Global Rise Of Oil Prices Economics Essay

Energy and Oil is a strategic commodity and very valuable to everyday life. Millions around the world are affected if there is a significant change in the price of oil, especially if the prices increases. The price is affected by two factors, supply and demand. If the supply is steady, stable and adequate to meet up with world demand there wouldn’t be an issue. But this isn’t the case, to say the least World prices of energy sources began to rise as early as 2005 and showed no sign of stopping, By march 2005 OPEC had admitted to losing control on prices and immediately sought to pump additional barrels but wasn’t sufficient. In 2007 the price of oil nearly doubled and continued to rise into early 2008, leading on to the economic crisis. Gas, coal, nuclear energy and in particular oil reached soaring prices as high as $160 a barrel like someone had lost a grip on it somewhere.

This price spike in oil prices is due to a combination of factors, first the Kyoto protocol that finally came into effect in 2007, the rising demand from India and china, the neglect from oil companies and investors as they search and research on other alternative source of energy. Political struggles, corruption and attacks on oil pipe lines in one of OPEC’s member country Nigeria. Where unrest in the African oil region has resulted to a lost in 175,000 barrels per day. [1] The fall in value of the US currency played a major role and is partly responsible, since the price for these commodities is typically quoted in US dollars. The financial crisis and recessions in the global economy also appears to have contributed to a substantial increase in speculative interest in energy future markets, helping to boost prices.

World oil demand is expected to increase substantially until 2020 according to the Energy Information Administration (EIA , 2006) while in the IEO (Independent Evaluation Office) 2009 projections total world consumption of energy is projected to increase by 44 percent until 2030 with most of its demand from non-OECD economies.

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Although the price of a barrel has gone down in recent times and settled, the question is what happens in the event of another decline in supply or demand continues to persist, with failing and short term policies by the institutes involved, policies that fail to come together, correlate and aline with each other, ignoring the fact that the issue at hand if neglected again or not carefully managed can cause devastating effect to the world economies.

Today oil has proved to be a powerful economic tool it has also proved to be a capable political weapon. In other words, oil contributes directly and indirectly to the production of all goods and services. For example, in 2003 oil as a source of energy accounted for about 37% of total energy sources. There is compelling body of evidence that oil production is determined by the interplay of institutional and economic forces. The issue is the policies that the key players implement from the U.S. to the EU and OPEC itself.

Statement of the Issue/Problem:

What policies energy institutes and oil producing countries including government bodies have to stabilize and control the market? There is pressure on the industry and oil market, with concerns about CO2 emissions and global warming since the time of Kyoto and increasing environmental awareness but no adequate policies to resolve the issue or at least one that works in the competitive and challenging industry.

Background (of the problem):

Oil, coal and gas currently provide more than two-thirds of the world’s energy and electricity, but also produce the greenhouse gases largely responsible for global warming. A number of models suggest that implementation of the Protocol will affect energy markets and oil revenues. At the same time, world energy demand is expected to rise sharply in the coming years, presenting all societies worldwide with a real challenge see appendix (1). Several factors as mentioned earlier has caused the previous drastic rise in price and decline supply. Presently as the prices continues to remain low the demand from Asia for oil is increasing by more than two million barrels per day’ [2] if demands from Asia grow significantly at such a rapid rate when prices are at a stable range then there are no doubts that prices would not and cannot stay low for too long ( Merlin Flower 2010) .

Another issue is that of ‘pegging’, many oil producing countries like Saudi Arabia and Kuwait peg their currency to stronger currencies like the U.S. dollar. When we experienced the decline of the dollar during the recession their economies are relatively affected there after they let their currency float. A classic example is in 2006 when other countries with Kuwait leading the way ‘unpegged’ their currency from the dollar following suit was the expected rise in energy prices. Speculations and uncertainty affect businesses and stock value not to say the least oil field services companies (Giuseppe Marconi 2008). Many oil-exporting economies argue that they peg to the dollar because oil is priced in dollars. Pegging their currency to the dollar eliminates the apparent mismatch between the government’s dollar-denominated oil revenues and its local currency spending. The IMF after undertaken research indicates that a significant increase in price of oil on average leads to real appreciation of the currencies of oil exporting economies therefore might have been another reasons for their actions. This logic, however, fails to accurately diagnose the real fiscal problem of oil-exporting economies. Appendix (2) shows a list of major exporting economies and those that peg or float their currency.

