Saudi Oil Market: The Effects of Prices on Supply and Demand - Example

Gaurav Kumar No. 348595 24 April 2008 Saudi Oil Market: The Effects of Prices on Supply and Demand The 2007 blockbuster ‘There Will Be Blood’ is a gripping reminder of the fact that crude oil is not only an integral part of the modern Western economies, but also has a direct bearing on our social and national values, ethics and political power structures (“There Will Be Blood”). Oil is a paramount factor that has seeped deep into the consciousness of the 21st century man. It is the lifeblood that nourishes and sustains our economies. It is next to impossible to think about economic growth and development without having an ample access to crude oil. The surprising thing is that this factor of growth which gained paramount importance during the dawn of the Industrial Revolution still continues to rule the roost in the contemporary IT driven economies. Oil prices have the diabolical power to influence the quality of life of people in both the developed and the underdeveloped economies. Thus, the economics of oil deserves to attract the attention of any educated individual who has a rudimentary interest in the working of modern economies. United Kingdom consumes about 2 million barrels of oil per day (The World Fact Book). Following the same trend, USA consumes nearly 5,102,000 barrels of oil everyday (“Basic Petroleum Statistics”). Japan absorbs about 5.578 million barrels of oil per day (“Japan Oil-consumption”). These astounding figures are indicative of the extent to which the developed economies are dependent upon oil. Ironically, the newly emerging economies like China and India have opted for the same model of growth as their developed counterparts. China consumed roughly 319.08 million tons of oil in 2006 (“China oil consumption”). Even a naïve analysis of this statistics is enough to awaken us to the fact that the demand and supply of crude oil, and the crude oil prices are perhaps the strongest economic parameters that have a sharp and direct impact on the world economy. Even a marginal fluctuation in oil supplies or prices has the potential to rock the foundations of all the major and nascent world economies. The world oil prices shot up to $ 110 a barrel in March 2008. Though it is held that such a sharp increase in oil prices occurred primarily due to fluctuations in the monetary factors, there is no denying the fact that the fast depleting oil reserves are at present facing an acute demand pressure. Not only the demand for oil in the developed countries picking up, the developing countries also expect a stark increase in their oil consumption over the next decade. Security related issues like the situation in Iraq, US led ‘War on Terror’, US’s tensions with Iran and North Korea are expected to augment the demand for oil even further. In 2005, the global consumption of oil skyrocketed to 31 billion barrels as compared to 30 billion barrels in 2004. The power which the oil prices command in the world economy can be estimated by the fact that oil prices were the one major reason that led to economic recession in 1973 (“Peak oil”). If we combine this vital trend with some other economic facts, the third world economies could face drastic challenges in the next few years if the oil prices fail to stabilize. The world food prices have already increased by four times in the last five years. The situation could even worsen if the oil prices shot up beyond reasonable expectations and calculations. As the taxes on the petroleum products in the underdeveloped countries are already very low, the governments in these nations will be left with not many options to tackle the ensuing mass tension and unrest. The scope for alternate energy resources is still a pie in the sky. A realistic substitute for petroleum is not foreseeable, at least in the next two decades. Reasons behind high oil prices Like other commodities traded in the global markets, oil is also susceptible to demand and supply pressures. One does not need to have a doctorate in economics to workout a basic understanding of the reasons behind high oil prices. The price of crude oil dramatically increased last year because of an increasing demand and highly constrained supply arrangements. Politically instability in many of the oil producing countries also added to this hike. Owing to an unprecedented economic growth in the USA, Western Europe and Asia, the demand for crude oil is expected to increase by 3 percent in 2009 (“Determining fuel prices”). These calculations do not take into consideration the possibilities of disruption in the oil supply. Considering the fact that most of the oil reserves are located in politically unstable countries, the supply of the crude oil is realistically expected to fluctuate at one time or other. An inevitable outcome of these factors could be an unbridled increase in the oil prices. It is the crude oil that is refined to obtain useful products like gasoline and diesel. One of the reasons why the oil supply has depleted in the last few years is because of an increase in the cost of refining petroleum. Added to this, the instability in the Middle East, the situation sounds perfect for a diminishing supply in the face of a roaring demand, resulting in a price hike. The other reason behind high fuel prices is the exorbitant taxation resorted to by many governments on the petroleum products. This significantly contributes to the increase in the price of oil for the end user. At some places, like in Hong Kong, the rate of taxation on petroleum products is as high as 50 percent. The situation may get even worse if we add to it the possibility of government regulations, forex problems, distant geographical location, local competitions, etc. Another reason for appreciation in the