the use of structural models. In these models, the oil price changes are showed as a function of fundamental explanatory variables such as oil production and consumption, oil inventory level, and OPEC behavior and non-oil variables such as exchange rates, economic activity, other commodity prices, and interest rates. The suitable structural model to use in analyzing how the oil price change impacts the worldwide demand for Russian oil is the demand model that focuses on Russian GDP, the per capita consumption of oil, and the oil price in a given year. The worldwide consumption of Russian oil in a given year say year n is modelled as a function of its Gross Domestic Product per capita in year n, the real retail price of oil in year n, and an assumed random error term that is presumed to possess conventional properties as below shown.
Ln Dn = Ln α + β Ln Pn + λ Ln Yn + Ω Ln Dn-1 + πn where,
Dn is per capita consumption of oil in Russia in year n
Pn is the real price of oil in year n
πn is the random error term
Ln is the natural logarithm
Yn is the Russia’s real Gross Domestic Product per capita in year n
Ω, β, α, and λ are the parameters to be estimated
Factors That Cause the Change in Oil Prices
The price of oil just like the prices of other products experiences extensive price swings during the times of oversupply and shortage. The worldwide changes in demand and supply are the primary drivers of the oil prices. The number of oil producers in the global market is limited, implying that the supply of oil is low compared to the demand. Most of the producers in the oil market are members of OPEC, which is a cartel that limits the competition. In essence, OPEC influences oil price fluctuations as it controls a substantial percentage of the supply of oil in the world. The oil market is perfect competition market due to the nature of the product, which is homogenous. Besides, the oil market is characterized by sufficient market information. For this reason, the prices of oil are determined by demand and supply. An increase in the price of oil occurs when the supply decrease or demand increase. The nature of global oil market results in daily price fluctuations. Oil is an unstable commodity. It experiences larger price fluctuations compared to the more stable such as bonds and stocks. There are some main factors that cause the change in the price of oil. These factors include the new technologies, alternative energy sources, and competition.
New technologies
The new technologies affect the supply and demand for oil. The deployment of innovative drilling and recovery methods to tap the unconventional oil sources drop the demand for oil and affect the prices. Additionally, the technological innovations in the energy sector impact the long-term oil prices. The fast-developing technological innovations in the oil sector will primarily affect the price in the long-run. High technology is required in the transportation of oil hence it is a crucial requirement for those investing in the oil sectors. The security fears are high during the times of war. The corporations in the oil markets are required to observe the safety precautions during the transportation of the crude oil. Consequently, they are required to have the high level of innovative technologies that affects the price of oil in the long-run. The United States new drilling technologies increase the supply of global oil and results in the decline of the price of oil in the worldwide market. Hydraulic fracturing is one of the most common techniques used in the United States. Fracture stimulation increases not only the rate of oil production but also the reserves’ net present value. The rise in the rate of oil production in the US as a result of the use of hydraulic fracturing has resulted in the fall in oil prices.
Alternative sources of energy
The renewable energy sources such as solar energy, nuclear energy, and wind energy are increasingly turning out to be more economically competitive in the energy sector. Compared to the price of oil, the price of the alternative sources of energy is not high. These energy sources are preferred by numerous people because they are clean sources of energy and not costly. The methods utilized to extract fuel, for instance, offshore oil drilling might be extremely disruptive to the ecosystem. The increasing substitution of oil by the alternative sources of energy has an impact on the price of oil. The decrease in demand for oil due to the rise in the demand and use of alternative sources of energy reduces the price of oil. In essence, the decline in the oil price does not affect the demand for alternative sources of energy.
Competition
The competition in the oil markets causes the change in oil prices. The main competitors in these markets impact the price of oil. The competition among the major oil producing companies significantly impacts the prices of the oil in the market. OPEC, an international cartel has the capability to influence oil supply. The ability of countries that are members of OPEC, as well as non-member countries to influence oil supply in the global market result in the change of oil price. The participants in the oil markets, for instance, Saudi Arabia and U.S can collude in either increasing or dropping the price of oil. The imperfect competition in the global oil market causes market failure.
Conclusion
Russia benefits significantly from her oil exports. These exports contribute a significant portion of the government revenues. The oil sector is one of the most vital branches of the economy of Russia. The fluctuations in the global oil prices have great impacts on the Russian economy. When the prices are high, Russia benefits from the increased oil revenues. Oil exports play a significant role in the Russia’s economic growth. Additionally, oil exports contribute to the Russia’s GDP. However, the paper has established that the high oil prices in the global market have little direct impact on the growth of Russia’s GDP. Additionally, it is now comprehensible that the forces of demand and supply of oil in the world market determine the price of the Russian oil. The paper has established that demand model, which focuses on Russian GDP, the per capita consumption of oil, and the oil price in a given year is an appropriate structural model to use in analyzing how the oil price change impacts the worldwide demand for Russian oil. The paper has also elucidated the three main factors that affect the change in oil prices.
Bibliography
Bashiri Behmiri, Niaz, and José Ramos Pires Manso. "Crude Oil Price Forecasting Techniques: A Comprehensive Review of Literature." José Ramos, Crude Oil Price Forecasting Techniques: A Comprehensive Review of Literature (June 6, 2013) (2013).
Hill, Fiona, and Florence Fee. "Fueling the future: the prospects for Russian oil and gas." Demokratizatsiya 10, no. 4 (2002): 462-487.
Konończuk, Wojciech. "Russia's best ally: The situation of the Russian oil sector and forecast for its future. OSW Study 39/2012." (2012).
Simola, Heli, Laura Solanko, and Vesa Korhonen. "Perspectives on Russia's energy sector." (2013)
Six. S. "Russia’s Oil Export Strategy: Two Markets, Two Faces." Clingendael International Energy Program, (2015). 9-46
Tabata, Shinichiro. "Observations on the influence of high oil prices on Russia's GDP growth." Eurasian Geography and Economics 47, no. 1 (2006): 95-111.
Trading Economics. "Russia Crude Oil Production | 1992-2015 | Data | Chart | Calendar." TRADING ECONOMICS | 300.000 INDICATORS FROM 196 COUNTRIES. Last modified 2015. http://www.tradingeconomics.com/russia/crude-oil-production.
Vatansever, Adnan. Russia's Oil Exports: Economic Rationale versus Strategic Gains. Carnegie Endowment for International Peace, 2010.
Kose, M. Ayhan, Franziska Ohnsorge, and Marc Stocker. The great plunge in oil prices: Causes, consequences, and policy responses. World Bank Group, Development Economics, 2015.
Rutland, Peter. "Russia as an energy superpower." New Political Economy 13, no. 2 (2008): 203-210.
Erochkine, Pavel. "Russia and Its Oil: Friends or Foes?" Blueprint for Russia (2005): 13-34.
Shafi, Khuram, and Hua Liu. "Oil Prices Fluctuations & Its Impact on Russian’s Economy; An Exchange Rate Exposure." Asian Journal of Economic Modelling 2, no. 4 (2014): 169-177.
Montgomery, Carl T., and Michael B. Smith. "Hydraulic fracturing: history of an enduring technology." Journal of Petroleum Technology 62, no. 12 (2010): 26-40.
Morriss, Andrew P., and Roger E. Meiners. "Competition in global oil markets: a meta-analysis and review." Securing America's Future Energy commissioned research (2012).
Greenstone, Michael, and Adam Looney. "Paying too much for energy? The true costs of our energy choices." Daedalus 141, no. 2 (2012): 10-30.