There is a growing view that, if nothing is done to cut the growing demand on world consumption of oil , there is likely to be an oil supply crunch within the next 10 years, Because oil consumption is responsible for some 25% of greenhouse gas emissions, efforts to reduce emissions would seem likely to affect the market for oil According to the economist in 2004 global consumption of oil increased by 3.4% , with nearly a third from growing nations like china where its demand is predicted to be about 16%. Supporting that is a chart from the European Commission in Appendix (3). Upon that there is insufficient investment by the international and oil companies many multinational oil companies are or have spent time buying their own shares rather than developing the society they present. [3] Although with the exception of a few whom participate in the development of their local economies but how adequate is this? If this is to happen, there is no doubt it might trigger another economic crisis and causing a global impact.

Oil export revenues account for between 9% and 40% of GDP in OPEC economies, so reduced oil revenues means reduced economic growth. For most of its members which are developing nations a decline in economic growth has implications for their relative economies most especially unemployment for those with high population growth rate.

So far all parties involved with significant influence in the market have policies of their own different interest. Policies tried have been short term policies and have proved no effect so far. A typical example of short term policy was in 2001 the U.S under introductions from the president, the U.S. announced it would release 30m of barrels from the Strategic petroleum Reserve (SPR) rather than selling the oil. Between August and November the department of Energy (DOE) requested offers for oil to be replaced back. These efforts proved to have back fired increasing the cost of crude oil having been handled in a clumsy and old fashion way. The U.S policy whether short-term or long term can have the long term negative effect of increasing the cost of crude oil. This showed the importance of set policies and reform in the energy market especially oil which the world depends on. If there isn’t no change in policies the by 2015, then there is likely to be a future crash in the energy oil market affecting individuals across the globe either in little ways from transportation or domestic energy consumption.

Critique of Pre-existing Policies:

When it comes to policies either set by OPEC or the U.S. Energy policymaking in the past 35 years has been neither decisive nor strategic. The world can no longer afford to forward oil policies which we fail to implement. (Thomas D. May 2006). Previously OPEC adopted the ‘quota system’ to limit its oil supplies to keep oil prices at certain levels. According to this system each OPEC country is allocated a specific level of oil production to limit total OPEC oil supply and thereby influence oil prices in the international market. In the late 19’s around 1986, this system did not help OPEC to avoid the oil price collapse because most OPEC countries did not respect their quotas, Angola, Venezuela, Iran and Nigeria named the biggest cheaters. Bearing in mind These OPEC short term policies affect international affairs.

It is thought that implementing the Kyoto Protocol will require a carbon tax (or equivalent)

in Annex B countries, and this will raise the price of oil to consumers and therefore reduce demand there. Because these Annex B countries account for more than 60% of world oil consumption any significant reduction in demand there may well cause a decline in the producers’ price of oil on the global market. Further, if the principal mechanism by which Annex B countries reduce emissions is through a carbon tax, then this tax wedge may increase the ‘rent’ that governments in energy importing countries have in the oil market, transferring wealth from oil producers to consumers (Mabey et al., 1997, p. 274). To put this in perspective, the G7 countries (US, Canada, Japan, Germany, Italy,

Britain and France) already earn some 70% more income from oil taxes than OPEC members earn from petroleum exports (OPEC, 2001). So, through reduced demand, reduced price and reduced market rent it is thought that implementation of the Kyoto Protocol will reduce oil export revenues. Other concerns expressed by OPEC countries include the potential increase in renewable subsides, which they perceive to be given at the expense of other energy forms (e.g. oil) and discriminatory in nature (WTO, 2002. Problem is that everyone seems to have or develop their own policies from the Arab council… to the European Union, all different policies different directions and interests. In the last few years OPEC agreed on a range of oil prices (ie between $22-28/B) and used its quota system to keep its oil prices within these limits. However, OPEC did not give any scientific rationale for this range or explain whether or not it was based on any scientific study. Nor did it say such a study took certain factors into consideration. In other words this price range seems to be arbitrary.

On October 2007 in London the EU proposed new energy policies to come into place in other to tackle the challenging industry . The EU has clearly recognised that the internal energy market is the policy line that ensures fair prices to citizens and industries. At the same time, it guarantees that even smaller companies, for instance those that invest in renewable energy, have access to the energy market. Absent from this section of the initiative are measures to directly address the current peaking of internal Natural Gas production. Although put forward as so, market liberalization wont secure the increasing Natural Gas imports needed in the following years to meet internal demand. Lines of action to substitute Natural Gas or to secure other foreign sources simply do not exist. The main energy problem in Europe is not mentioned even less dealt with.

These policies have a unique flexibility in that they can be used as a cure or as a weapon, but commonly their primary purpose is to promote or protect economic interests.

Policy options and recommendations:

As regards to reform of the oil or energy sector, in order to meet the requirements concerning the opening up of the market, an appropriate legislative and regulatory framework is necessary, in particular as regards regulation, and implementation of energy policy. Apart from the formulation and implementation of an energy policy, work should be concentrated on two aspects: opening up production, distribution, pricing and restructure of economic development plans by adopting efficient policies and procedures.

