Discuss about the Report on Global Oil Market?
The global oil market is considered to be economically matured commodity market. Most of the crude oil is produced by a relatively small number of countries in remote areas, and so the trade in crude oil is vigorous. Oil traders redirect transactions towards markets where the prices increase. Oil is regarded as a global commodity, so the price of the oil is determined by the interaction of the demand and supply of the oil all over the world. The global oil market had been witnessing booms and busts over the years when recently there was a sharp decline in the oil price (Liu, Schultz and Swieringa, 2014). There were many companies that in the past years have earned supernormal profits but now they are forced to decommission rigs and sharply declined their investment level in the exploration and production of oil. From the year 2010, the international benchmark for the Brent crude oil price was around $155 per barrel and stagnated till mid-June 2014. The Brent Crude oil price declined sharply after that. The oil price fell almost more than half the previously oil price (Moneycontrol.com, 2015). This paper deals with the causes and the consequences of the sharp fall in the global oil price. The paper also highlights the case of the major oil importing nation that is the China with respect to the aggregate demand (AD) and aggregate supply (AS) framework.
The key drivers of the decrease in the oil price include the US’s oversupply of oil and the strong US Dollar. The negotiation of the nuclear deal between the US and Tehran also increased the oil exports by Iran driving up the global oil price (CNBC, 2015). The oversupply of oil from all sources created a situation of excess supply which suppressed the global oil price. The situation of excess supply is best understood by the demand and supply mechanism (Angelidis, Degiannakis and Filis, 2015). The market for the global oil price was initially oligopolistic but with the increase in the number of oil traders the competition increased making the oil market as a perfectly competitive market structure. The characteristics that the market follows are; there are many number of buyers and sellers, the sellers are price takers, the product sold in this market are homogenous in nature, there are free entry and exit into and out of the market, and the sellers maximize their profits. The demand and supply curves for the oil are considered to be relatively inelastic, so the curves are steeper. The inelasticity of the oil demand and supply is because huge changes in the price of the oil bring about little changes in the quantity of oil demanded and supplied. The demand and supply mechanism in the global oil market are attached as Appendix 1.
The decline in the global oil price has been categorized into two sections. Both the reasons have caused the oversupply of oil in the global market. This caused the excess supply of oil in the market that drove down the global oil price that is explained by the demand and supply mechanism (Flows, 2014). The diagram of the demand and supply of the oil along with the phenomenon of excess supply are attached in Appendix 2.
The reasons for the fall in the global oil price are two-fold. The first reason is contributed to the weak demand for oil from the emerging economies like China. The weak demand by the oil importer China and other countries paved the path for the situation of excess supply of oil which decreased the global oil price. This is explained using the demand and supply mechanism attached in Appendix 3. The second reason for the oil price fall is the refusal by the OPEC to cut down the production of oil. Around 60% of the total oil supply in the world is done by the OPEC, which implies that OPEC has considerable market power (Forbes, 2015). OPEC is the oil cartel which is comprised of 12 member countries and with significant market power; it can increase or decrease the oil price through the changes in the supply of the oil. During a meeting of the OPEC, countries like Venezuela and Iran had offered to lower the production of oil to stabilize and equilibrate the global oil market but it is Saudi Arabia who refused to cut down the production so that the oil price remains low. This phenomenon is depicted using the diagram that is attached in appendix 4.
The decline in the global oil price has affected almost all the nations of the world. The impact has been felt by both the importers and exporters of oil thus, it can be said that the winners in the current situation of the global oil price are oil importers and the losers are the oil exporters. The decline in the global oil price had benefitted the oil, importers (BBC News, 2015). This is because as the price has decreased, the consumer of the importing countries has to pay less which increased their disposable income. Through the increase in the disposable income, the consumption expenditure will increase. Countries like India (an oil importer) had been positively impacted by the decline in the global oil price and had executed the disinflationary pressure (Gupta and Goyal, 2015). According to a survey commenced by the IMF, it has proved that 30% fall in the oil price there is 0.8% increase in the economic growth of the oil importing countries. On the other hand, the oil exporting countries had been adversely affected by the fall in the oil price as their oil revenue has decreased which hindered their path of development and growth . In this regard, Venezuela had cut down 20% of their public expenditure to overcome the budget deficit.
