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ESSAY 1: FLUCTUATIONS OF OIL PRICES

NAME: SAURABH THORAT


ID: 1603421
"My formula for success?"......."Rise early. Work late. Strike oil"
- J.Paul Getty (1892-1976)
It's easy to understand why oil is so important in our lives. You couldn't drive
your car unless it was filled with petrol or diesel. Our world, without oil, will
come to a standstill. Over the past 5-6 years the oil prices have fluctuated
violently on a global scale due to various factors and it
has affected us all in some way or the other. Though a lot of us do not follow
the oil prices daily, I can assure you that its been a roller coaster ride.
The reasons behind this roller coaster ride of the prices are many but some
are very prominent
and we shall look at them in detail. As with any commodity, the laws of
demand and supply
cause oil prices to change. When supply exceeds demand, prices fall and the
opposite is also true. Lets look at the supply of oil on a global scale. OPEC, or
the Organization of Petroleum Exporting Countries, is a consortium made up
of 13 countries: Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya,
Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela and
controls 40% of the world's supply of oil. This proves the kind of influence
it has on the prices of oils.
OPEC planned to keep the price of oil above $100 a barrel for the foreseeable
future, but in mid-2014, the price of oil began to tumble. It fell from above
$100 a barrel to below $50 a barrel. The reason? It refused to cut oil
production even when the demand was low, which in turn reduced oil prices
drastically.
The reasons for low demand are interesting and range from politics to climate
change. Demand
is high during winter in the Northern hemisphere and also during summers in
areas where air conditioning is used for comfort. Also if producers think the
price is staying high, they invest, which increases supply. Similarly, low prices
lead to an investment drought.
Demand is low because of weak economic activity and partly due to rise in
the use of oil substitutes. On the political front, Iraq, with all its problems
with wars has not reduced
oil production. One interesting factor is the role played by Saudi and the
other gulf countries.
By curbing oil production, they can restore the oil prices. But this would mean
that Iran and

Russia will benefit hugely as they export a lot of oil. This is why Saudi isnt
curbing oil production. USA has become the worlds largest producer of oil.
Since it imports less oil as
compared to the previous years, it leaves a surplus in the market. This has
helped decrease the
oil prices as well.
Beyond slow economic, a number of Asian countries have begun cutting
energy subsidies, resulting in higher fuel costs despite a drop in global oil
prices. In 2012, Asias top spenders on energy subsidies, as a percentage of
GDP included: Vietnam 2.5 percent, Malaysia 2.3 percent, and India 2.3
percent. India is a primary example. Between 2008-2012, Indias diesel
demand grew between 6 percent and 11 percent annually. In January 2013,
the country started cutting the subsidies of diesel. Since then, diesel
consumption has plateaued.
The demand for oil is inelastic. The inelasticity of demand also means that
the total revenue the seller receives will not rise when prices fall. On the
other hand, if a ten percent price reduction were to lead to a more than ten
percent increase in the volume sold, then total revenue would rise as a result
of the price cut.
When prices are rising, inelasticity of demand works in the favour of the
seller. An increase in price leads to a lower volume of sales but higher
revenue. That is, the relative decline in volume is less than the rise in price,
resulting in more money taken in by the seller.
Thus the current condition shows a very competitive market but a weak
response from the
consumers in the short run.
Another issue as mentioned earlier is the co-operation between the oil
producing countries.
These countries are not united to try and increase the prices of oil. They have
varying foreign policy interests and economic structures. The biggest
producer, Saudi Arabia, is even accused of purposely trying to keep prices
low to run upstart American producers out of business.
Prices in oil started seeing a rise in mid-2015. Prices in May 2015 were 40%
more than they were in march 2015. But this was mostly for short-term
reasons, such as worries about upheavals in the Middle East. Demand in
China, now the worlds second-largest consumer and biggest importer of
crude, is high. Americans are buying more gasoline as people respond to low
prices by driving more miles in bigger cars. American oil output is down
slightly too. But this price hike was unlikely to be sustained.
An announcement by OPEC in October stated that global investment in oil
projects would drop by 23 percent in 2015, leading to lower supply before
long. Also Late 2015 started seeing a
decline in oil production in the USA causing them to import more oil and in
turn create less

supply. The Iran nuclear deal caused anticipated return of Iranian oil to the
world market caused a drop in oil and gas prices.
The market price of crude oil is valued in US dollars. Therefore, when the oil
price falls or rises, you also need to look at the value of the dollar against a
range of currencies. If an oil refinery in China needs to buy crude oil, it has to
convert its income, derived in the local currency, Yuan into dollars. An oil
producer, such as Saudi Arabia, needs to convert its income into the local
currency, the Riyal in order to cover its costs. Large buyers go direct to
suppliers in order to get a good price for their oil. China is particularly adept
at this practice and has written up agreements to pay in its own currency for
crude oil, rather than in dollars. So, if the value of the dollar falls by 10 per
cent, the contract price of those agreement rises by 10 per cent, even though
it hasn't changed at all in the contract currency. In fact, this phenomenon is
notable in all commodities priced in dollars - steel, copper, gold, and silver
have all experienced price rises in 2016. This is not because there is a
shortage in those commodities; it is just because the currency in which they
are priced has fallen.
Disruption in supplies has also played a major role in the increase of oil
prices. Terrorism, strikes, sabotage or lack of maintenance are all sharp
reasons for price fluctuations. In all, "unplanned disruptions" accounted for a
loss of about 2.5M b/d. Evidently, this is rarely reported, but when oil prices
are low expect more disruption. This has more to do with human nature than
economics. With oil revenues down, oil producers cut corners and reduce staff
levels. Maintenance becomes comparatively expensive and in some parts of
the world it is simply postponed, turned into technical indebtedness.
With the emergence of ISIS, supply from Kudristan has gone down This
February; oil exports from the region were halted due to attacks on pipelines
through Turkey. Production in Northern Fields operated by Iraq's National oil
company remains in doldrums because of political tensions with the Kurds. A
worker's strike in Kuwait forced the Gulf state to reduce its oil output. The
three day strike wiped out 1.5 million barrels from the daily production.
Indeed, that's roughly equivalent to the 'overproduction' of oil in the world
today. Since the refining operations too were affected, traders reacted to the
strike by buying more oil on the following Monday. Further, a pipeline fire in
Nigeria affected the flow of 142 kb/d of crude. Apart from this too, Nigeria has
been plagued by supply disruptions. Pipeline disturbances in Iraq and Nigeria
removed more than 800,000 barrels of crude a day off the market,
contributing to about two percent of oil price rise last February.
Volatility of the market makes traders nervous, pushing the prices to higher
margins because of geopolitical factors. OPEC countries are hurting because
of budget deficits. It may be their own fault to use their oil dominance and it
may be biting them back to be still relying on oil to fund everything. For the
first time since pretty much anyone alive can remember, OPEC countries

have to tighten their belts. The cash crunch and crumbling infrastructure in
Venezuela is a major worry for OPEC's production.
In the long run, oil supply and demand is elastic because future alternatives
give the potential for reduced demand and higher supply. Technological
advances shift the supply curve towards
the right and reduce oil prices. Demand maybe decreased by the use of ecofriendly vehicles
or hydrogen fuelled cars, shifting the demand curve towards the left and
lowering prices.
However such developments take time and until they are implemented, the
price of oil will remain volatile and fluctuate in the short run.