oil prices is the speculation on oil futures (“Three factors behind oil prices”). The future trading in oil significantly pressurises the oil prices. With no dearth of liquidity in the world economy, the situation pertaining to this factor is going to be more or less the same in the coming times. The US government’s weak dollar policy in the last few years has also massively contributed to an augmentation in the oil prices. Every increase in the dollar price causes a proportionate increase in the oil prices. OPEC The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental club of the world’s major oil producing and exporting countries (“OPEC’). It has member nations spread across three continents i.e. Africa, America and Asia. The 13 permanent members of OPEC are Venezuela, Algeria, UAE, Angola, Saudi Arabia, Ecuador, Qatar, Indonesia, Nigeria, Iran, Libya, Iraq and Kuwait. These countries are the home to a major chunk of the world population and oil constitutes an important factor in their quest for social, economic and political development. With their economies being so dependent on oil, the major nations in this club decided to get organized in a single group in 1960. OPEC was constituted primarily in response to the unethical attempts by Western oil companies to control and regulate the world oil prices. The primary objective before OPEC is to regulate the world oil prices and to protect and safeguard the interests of the member nations. OPEC also intends to stabilize the world oil prices as a precaution against unnecessary and irrational price fluctuations. One of the self imposed duties of OPEC is to ensure a cost effective and unobstructed supply of petroleum to the customer nations. It also tries to ensure a fair return on the investments made by the member states and private entrepreneurs in the petroleum sector. OPEC is a force to be reckoned with in the international political and economic arena. Almost two thirds of the global oil reserves belong to this club and nearly half of the worlds petroleum exports originate from its member states. Since its conception in 1960, its member states have experienced an unprecedented economic growth. The GDP of Saudi Arabia only in 1980 was $102 billion. Though OPEC is seen as a villain and sort of an obstruction in the path of free trade, it has contributed a lot in uplifting the people living in its member states and has ensured a fair price of petroleum for them .It has curtailed the ability of the Western conglomerates to manipulate and tilt the world petroleum prices for their advantage, OPEC has not hesitated in wielding its immense political and economic power from time to time. In the 1973 Arab/Israel war, OPEC imposed an oil embargo against USA and its Western allies who supported Israel. This also resulted in an immense increase in the income of Arab nations that was much desired owing to the expenses incurred in supporting the war efforts. The impact of this embargo was so severe that the US was forced to tighten its belt and the US government issued strict guidelines and instructions to its citizens, pertaining to the consumption and usage of oil products. Infact, the nations dependent on OPEC for their oil supplies went into a recession in 1974-75. OPEC countered the fall in the world oil prices in 1990 by deciding to decrease the petroleum production without any exceptions. This significantly contributed to the recession in the USA in 1990-91. The world community had to face a really tough situation owing to this unprecedented increase in the oil prices. Supply and Demand of Petroleum in 2004 The oil prices exhibited a sharp increase in 2004. This happened primarily due to the practical constraints on the supply side owing to the limits set by OPEC on the production of petroleum in its member states and the damage caused to US oil refineries by the hurricanes. This was matched by an exceptional increase in the demand side caused by to the gas guzzling, developing Asian economies like China and India. Price Dollars/Barrel 70 65 60 55 50 45 Supply Demand Curve 40 Curve 35 30 82 83 84 85 86 87 Price/Demand Million Barrels/Day (2004) From Criepi News Supply and Demand of Petroleum in 2006 Continuing with the previous trend, the oil prices exhibited a sharp increase primarily owing to the security issues like US nuclear standoff with Korea, tensions with Iran and the war between Israel and Lebanon. This considerably decreased the world demand for petroleum. The supply side also exhibited constraints due to the hurricane disruptions in the US and the production limits set by OPEC. Oil Prices in 2007 In September 12, 2007, oil prices exhibited an unprecedented increase of $80 per barrel. The problem was further aggravated by the rise in prices accompanied by a restricted supply. Oil Prices in 2008 Oil prices continued this with this surge right from early 2008 and reached $115.07/barrel on April 16, 2008. they are expected to continue with this trend owing to a high demand and a significantly steep drop in production levels. Despite our best wishes and intentions, oil prices will continue to play a vital role in our economies and are expected to give us many sleepless nights in the times to come. Works Cited ‘Basic Petroleum Statistics’, Energy Information Administration, viewed 24 April 2008, ‘China oil consumption-imports decreased’, CHINAdaily, viewed 24 April 2008, ‘Determining fuel prices’, Caltex, viewed 24 April 2008, Hashino. Y, ‘Outlook for crude oil prices and its effects on Economy in 2005 and 2006’, Criepi News, viewed 24 April 2008, ‘Peak oil’, Wikipedia, viewed 24 April 2008, ‘There Will Be Blood’, The New York Times, viewed 24 April 2008 ‘The factors behind oil prices”, viewed 24 April 2008, ‘United Kingdom’, The World Fact Book, viewed 24 April 2008, Read More