There are several policy measures and recommendation that might minimise any possible losses to OPEC countries.

One, assistance from developing countries to exporting economies to diversify sources of income, as models results show that economies with a diverse pattern of production and exports will be least affected by the Kyoto Protocol (Polidano et al., 2000).

Two, OPEC’s share of oil market and cartel power would increase if there are measures to discourage the production of fossil fuels within developed countries Third, measures to abandon nuclear power generation would also favour oil exporters as more primary energy needs would presumably be met by oil.

Fourth creating a situation where by countries wouldn’t be able to peg theirs with another and jumping off once the market changes rather look to creating fiscal policy and finally the issue to sell essential and vulnerable commodity in a more stable currency like the euro, as the U.S. is unpredictable the least to say.

However, this does not mean that all policies are going to be successful; they need to be well managed within a sustainable balance of power from global institutes.

Appendices

Appendix (1)

Table 1. World Marketed Energy Consumption by Country Grouping, 2006-2030

(Quadrillion Btu)

Region 2006 2010 2015 2020 2025 2030

Average Annual

Percent Change,

2006-2030

OECD . . . . . . . . . . . . . . . . . . . . . 241.7 242.8 252.4 261.3 269.5 278.2 0.6

North America . . . . . . . . . . . . . . 121.3 121.1 125.9 130.3 135.6 141.7 0.6

Europe . . . . . . . . . . . . . . . . . . . . 81.6 82.2 84.8 87.9 90.0 91.8 0.5

Asia . . . . . . . . . . . . . . . . . . . . . . 38.7 39.5 41.8 43.1 43.9 44.6 0.6

Non-OECD . . . . . . . . . . . . . . . . . 230.8 265.4 299.1 334.4 367.8 400.1 2.3

Europe and Eurasia . . . . . . . . . . 50.7 54.0 57.6 60.3 62.0 63.3 0.9

Asia . . . . . . . . . . . . . . . . . . . . . . 117.6 139.2 163.2 190.3 215.4 239.6 3.0

Middle East . . . . . . . . . . . . . . . . 23.8 27.7 30.3 32.2 34.6 37.7 1.9

Africa . . . . . . . . . . . . . . . . . . . . . 14.5 16.2 17.7 19.1 20.6 21.8 1.7

Central and South America . . . . 24.2 28.3 30.3 32.5 35.2 37.7 1.9

Total World . . . . . . . . . . . . . . . . . 472.4 508.3 551.5 595.7 637.3 678.3 1.5

Note: Totals may not equal sum of components due to independent rounding.

Sources: 2006: Energy Information Administration (EIA), International Energy Annual 2006 (June-December 2008).

Summary data on major oil-exporting economies Appendix (2)

Country

Oil and gas export revenues, 2006

(billions of dollars)

Average oil exports, 2006 (millions of barrels

a day)

Population (millions)

Exchange

rate regime

Change in REER,

end 2001

to end 2006 (percent)

Saudi Arabia

195.6

8.8

21.4

Fixed (to dollar)

-22.2

Russia

190.8

7.4

142.9

Managed float

(euro-dollar basket)

39.6

Norway

75.7

2.3

4.6

Floating

6.2

United Arab Emirates

70.2

2.2

2.6

Fixed (to dollar)

-18.9

Venezuela

60.3

2.4

25.7

Fixed

-25.6

Iran

60.1

2.4

68.7

Managed float

22.3

Kuwait

55.9

2.3

2.4

Fixed (to basket)

n.a.

Algeria

53.3

1.7

32.9

Managed float

(to dollar)

-22.0

Nigeria

48.5

1.9

131.9

Managed float

(plans to float 2009)

12.8

Libya

38.3

1.3

5.7

Fixed (to special drawing rights)

n.a.

Kazakhstan

24.6

1.5

15.2

Managed float

n.a.

Qatar

21.9

1.0

0.9

Fixed (to dollar)

n.a.

Oman

16.4

0.7

3.1

Fixed (to dollar)

-18.4

Bahrain

9.4

0.0

0.7

Fixed (to dollar)

-25.4

n.a. = not available

Note: Oman and UAE real effective exchange rate (REER) estimates are based on International Monetary Fund annual data,

which end with 2005. For Nigeria, it reflects revenues of net oil and gas exports. Iran’s exports reflect its fiscal year 2005-06.

Sources: IMF, International Financial Statistics ; IMF Country Reports; BP Global (for energy data); national central banks;

CIA, World Factbook (for population).

Appendix (3)