The Fall of Oil Price in 2014: How Will It Affect Economies around the World - Essay Example

During The Latter Part Of The Oil Price Fell From Well Over $100 Per Barrel To Around $50 Per Barrel. Why Might This Sudden Fall Have Occurred And How Will It Affect Economies around the World Table of Contents Introduction 3 Fall In Oil Prices In 2014 3 Reasons for Fall in Oil Prices 4 Impact on Economy 6 Economic Theories Linked With the Changes in Prices 7 Conclusion 9 References 11 Introduction The fall in the oil prices in the later part of 2014 has been a matter of concern for the economic development of the nation. The traders of the commodity market who are involved in a future contract with the oil companies determine the oil prices. The traders who are involved in the price setting business can be classified under two headings, one who represents a company and the other are the speculators whose main motives is to gain profits by regulating the oil prices. It was observed that the oil prices fell nearly to half of its rate. The main objective of the paper is to study the reasons behind reduction of oil prices and its overall impact on the economy and individuals. The theories of aggregate demand and supply have been linked with the fall in price of oil to understand the macroeconomic policy (Arnhem, 2014). Fall In Oil Prices In 2014 The traders who are responsible for setting the prices are to consider the current production and supply of oil before bidding for the prices. Other factors are the future supply of oil that is the capacity of the oil reserves. These reserves play a crucial role when the price of oil gets too high and in case when the demand exceeds the supply. The third factor to be taken into account is the demand for oil in the economy. The demand and the supply of oil are the essential components responsible for the changes in the oil prices. The global demand for oil is less than supply and that is responsible for the fall in oil prices. A major factor for fluctuation of the prices was the sudden increase in oil production in the US. This had resulted fall in the crude oil prices (Times Internet Limited, 2015). It was also observed that in order to keep the oil prices high, Saudi Arabia the largest exporter of petroleum reduced the oil prices affecting the economy. Moreover, the increase in production was also observed in Libya and Angola that raised the total output of the Organization of Petroleum Exporting Countries (OPEC). OPEC is an organization that that controls the production of oil in the world. Currently, the members of the OPEC are pumping 42 percent of the global annual supply. The organization is also responsible for controlling the exports of the petroleum. The member countries also support the oil reserves in case of excess demand. Therefore, for this reason OPEC’s decisions regarding control of oil prices are crucial for those countries dependent on import of oil (Bloomberg L.P, 2014). The economic activities are influenced by the demand for the energy resources. The supply of oil is also affected due to the geographical changes like for example the changes in weather conditions that may create problems in tanker loading. The weak economic activities have resulted into lower demand. Moreover, the availability of other sources of energy and a shift in demand from oil to other fuels is also a major cause for the fall in oil prices and its positive effect on the economy. On the other hand, reduction in import of crude oil by America is also resulting into excess supply. Therefore, excess of supply in comparison to demand is also factor that has resulted in the reduction of oil prices in 2014 (Sheppard, & et. al., 2014). Reasons for Fall in Oil Prices One of the main reasons identified for the fall in oil prices 2014 was the increase in oil production in the US. Moreover, the OPEC has also reduced in its export activities nearly to its half that also reduced the price further. In order to maintain the market shares many countries like Kuwait and Saudi Arabia were involved in price wars as well. This has resulted in continuous reduction in the oil prices. A number of Asian countries have stated to reduce the energy subsidiaries that results in the high fuel prices despite the reduction in oil prices (1The Financial Times Ltd, 2015). The OPEC decision for not cutting the production of the excess of oil is also a main reason for the collapse of oil prices, which is affecting the economy in the present day context. Even if the production was kept at a steady level but still the ‘Shale oil revolution’ in the United States has resulted in the introduction of various new technologies in petroleum industries like the ‘horizontal drilling’, which permits access to the energy reservoirs deep in the earth surface. This factor may also be considered as a reason for the explosion in oil production (Kilian, 2014). Apart from the increase in production, the reductions in demand for oil from many regions like Europe and Japan have influenced the oil prices as well affecting the barrel prices of oil. With the improvement in technology and the invention of the fuel-efficient vehicle has also resulted reduction in the consumption of the oil. All these aspects are creating issues in the economy and in policy making for the economic growth. In the United States, people are buying fuel-efficient cars declining the consumption of oil (BBC News, 2014). Other fundamental factors that affect the price are the demand and supply factors as aforementioned. The demand for the oil products changes according to the need of the consumers and based on the monetary policy. The imbalance between the demand and supply may also cause fall in the oil prices. If the total production of oil is able to meet the growing then the price remains in the equilibrium level but if the supply exceeds demand then this may cause fall in prices. The seasonal factor in also responsible for the fluctuation in the prices that causes imbalances between the total quantities produced and demanded. The production capacity of the members of OPEC also affects the pricing strategy. The policies implemented by OPEC also influence the price levels and economy (Cushman & Wakefield, Inc, 2014). The discovery of the alternative sources of energies like natural gases, coal and other substitute has also affected the demand for crude oil and is affecting the lives of the people. In this context, it is important to state that the falling prices of the commodity affect the economy. This implies that debt bubble is unable to expand as expected. Therefore, it can be stated that with the fall in the debt prices the economy will be affect massively. With the introduction of the alternative sources of energies those are cost efficient charges less to the consumers. The oil is traded in the global market and its value changes according to the foreign exchange rates. The amount of oil exported when is valued according to the foreign currencies sometime may be cost more to the producing countries (Ebrahim & et. al., 2014). Impact on Economy From the macroeconomic perspective, the