INDIVIDUAL PROJECT: OIL PRICES CASE – Report One

INDIVIDUAL PROJECT: OIL PRICES CASE

ECO 100 – Introduction to Economics

Report ONE

Introduction

In recent decades, the world has witnessed a significant increase in the global demand for oil which is largely attributed to the considerable growth in the economies of major developing countries such as China, India, and Brazil. Estimates by the US Energy Information Agency show that in 2011, China accounted for nearly half of the world’s increase in oil consumption (Beirne et al., 2013).  Forecasts by the IEA (International Energy Agency) indicate that China will remain the largest global importer of oil in the coming years. As of 2012, China, the United States, India, and Japan constituted the largest global consumers of oil (Alquist et al., 2013). Of particular interest is the surge in demand for oil by both India and China, a trend that is expected to hold for the foreseeable future (Ratti and Vespignani, 2014).  Such a rise in demand for oil is likely to drive prices up, considering that the commodity is a key driver of a nation’s economy. Oil is one of the commodities characterised by considerable price fluctuations, a development that is likely to affect the economic stability and sustainability of a country negatively. This is especially the case for key net importers of oil. Some of the factors that affect fluctuation in oil prices include disruptions in commodity supply, demand for the commodity, as well as the presence of precautionary motives. This essay seeks to examine fluctuations in oil prices between 2012 and 2016, as well as a forecasting of the anticipated prices of the commodity over the next five years.

Background

The 1973/74 oil crisis is by far the greatest crisis of this commodity to have been experienced in history. This crisis happened at the same time as when the global market for crude oil was ushering in a new regime that is now characterised by fluctuations in price as a result of the market forces of demand and supply (Baumeister and Kilian, 2016). The 1973/74 crisis was triggered after there was a nearly four-fold increase in the price of imported oil in about four months, a development that in turn triggered considerable adjustments by various oil-consuming nations. Matters were not made any easier after several industrialised nations decided to cap the price of crude oil produced locally in response to the rise in global oil prices. This price cap also affected other refined oil products like gasoline, resulting in a fall in demand for the product. Ever since, we have witnessed considerable fluctuations in crude oil prices. According to available literature, the oil price fluctuations witnessed over the past four decades is largely attributed to various factors, including (i) the effect of global political events taking place in the oil-producing countries, sending shock waves in the production of the commodity, as well as the discovery of crude oil in new fields, along with advances in oil extraction technology; (ii) unanticipated variations in the business cycle globally, thereby sending shock waves in the demand for the commodity; and (iii) anticipation in the decline in global oil supplies (Baumeister and Kilian, 2016).

Fluctuations in global oil prices: 2012-2016

Considerable fluctuations in global oil prices have been of special interest to academics, policymakers, as well as practitioners. These professionals appear to hold a common theme to the effect that the major swings witnessed in global oil prices are a result of varied factors, including disruptions in global supplies of crude oil, shifts in global demand for the commodity, and the existence of precautionary motives (Caldara, Cavallo and Iacoviello, 2016).

The first quarter of 2012 witnessed an increase in crude oil prices, a development that was attributed to concerns regarding the likely disruptions in the international supply of the commodity (EIA, 2012). However, during the second quarter of 2012, crude oil prices fell, but the third quarter witnessed an upward swing in the price of the commodity. The price of crude oil during the first half of 2012 was attributed to several factors. The first of these factors was variations in the growth expectations of the global economy. These changes include a reduction in interest rates by a number of European countries, an increase in employment in the U.S. as well as the growth of the manufacturing sector in China. Nonetheless, the second quarter of 2012 witnessed a reversal of the aforementioned factors, and this played a role in the downward push for global crude oil prices recorded in the second quarter of 2012 (EIA, 2012).

Disruptions in the production of oil in such areas as Yemen, Syria, and Sudan also caused a rise in oil prices, by reducing daily production levels. In addition, the European and U.S. sanctions on oil imports from Iran in a quest to compel Iran to surrender its nuclear program was yet another contributing factor, while the United States recorded the highest daily oil production levels in nearly two decades and this caused a downward fall in global oil prices.

