The Demand and Supply Side Factors

Write an essay on supply and demand of oil.
 

Since the 1990s the oil industry with its varying trends in demand and supply is at its biggest downturn. The dramatic fall in oil prices lately has left economic forecasters worried about the future growth of economies. The fall in oil prices had been affecting the different sections of the economy including consumers, producers, exporters and the governments. The fall in oil prices went through different phases. In June 2014 a barrel of Brent crude would cost $110, which dropped to $60 in 2015 and in recent time it just cost $33, which implies a tremendous decline.

The factors that contributed to this tremendous decline of oil prices were from both demand and supply sides, though the supply side factors is considered to have had a bigger impact on this fall. Now if we consider the demand side, then we see that the European economies and the developing countries are weak with the vehicles becoming more energy efficient, hence resulting in slight fall in demand for fuel but demand is also seen to be growing in the United States.  The entire fall in prices cannot be because of this the marginal fall in demand and there are supply side reasons which contribute substantially towards this fall in prices of oil. The higher supply of oil resulted from the formations of non- OPEC developments like the US shale oil and the more than expected output from Saudi Arabia, Iraq and Libya whereas on the other side there was less than the expected demand from Europe and Asia. Prices fell more quickly (by 20%) when OPEC in November decided to not to curtail the market supply of oil and in effect the markets changed their opinions regarding the oil supply by OPEC in the future. The method of hydraulic fracturing and other technologies had made it possible to access inaccessible energy reserves and hence increasing significantly supplies in the North America. According to the prevailing data, in recent times USA and Canada’s oil production has increased by more than five million more barrels of oil each day which has its significant effects on the price of oil. The North American production has growth about 38% more than the total oil demand growth. As per the revisions of International Energy Agency forecasts it suggest that the unexpected fall in demand accounts for only 20-35% of the fall in price, hence the rest of the impact is due to the tremendous rise in supply. Saudi Arabia can curb the supply but the benefits will be experienced by countries like Iran and Russia which they do not want to happen. Hence, the not so substantial fall in demand of oil and the rising supply of oil has contributed to the falling prices of oil.

Impact on the Huge Oil Importing and Exporting Countries

The falling oil price has effects on both exporters importers of oil. India and China is considered to be the biggest importers of oil and hence falling oil prices has positive effects on the theses energy intensive economies. China and India has already taken advantage of the falling oil prices to reduce their domestic oil subsidies and also increasing their oil related taxes to support public finances. Falling oil prices acts benefits India by helping improve macroeconomic budget and fiscal managements through improvement on factors like inflation, current account deficit and fiscal deficit. 30% of India’s imports constitute of oil, hence fall in oil prices help sustain domestic prices of oil products. China and India being largest importers falling oil prices increases the real income and hence consumption, along with decrease in the cost of production of goods and in turn on investment and profit. There are also positive effects on the rate of inflation. On the other side there are also likely downturns related to businesses and companies and how they operate after huge fall in oil prices leading to shutting down of many oil projects. Oil exporters depend more on oil being more concentrated across countries.  For countries such as Saudi Arabia and Iran who are large exporters of oil net export revenues fall which slows down GDP growth. Iran was on a pace to grow in years when the fall in oil prices hit which reduced revenues for the country. It needs the oil price to rise to at least $100 barrel to balance the country’s budget. Saudi Arabia has large reserve funds of about 750 billion USD for financing its deficits; hence the current price levels might not be disastrous for the country in the short run. However in the longer run, it needs the oil prices at least to be $80 per barrel. Low oil prices will generate socio economic disturbances in the Gulf States whose ripple effect will be felt in Saudi Arabia. Saudi Arabia can easily cut back on supply to increase prices, but their present strategy is to sacrifice the price and maintain their market share simultaneously force the US shale oil producers and Canada oil producers out of the market. 

Lower oil prices for the US economy is considered to be beneficial for the consumers as there expenditure on oil consumption falls but the losses are felt by energy companies who cut back on investment who lay off workers slowing down economic activity. Moreover the increase in production of oil by the country has changed how oil prices affect the country incurring losses to energy producers as reliance on imports for oil has significantly decreased for the country. The negative effects on the energy sector happen immediately whereas the positive effects on the consumers occur with time. Similarly decrease in oil prices affect Indonesia through fall in export revenues. But it will also encourage Indonesia’s current account deficit. The government also recalculated the amount of subsidized fuel prices, hence reducing fuel subsidies and increasing spending on other sectors, whereas the consumers also enjoy lower fuel prices.

Impact on USA and Indonesia

There are a number of sectors or businesses who benefit from the falling oil prices. These include the retail sector which depend upon consumer spending since demand for products increases as consumers save from fall in oil prices provided they spend those savings on retail goods, automobile companies also make profits as oil prices fall the demand for automobiles increases helping auto-makers sell cars more easily increasing revenues and profits, the transportation industry also experiences a boost as falling oil prices makes transportations cost fall which also helps shipping companies to curb transportation costs. There are also the travelling agencies or travel related industries and airlines who make more profits as with money in their pockets people take more trips outside. On the other hand we also have the industries or companies which turn out to be the losers due to fall in oil prices. There are oil service companies which make fewer sales and have to cut back on production due to falling oil prices. As these companies reduce output they also lay off workers or stop hiring workers hence increasing unemployment. Unemployment in turn then reduces the wages of already employed workers as there are many workers who can be replaced for them at lower wages. There are also the manufacturers and the industrial companies who face losses along with the oil companies as they are responsible for the supply of materials used to build and expand several oil drilling operations. Due to fall in oil prices, oil producers do not undertake new projects and cut back on production, which affect manufacturing industries that of steel, machinery, heavy equipments and other machine parts. On the other hand there are also financial companies who feel the pinch. During the times of high oil prices, more capital investment flurried for extracting expensive and difficult to produce oil. Lower prices hinge this which makes financial institutions or regional banks experience the effect.

Conclusion:

Hence we saw the various causes as well as the effects of the continuous falling oil prices. We can say that this fall can be easily curbed if countries producing oil hinge supply of oil leading to rise in prices. But countries exporting oil have tendencies of increasing supplies further during fall in prices. Adding to that countries like Saudi Arabia who contribute to the majority export share of oil in the world, is not reducing oil supply to maintain its market share and make new oil producers like that of shale oil producers of the USA to leave the market. Thus, in between these strategic affairs, there are the consumers who experience the falling oil prices and benefit at a time lag and there are the producers, investors, manufacturing industries who are at greater loss facing falling prices, reducing output and losing profit. Workers in turn also suffer as output is reduced and companies stop hiring or fire workers increasing unemployment and curbing economic growth. Hence one obvious fact we observe is that there are too many players in the market which results to excessive supply pushing down prices. To drive up prices, some players should either leave the market or the supply should reduce enough for prices to rise again. 

References:

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