OIL PRICES

Oil Prices and the Economy

Oil Prices and the Economy

Q1. Describe how the oil price has changed since 1960. Identify in particular the extent to which the 2008 oil price was exceptional?.

Crude Oil has gone through a series of price changes from 1960s. The price per litre of Crude Oil rose from $0.5 in January 2007 to $0.92 in July 2008. The year 2008 is considered as the worst year as Crude oil prices increased significantly. In May 2009, the prices of crude oil again fell to $0.55.

Until the year 1973, the oil prices were pretty low at around $0.015 per liter, but after 1973, the oil prices rose significantly. In 1980, the world faced another oil price hike shock as the prices increased to $0.23 in 1980. The prices saw a sea saw the situation and again declined in the year 1986 to $0.08. In the year 2004, it again crossed 1980 peak point.

The prices of most commodities tend to rise due to decline in value of currency (inflation). If the price of crude oil increases more than the increase in price of the dollar or any other commodity, then oil is becoming more expensive than other commodities and vice versa. Economist terms this as the real adjustment of oil prices. The real value of oil prices remained steady through 1960s and 1970s, but it faced a sharp increase in the 1980s, then declining in the 1990s. The oil prices witnessed the most significant increase in the prices (real terms) in the year 2008, when it passed the record of 1980s (Gateley, G. & H. G. Huntington, 2002, pp. 19-55).

Q2. Why has the demand for oil been increasing?

The increase in oil prices is dependent upon the increase in demand for oil against its supply. When the demand for oil increases, the prices increase. The demand for oil could be increased due to a change in price of substitutes for oil, the price of complementary products, incomes, technology and population. In the less developed countries, the demand for oil increases with the rate of development. In low income countries, when the overall income level of an economy increases, the demand for any good which are intensive in energy consumption increases. Moreover, the energy efficiency is very low; hence with rapid industrialization oil consumption is increasing rapidly.

From the year 2003-2007, the oil demand remained static or saw a decline in USA, Canada, EU and Japan account for 45% of world demand. After the oil shock of 1985, oil consumption kept on increasing by 1.6%. Moreover, the price elasticity of oil is low, and the alternative fuel sources are not very efficient (Hamilton, J. D, 2008, pp. 1-45).

Table 1 World and regional oil consumption 2010

 

US + Canada

EU

Japan

S & C America

Middle East

Africa

Asia Pacific*

China

Other

World

Oil consumption

952.3

662.5

201.6

309.4

360.2

155.5

637.6

428.6

320.4

4028.1

% world total

23.6

16.4

5.0

7.7

8.9

3.9

15.8

10.6

8.0

100.0

% change 03-07

0.2

-2.6

-3.5

4.4

4.4

4.6

3.8

33.5

3.6

7.3

% change 07-10

-7.8

-6.5

-12.2

-12.5

14.7

10.4

5.8

16.1

25.2

0.5

Q3. How is the increase in the price of oil likely to affect the demand for oil in the short and the long term?

An economy goes through different ...