In 2012, the price of a barrel of crude oil was trading at $ 120 but by the end of 2016, it was trading at an average price of $ 43, representing a decline of almost 60 percent. Economists indicated that the fluctuation in crude oil prices as witnessed during this period was a result of economic and geopolitical turmoil (U.S. Energy Information Administration, 2012). Following the global financial crisis of 2007/08, there was an increase in the demand for oil, and this caused prices to rise, as did the supply for the commodity. However, supply outstripped demand, and this is responsible for the significant decline in oil prices.

Source: (U.S. Energy Information Administration, 2012).

In January 2013, crude oil was trading at $105.04 a barrel and by June of 2014, there was a noticeable slight increase in the price to $ 108.37 a barrel. However, between 2014 and 2015, there was a noticeable significant reduction in global oil prices after OPEC decided not to limit crude oil production by its member states. Consequently, such OPEC member states as Saudi Arabia and Libya recorded considerable increases in their daily crude oil production. This development brought about stability in crude oil prices after there had been weak demand for the commodity in leading net crude oil importers in Asia and Europe. By the end of the first quarter of 2015, the price per barrel of crude oil had risen to $ 62.5 only to hit a new low of $ 29.92 by January of 2016.  In February 2016, crude oil retailed at $ 26.21 a barrel, which was the lowest price in over a year. This was attributed to such factors as increased production of crude oil in Russia and by OPEC member states, as well as high inventories of crude and refined oil products (Kristopher, 2017). By December 2016, crude oil was trading at an average of $ 55 a barrel.

A five-year forecast on global crude oil prices

            In 2017, global oil prices experienced an upward swing. For example, by mid-January, the price of crude oil experienced a near 100% rise from its lowest levels recorded in 2016. The crude oil market is expected to be bearish in 2017 and over the next few years as the U.S. continues to increase its production levels, while oil inventories in the U.S. and other leading economies in Europe hit the highest levels in nearly three decades. Moreover, countries like Nigeria and Libya have also increased their daily crude oil production (Kristopher, 2017). The strength of the dollar relative to the value of other leading currencies will also influence the price of oil in the next five years. Moreover, as the global economy becomes increasingly unpredictable and volatile, this will also cause a likely rise in the price of crude oil. Estimates by the EIA show that Brent crude oil will average at $ 55 a barrel in 2017 but will increase slightly in 2018, to $ 57 a barrel (EIA, 2017).

(Source: Knoema, 2017)

This upward rise in the average crude oil price per barrel is expected to hold, averaging $ 54.5, $ 55.7, $ 56.9, and $ 58.4 in 2019, 2020, 2021, and 2022, respectively (Knoema, 2017).

Conclusion

The price of oil is reliant on the market forces of demand and supply. For nearly 40 decades, the price of crude oil has been largely volatile and unpredictable, with statistics showing that as the production of the commodity increase, there is a resultant decline in price and by extension, demand for oil imports. The price of crude oil between 2012 and 2016 was highly reliant on demand for the commodity in China and India, as well as increased production in the U.S. and Russia.  Political tensions in Syria, Iran, and Iraq also played a crucial role. This trend is expected to continue in the foreseeable future, up to 2022, due in part to increased demand from developing economies and growing political tensions in oil-producing countries.

References

Alquist, Ron, Kilian, Lutz, and Robert J. Vigfusson (2013), “Forecasting the Price of Oil,” in:

Elliott, Graham, and Allan Timmermann (eds.), Handbook of Economic Forecasting, 2,

Amsterdam: North-Holland, 2013, 427-507.

Baumeister, C., and Kilian, L., 2016. Forty years of oil price fluctuations why the price of oil may still surprise us. [Online]. 

Beirne, J., Beulen, C., Liu, G., Mirzaei, A., 2013. Global oil prices and the impact of China.

China Economic Review 27, 37-5.

Caldara, D., Cavallo, M., and Iacoviello, M., 2016. Oil Price Elasticies and Oil Price Fluctuations. [Online].

Dvir, E. and Rogoff, K.S., 2010. Three Epochs of Oil. [Online].

EIA., 2012. Crude oil prices peaked early in 2012. [Online].

EIA., 2017. Short-term Energy Outlook. [Online].

Kristopher, G., 2017. Analyzing Crude Oil Prices in 2016 and 2017. [Online].

Ratti, R.A., and Vespignani, J.L., 2014. Oil prices and the economy: A global perspective. [Online].

U.S.  Energy Information Administration, 2012. EIA’s Annual Energy Outlook 2012. [Online].