decline in the oil prices is beneficial for the consuming countries whereas it has a negative impact on the producing countries in the short run. Lower prices results in the economic growth of the economy because reduction in supply means that the country can spend and invest more on the domestic activities. The amount spent in the production of oil can be utilized in stimulating the economy by creating more jobs for the individuals and this will result reduction in unemployment (Organisation for Economic Co-operation and Development, 2011). In this context, it can be stated that the individuals are getting affected in the economy due to the price fluctuations. On the other hand, considering the ‘Shale Revolution’ in the US the reduction in the oil prices may have a negative impact on the revolution because the production of oil from the Northern Sea is very expensive. Even if the production cost is less in Middle East, the low price of oil is not sufficient to balance the financial budgets of the economy. The Middle East countries need high prices of their production in order to maintain the standard of living (Bordoff & et. al., 2014). Oil prices affect not only the producers and the consumers of oil but also the other industrial sectors of the economy. The reduction in the oil prices also influences the prices of the goods and services linked with its production. For example, the air transportation also depends on the production of oil as with the reduction of oil prices the air industry can save cost in the consumption process. Contextually, it is observed that the fluctuation in the oil price affects the related industries along with the individuals (Vox Media, 2015). Moreover, the affect is largely on the economy both positive and negative depending on aspects as aforementioned. The changes in the oil prices also have a positive impact on the political and security relations between the nations. In case of sudden war situation the producers can provide immediate help to the economy by supplying them at lower prices and so enhancing the relations between the producers and consumers (CNBC, 2014). Economic Theories Linked With the Changes in Prices The fluctuation in the oil prices also affects the standard of living of people. The reduction in the oil prices directly benefits the transport business. As the cost involved in fuel is reduced and so maximizing the profits of business. In economic terms the fall in the oil prices results increased spending in the other products and services and so it is expected to have a positive impact on the Gross Domestic Product (GDP). The changes in the oil prices affect the aggregate supply that results price shock. The sudden changes in the price level results misbalance in the equilibrium level. On the other hand, the increase in the price results toward upward shift in the aggregate supply curve and production falls that is a downward shift in the demand curve. The fall in the oil prices shifts the aggregate supply in the short run that causes lower inflation (The Financial Times Ltd, 2015). The oil importing countries will be benefited from the reduction of oil prices because the value of total import decreases. This will further reduce the debt burden on the oil importers. This can be beneficial for developing countries importing huge amount of oil and facing financial problems because of heavy debt. For the oil exporters the reduction in the prices has a negative impact because some of the oil exporting countries like Russia is dependent on the tax revenues earned from the oil production and its import (Kilian, & et. al., 2014). Falling oil prices may influence the government to raise the taxes on the various import and export activities in order to balance the fall in prices. The countries self sufficient in oil production and consumption are not affected by the fluctuations in the prices of the products. Moreover, the countries involved in the export activities are expected to face either rise or fall in the aggregate demand when the oil price changes (Tatom, 1987). The change in the aggregate supply and aggregate demand curve is depicted in the figure below. (Tatom, 1987) The demand and the supply framework of economics can be linked with the fluctuation in the price of oil. In long run the interaction between the supply and the demand curve determines the oil price. Some the external factors that is to be taken into consideration while determining the prices are like natural calamities, technological disturbances and many more. Apart from the external factors other components that also affect the oil prices lack information’s about elasticity of demand, and the export decisions taken by the OPEC. The price elasticity of demand depicts the relation between the oil price and quantity demanded globally (Montgome, & et. al., 2008). In this case the fall in oil prices can be linked with the concept of ‘price elasticity of demand’ that measures the change in the quantity demanded with respect to the changes in the prices. Here demand is said to be elastic if demand of oil changes a lot with the fluctuations in prices whereas it is said to be inelastic if it does not respond with respect to the fall in prices. An increase in oil price may reduce the demand for the product but that does not mean that the reduced demand influences price falls. The fall in prices can also be seen from a positive point that it may increase investments in other areas as well (Fattouh, 2007). Conclusion It can be concluded from the paper that the main reason for the fall in oil prices in 2014 was the over production of oil in the United States affecting the economy in positive to a considerable extent. Moreover, the ‘Shale Revolution’ and implementation of new improved technology in the oil production has also resulted in excess supply as compared to demand. On the other hand, reduction in import of oil by America is also a contributory factor to the fall in oil prices. The fall in oil prices has a positive impact on the importing countries as they can import more quantity with the reduced price, but has a negative impact on the exporter. Apart from all this the strategies followed by OPEC is also responsible for the fluctuations in oil prices. From the theories of aggregate demand and aggregate supply we conclude that the change in the demand and supply is responsible for the price change and its affect in economy. References Arnhem, 2014. The Shale Explosion Impediments to US Energy Independence and Impacts On Global Markets. Report. [Online] Available at: http://www.bnpparibas-ip.com.au/publications/documents/other/IP/documentlist/arnhem-reports_AU-NSG/1401_ARNHEM_The-Shale-Explosion.pdf [Accessed February 09, 2015]. Bloomberg L.P, 2014. Oil Prices Fall, and the Global Economy Wins. Energy. [Online] Available at: http://www.bloomberg.com/bw/articles/2014-09-29/oil-prices-fall-and-the-global-economy-wins [Accessed February 09, 2015]. 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Available at: http://www.vox.com/2014/12/16/7401705/oil-prices-falling [Accessed February 09, 2015]. Read More