There are basically three impacts of the decline in the global oil price in the oil importing countries. The first impact is the increase in the disposable income which can increase the consumption expenditure of the consumers of the oil importing countries. This will increase the aggregate demand as consumption expenditure is included in the aggregate demand. The second impact is the decrease in the production cost of the final goods which will thereby increase the profit and thus raise the investment. The third impact is lowering the inflation rate. The fall in the oil price influence the decline in the price of the other commodities which causes a decrease in the real interest rate. The sharp decline in the oil price can be directed towards lowering the energy subsidies by the government of the oil importing countries. Thu, the fall in the oil price raises the aggregate demand curve that is best explained using an example of an importing country (Liu, Schultz and Swieringa, 2014).
China is regarded as one of the top importers of oil in the world after the United States. The sharp decline in the oil price had positively impacted the Chinese economy. The current account surpluses in China have been due to the decrease in the value of import of oil in dollar amounts. In the year 2015 China imported 6.5 million barrels per day whereas in the year 2014 China imported 6.2 million barrels per day (Beirne et al., 2013). The low oil price had triggered the import of oil that augmented economic growth in the country as attached in Appendix 5 (Tradingeconomics.com, 2015). The government in such a scenario can reform the tax structure and the fiscal systems of China. The fall in the oil price has caused the real income of the Chinese consumers to increase (Wu, 2015). The increase in the real income causes the consumption expenditure to increase and thereby increases the aggregate demand (Zhang and Chen, 2014). The changes in the aggregate demand are depicted using the diagram attached as Appendix 6. The increase in the aggregate demand curve has shifted the AD curve to the right causing the real GDP of China to increase.
The global oil market had been subjected to different fluctuations over the years but from mid-June 2014, there was a sharp decline in the global oil price. There are two causes of the decline in the global oil price. The weak demand from emerging economies and the over production by the OPEC member countries are two main reasons behind the situation of excess supply in the oil market that caused a fall in the global oil price. This fall in the global oil price has impacted both the oil importing and the oil exporting countries. In this case, the oil importing countries are the winners as they have to pay less for the same amount of oil purchase and the losers are the oil exporting countries due to the fall in their oil revenue. The paper explains the impact of the decline in the oil price in the China which is one of the largest oil importing countries in the world. The explanations are made with respect to the AD framework where the AD curve of China had increased due to the fall in oil price and increased the real GDP of China.
Angelidis, T., Degiannakis, S. and Filis, G. (2015). US stock market regimes and oil price shocks. Global Finance Journal.
BBC News, (2015). Falling oil prices: Who are the winners and losers? – BBC News. [online] Available at: https://www.bbc.com/news/business-29643612 [Accessed 10 Aug. 2015].
Beirne, J., Beulen, C., Liu, G. and Mirzaei, A. (2013). Global oil prices and the impact of China. China Economic Review, 27, pp.37-51.
CNBC, (2015). Oil ends up as Iran exports seen slow to resume. [online] Available at: https://www.cnbc.com/2015/07/13/oil-prices-tumble-as-iran-global-powers-reach-nuclear-deal.html [Accessed 10 Aug. 2015].
Flows, C. (2014). Why Are Oil Prices Dropping?. [online] Forbes. Available at: https://www.forbes.com/sites/realspin/2014/11/24/why-are-oil-prices-dropping/ [Accessed 10 Aug. 2015].
Forbes, (2015). Oil Prices Will Fall Further But Futures Look Undervalued. [online] Available at: https://www.forbes.com/sites/gauravsharma/2015/07/24/oil-price-will-fall-further-but-2016-17-futures-look-undervalued/ [Accessed 10 Aug. 2015].
Gupta, P. and Goyal, A. (2015). Impact of oil price fluctuations on Indian economy. OPEC Energy Review, 39(2), pp.141-161.
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Moneycontrol.com, (2015). Oil prices fall on oversupply fears. [online] Available at: https://www.moneycontrol.com/news/commodities/oil-prices-falloversupply-fears_2417261.html [Accessed 10 Aug. 2015].
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