Oil is one of the leading good consumed in the world. It is a commodity that is mostly traded at the global scene. Majority of countries in the world depend on this good for servicing their industries and for manufacturing. Oil is the major source of energy in the world. The case of fluctuation in prices of oil is a very common global phenomenon, with the rise in prices bringing a blame game.
When oil prices rise a lot of friction is witnessed with most governments blaming the international oil cartels, the citizens blaming the governments for not taking steps to regulate the prices of oil while other economists stand to argue that market forces are the determining factors and hence no need for blaming one another.
The effects of changing prices of oil have far reaching impacts to the global economy (Riley, para. 1). This paper explores the market forces in the oil market and how their elasticity affects the supply and demand of oil.
The efficiency of energy, for instance oil can be established by measuring the energy quantity used per unit of the output attained. This is also referred to as energy intensity.
It can also be established by comparing the increase in the rate of energy consumption and the rate of gross national product growth which roughly equals to the demand elasticity for energy (Amuzegar and Fonds monetaire international, p. 87). It is a fact that energy demands is at greater length unrelated to the price of energy that is in the short-run. However, in the long-run, resilient changes in prices of energy have a significant effect on the demand for the commodity (Natal, p.26)
There exists a strong correlation between oil and the rate at which the world economy grows because of the essentiality of oil as an input in industry. As the economy develops, demand for oil in the economy rises. For instance, China’s economy has grown very fast, and this growth has been accompanied by a rapid growth of the output of the country in sectors that consume a lot of energy. This has necessitated an upsurge in the demand for oil in the economy of China. This is referred to as cyclical demand (Riley, para. 3).
The demand for oil can be also affected by the prices of oil substitute products, for instance the relative price of gas in the market. If more reliable and relatively cheap oil substitutes are developed, that is on a long term basis, the demand is most likely to shift away from oil to its substitutes. However, this is still at a wishful level. The changing seasons affect the demand for oil.
During the winter season in the United States and Canada, more energy is needed to run the heating systems both in houses and at the places of work thus the demand for oil rises (Riley, para. 4). There always exists a speculative demand for crude oil that is purchasers always do hope for an increase in oil prices in the world market. This has made many oil businessmen and corporations to invest in buying future oil contracts (Riley, para. 6).
When the supply of oil is discussed, a crosscut line should be made between short and long term supply of oil to the global market. The curve indicating short run supply is drawn basing on a given technological state of production and the use of capital inputs in a fixed basis.
In the daily supply of oil, a short-run limit is inevitable, but as production nears capacity limits, the short-run oil supply become elastic (Riley, para. 8). The short-run of oil supply is affected by a number of factors. Profit motives of both OPEC non–OPEC countries have a big impact on the supply of crude oil. OPEC accounts for approximately 40 percent of oil supply in the world while other countries account for the other percentage.
It thus has a central influence in determination of prices of oil – that is when members act together to take charge of production and put to balance the market forces in the world market. The cartel sets quotas on the amount of crude oil they are to produce with the reason to stabilize oil price at a certain targeted level (Riley, para. 9).
On the other hand, the long run supply of crude oil in the market is also influenced by certain factors. These are low oil reserves that results from depletion of the oil resources due to an ever increasing demand for the commodity. Exploration affects the supply of oil by the virtue of the investment in exploring new oil zones. Change in the technology of extracting oil affects the extraction cost and the profit levels of extraction and refining thus impacting on the supply of the commodity (Riley, para. 10).
Most classical economic theorists on argue that a rise in demand for a good or service results in the rise in the price for that good. They further add that when prices of a commodity rise, more businessmen are attracted to invest in the production of the commodity. This leads to a surplus in production, thus resulting in a shrink in price as competition between manufacturers continue.
However, these economics failed to consider their argument as it should be applied on a depleting good like oil, minerals and natural gas. The production and consumption of these commodities is relatively inelastic when other factors for example politics, cultural factors and environmental destruction are held constant. For these commodities the shifts in investment however huge the shift may be has no likelihood to lead to a correspondence rise in supply (Cooke, para.3).
The global oil market has been very inelastic to an extent that huge rises in upstream investment do not produce contemporaneous rise in supply anymore. Assuming that other factors remain constant, it takes a very long time to establish an oil field. Moreover, we have limited ability to bring newer production online thus.
The limit is caused by political objectives of nations and the cultural constraints. An example is countries like Venezuela, Iraq or Nigeria where cultural economics has worked in any potential elasticity to decline due to local restrictions (Cooke, para.3).
The efficiency of energy can be established by measuring the energy quantity used per unit of the output attained. This is also referred to as energy intensity. It can also be established by comparing the increase rate in energy consumption and the rate of gross national product growth which roughly equals to the demand elasticity for energy (Amuzegar and Fonds monetaire international, p. 87).
It is a fact that energy demand is unrelated to the price of energy that is, in the short-run. However, in the long-run, resilient changes in prices of energy have a significant effect on the demand for the commodity (Natal, p.26)
Peak oil production
After the mid 2008, the aggregate demand for oil declined due to very high prices. This is the time when the world recession was beginning. The oil price later collapsed. The demand for oil recovered in 2009. The sharp rise in price of oil followed and was accompanied by a sharp rise in commodities and services that utilize oil in its production (McGreal, p. 120).
Oil Price elasticity of supply
Price elasticity is the measure of the level to which production can rise to satisfy the rising demand. The increase in production is related to a rise in prices. If the supply of oil is inelastic, increased production is followed by a sharp rise in prices.
It is presumed that the ceiling price of oil that we experience today is linked to the recovering demand that has come after the recession rising against a tighter supply. The sharpest recession was experienced more than seventy years ago (Natal, p. 27).
Oil is a very important commodity that is widely consumed globally. Prices of oil have more often than not generated big debates and causing friction in some countries. The demand for oil keeps increasing. The demand and supply of oil is determined by numerous factors though there are some dominant factors that affect oil production and consumption. The elasticity of oil production and consumption is centrally impacted by the oil cartel that controls the production of oil in the world.
Amuzegar, Jahangir and Fonds mone?taire international. Oil exporters’ economic development in an interdependent world. Washington, D.C: International Monetary Fund. 2010.
Cooke, Ron. “The elasticity of oil production and consumption”, Energy Bulletin, 2007. Web. December 06, 2011.
McGreal, Ryan. Rising Gas Prices and the Unnameable Cause: Peak Oil, 2010. Web. December 06, 2011
Natal, Jean-Marc. Monetary Policy Response to Oil Price Shocks. Zurich: Swiss National Bank, 2010. Print.
Riley, Geoff. AS Markets & Market Systems: Market for Oil. 2006. Web. December 06, 2011.