The Supply And Demand For Oil: Impact On Global Economies

The Law of Supply and Demand in the Oil Market

Question:

Write an essay about the Supply and Demand for Oil. 

Some of the largest oil producers such as Saudi Arabia have the ability to initiate a recovery by cutting their production. This economy has a high production capacity such that even if the low prices persisted for so long, it has enough storage to maintain its supply for so many years to come. It is therefore deliberately refusing to initiate the recovery as a strategy to kick some of the competitors out of the market. Some of the economies targeted to be hurt by low oil price are Russia and Iran (Krauss, 2016).  Immediately after the competitors will be out of the market, it will gain the biggest market share. Consequently, it will limit supply enabling it to charge higher prices.

The law of supply as stated by McEachern (2012) holds that price falls with extended supply and rises when supply contracts holding demand constant. If the oil price has been falling dramatically even without a substantial fall in demand, it is evident that supply is exceeding the demand. There has been a greater production of oil in the past few year. This has raised the competition for a market share in the global markets. In the past, the US economy was a huge importer of oil from many oil exporting economies. When the US started producing its oil, it lowered the level of its imports. The oil used in the US became domestically produced. Since its consumers were still consuming oil but from its economy, the initial oil being exported to this economy became an excess supply.

Fig: Fluctuation in Oil Price for the past ten years

Economies such as China, India, Australia, etc., are huge importers of oil. Due to the increased supply of oil and consequently a deep fall in prices, these economies have been situated in a better position. Oil is a basic commodity for many industries in the economy especially the transportation industry. In industries dependent on oil for their production, it has translated to a reduced cost of production. The economic growth for oil importing economies is expected to rise by 0.1 % for every 10% drop in the price of oil.

Since the China economy has been shrinking, they are benefiting much from the reduced price of oil being that they are the largest net exporters. However, it’s projected that this won’t help the economy to recover fully. The other country that has benefited more from this price cut is Japan; oil the oil it uses is mostly from importation. For a long time, Japan has been faced with the problem of deflationwhich caused  its economic growth to lag behind. However, the low oil prices have helped in pushing inflation up. Shinzo Abe, the prime minister of Japan, had proposed this as a growth strategy. India is another large importer accounting for 75% of its oil. Its current account deficits is expected to be eased by the falling prices. A $2.5bn fall in the India’s fuel subsidies cost was projected with a condition that the oil price remained low.

Impact on Oil Importing Economies

Low oil prices are less profitable to the oil producing economies. Comparing the cost of production and revenues received from its sales, producers may be making losses. Huge economies that are dependent on oil exportation are shrinking as a result of the oil price shocks (Srikant, 2015). It is projected that some of these economies will end up into a recession if this situation doesn’t get contained. According to Bowler (2016), countries such as Russia depends on oil and gas for exports (energy income); accounting for around 70 %. If the oil price falls by one dollar, the revenues lost by Russia is about $2billion (Srikant, 2015). The World Bank had warned that failure of recovery in the oil price in 2015 would result in the Russian economy shrinking by at least 0.7%. The exporting economies have to make certain sacrifices as the government is forced to cut its spending.

There is the emergence of another problem of rising interest rate owing to attempts for resolving this issue. For instance, the interest rate in Russia has gone up. Arguing economically, high interest rates are harmful to the economy as they suppress its economic growth. It raises the cost of borrowing thereby making the investors avoid borrowing funds for investment. Venezuela is among the leading oil exporters and is being faced with the possibility of falling into a recession owing to the high inflation rate its facing.

The countries that will be most impacted is those with higher domestic budgetary demand. Comparing the population of some countries and the current oil revenues received, it is evident that it’s not sufficient to support the budgets. The following is a graph of some oil producing countries and their domestic budgets

Fig: oil price and the governments’ budget

Trinkunas (2016) referred the low oil price to be a mixed blessing for economies such as the USA. Though it negatively impacts the domestic producers, there are many benefits for the local consumers. Economies that has a higher capacity of oil production and their domestic demand is high will not be significantly impacted by the price fall. Low revenues will be raised, but it’s easier to control the price fall. Since the economy can impose a restriction on oil importation such that no oil should be imported, supply can be regulated so as to raise the domestic price. If producers come up with a strategy to supply less given a constant demand, it would be easier to raise the price.

Fig: Economies level of dependent on oil revenue.

Oil products are heavily used in many economies. Many industries use it as a raw material. The transportation industry is benefiting from the reduced prices. This is a cost reduction in offering their transportation services. The benefits are higher since it is most unlikely that those in charge of the transportation facilities will cut the prices charged to the consumers. Farming and airlines are some of the energy-intensive industries that are making huge profits (Hartmann and Sam, 2016).

The marginal cost of production for firms using oil for production have been reduced owing to the low cost of inputs. These benefits are then translated to the consumers in terms of low prices of the outputs. Consequently, it raises their social welfare.

Oil producing companies are making little profits and even losses. Their cost of production in exceeding their revenues; some of the companies are even shutting down (Schoen, 2016). A fall in oil price causes a decline in the price of other related goods. The price of gas has fallen as the oil price has slumped so low. Gas is a major commodity of export in Australia. Its reduction in price means that the Australian gas exporting companies are losing in terms of foreign earnings. Other products have experienced a fall in prices due to the substitution effects (Husain et al., 2015). 

Conclusions

Both oils exporting and importing countries are provided with a better opportunity to make serious reforms on taxation and fuel pricing during this period of low oil prices. The fiscal balances resulting are stronger thereby creating a space for priority expenditures increment and/or distortionary tax cutting. The access to reliable energy has been a major objective sector reform by some low-income and middle-income countries. They are therefore enjoying many benefits as the low oil price has broadened this access.

Due to the high uncertainty of the oil price outlook, the decline is expected to persist in the medium term. Some oil importing countries despite the bigger benefits, there is the possibility of a loss for those relying on foreign aid from the exporting countries. Such aid could not be available if the exporting countries are experiencing shocks. Low oil price is creating an incentive for the exporting economies to implement financial reforms to enable them in diversification. The real income gains for net oil importers is greater; they gain terms-of-trade, whereas the net oil exporters losses terms-of-trade.  

Bowler, T. (2016). Falling oil prices: Who are the winners and losers? – BBC News. [Online] BBC News.

Elliott, L. (2016). Venezuela tops list of countries most vulnerable to low oil prices. 

Hamilton, J. (2016). Why Low Oil Prices Haven’t Helped The Economy | OilPrice.com. [Online] OilPrice.com.

Hartmann, B. and Sam, S. (2016). What Low Oil Prices Really Mean. [Online] Harvard Business Review. 

Husain, A., Arezki, R., Breuer, P., Haksar, V., Helbling, T., Medas, P. and Sommer, M. (2015). 

Krauss, C. (2016). Oil Prices Explained: Signs of a Modest Revival. 

McEachern, W. (2012). Economics. Mason, OH: South-Western Cengage Learning.

Schoen, J. (2016). Oil is falling, but US keeps pumping—here’s why. [Online] CNBC. 

Srikant, R. (2015). A Complex Story: Global Impact of Low Oil Prices | Investopedia.