The Factors That Affect the Market Price of a Product - Essay Example

Introduction: Oil and its price have become an important issue around the world, as the price of this most important energy source has sky rocketed.To make the understanding of this escalation of the price of oil more clear, at first, an analysis of the factors that affect the price of a product would be useful. The history of the trends in oil prices provide a clear understanding of the manner in which the factors that affect the price of a product have come into play and the manner in which these factors have brought the price of oil to what it is today. A) Discuss the factors that affect the market price of a product. The definition of a product from a narrow perspective is anything that is manufactured. However, the broader description of a product as anything that is made available in a market, as provided by Philip Kotler in his book Marketing Management needs to be taken into account in this discussion. In simple terms again, the price of any product is controlled by the demand of the product and the supply of the product and yet there are many factors that play a role on the supply side and the demand side of the product and it is these factors that need to be examined (Fletcher. T & Russell-Jones N. 1997. VALUE PRICING: How to Maximise Profits Through Effective Pricing Policies. Pp 14 to 43). The initial factors on the supply side are availability of the product and cost of production of the product. The greater availability of the product will tend to lower the price of the product. The more the cost of production the higher will be the price. The next factor is competition. Competition in normal circumstances is present for all products and acts as a control on prices, unless a single entity or a group of suppliers is in a position to dominate the supply of the product and therefore exact higher prices. (Competition and the Effects of Price Controls in Hawaiis Gasoline Market. 2003.). The next factor is legislative control on the price of the product in the market. Legislative action is normally used as a measure to protect the consumers from being over charged by suppliers. The next factor is changing markets. Changing markets could have a positive or negative impact on prices. The next factor is technology, which tends to increase efficiency and thereby reduce the price of the products. Then we come to management strategies in terms of profit goals and growth objectives. These have an effect of raising the prices of a product. On the demand side there is only one factor and that is consumer demand for the product. Consumer demand is however controlled by the economic state of the consumer. In good economic conditions consumer demand will go up as affordability rises thereby pushing up prices. In a recession however consumer purchasing capacity drops and so too will prices (Fletcher. T & Russell-Jones N. 1997. VALUE PRICING: How to Maximise Profits Through Effective Pricing Policies. Pp 14 to 43). B) Describe the trends in world oil prices in the last two decades and discuss. The trend in world prices in the last two decades looks like a roller coaster with sharp spikes and steep falls. Oil has been and still provides a significant impetus to the development of human civilization and thereby the prosperity of societies spread around the world. This has meant that oil plays an important role in the dynamics of global politics and dynamics and thus has earned the additional name of black gold. This powerful energy resource has remained one of the potential caused for the conflicts that the world has seen particularly in recent times. The relevance of oil in global economics and politics shows no signs of abatement in the near future. (OIL - Politics and Economics). The period from 1974 to 1978 world prices remained more or less stable and turbulent free after the troublesome days of the Arab oil embargo in 1973. Prices remained in the $12 to $14 a barrel range. (Williams, L.J. Oil Price History and Analysis). However two political incidents were soon to disturb this period of calmness. The Shah of Iran was deposed in 1979 and a theocratic government with a strong anti-American stance emerged from this revolution in Iran. This was enough to trigger a sharp rise in the price of oil around the world and was compounded by the Iraqi invasion of Iran in 1980 and as a result oil prices jumped to $40 a barrel. (Sjuggerud, S. Dr. 2004. History of Oil: The Single Greatest Prize in All History). This spurt in oil prices was to have two reactions. Exploration for oil in countries outside the OPEC (Organization of Petroleum Exporting Countries) became more frenetic on one side and the OPEC countries increased production to stabilize prices leading to a drop in prizes as we approach the period of the last two decades and by mid 1986 prices of oil dipped to as low as $10 a barrel with the increased production of oil outside the OPEC countries and within the OPEC countries. (Williams, L.J. Oil Price History and Analysis). In an effort to raise the low prices of oil OPEC brought in a quota of production for the member countries and fixed a price objective of $18 a barrel in December 1986. This self enforced discipline by OPEC was showing signs of failing even by early 1987, with member countries overshooting the production quotas accepted by them, leading to a drop in prices of oil below the $18 a barrel objective. This clearly showed that OPEC was be unable to control prices in a supply driven market, because of the lack of discipline among the member countries. (Williams, L.J. Oil Price History and Analysis). The tensions in the Middle East in 1990, with the invasion of Kuwait by Iraq and the subsequent American led action to liberate Kuwait, was to see oil prices spike for a short period. The quick end to the conflict brought oil prices back to the pre-conflict levels. The prices continued to decline and by 1994 the prices had dipped below the $15 a barrel level, with increased production from OPEC. (The Organization of the Petroleum Exporting Countries (OPEC) Brief History). Technological advances in exploring and drilling were not only bringing down the cost of production, but also making it possible for more countries to exploit the available resources within the country. (OIL - Politics and Economics). The next upswing in the prices was caused by the impressive economic growth of the Southeast Asian countries. This upturn in the economic fortunes of the Southeast Asian countries coupled with an upswing in the American economy placed increased demands on oil requirements leading to a rise in the prices of oil from 1995 to 1997 with the price of oil reaching close to $ 25 a barrel in 1997. Then came the economic crisis in Southeast Asia in 1998 and with that the oil prices crashed, as OPEC failed to really measure the gravity of the economic recession in Southeast Asia, which would cause a drop in the demand for oil from this region and the price to around $10 a barrel. In 1999, the price of oil started recovering with the reduction in production from OPEC, even though again the production quotas were not really adhered to by the member countries. Still prices rose to $25 dollars a barrel and the growing economy of the United Stares of America and other countries around the world pushed up demand and even though OPEC increased quotas prices still held the end of 2000 (Williams, L.J. Oil Price History and Analysis). In 2001 the weakening economy in the United States of America and increased availability of oil from the oil exporting countries outside of OPEC, especially Russia caused a drop in the prices of oil. It would be useful here to note that there are several countries outside OPEC that export oil and the prominent countries are Russia, Mexico and Norway. There are other countries like Brazil and Malaysia that produce oil, which goes a long way towards meeting domestic oil demands. (Non-OPEC Fact Sheet. 2005). The drop in prices caused by this increased production from countries outside of OPEC and the weakening U.S. economy remained despite OPEC imposing a reduction on the production quotas of its member nations. The prices further nose-dived with the terrorist attacks of September 2001 to reach levels of about $16 dollars a barrel. This led to production cuts not only within the OPEC, but also outside of the OPEC and prices climbed back to the targeted $ 25 a barrel in 2002. (Williams, L.J. Oil Price History and Analysis). Since then prices have only climbed despite the increased production from within OPEC and outside OPEC, due to a succession of events on the demand and supply side of oil. Strikes at the oil production facilities of Venezuela at the end of 2002, resulted in a substantial drop in the availability of oil from Venezuela and in March 2003 the war in Iraq and the subsequent strife there deprived the oil flow from Iraq into the world markets. This loss of oil availability from these countries was not offset by the increased production by OPEC and prices of oil. The spare production capacity of oil that hovered around the six million barrels per day in the middle of 2002 dipped to two million barrels of oil in the middle of 2003. (Williams, L.J. Oil Price History and Analysis). Additional pressures from the demand side were to come in the form of the growing economies of China and India. These two countries have the largest populations in the world and the economy fortunes of these two countries have seen an upswing in this period and continue to do so, since the opening up of their economies. The increased energy requirements from the increased purchasing capacity of the burgeoning middle class of these countries was to add to the problems in the availability of oil and have an impact in pushing up the prices. The last eighteen months have seen oil prices sky rocketing to near $60 a barrel and besides growing demand from the newly growing consumerism of the emerging economies other factors have also had their role to play. Spare capacity has vanished, strategic storage no longer exists, peaking of oil production from the countries outside OPEC and the unwillingness of OPEC, especially Saudi Arabia to build up the infrastructure required to exploit the vast oil resources still available, the loss of Iraqi oil and the poor infrastructure and technology of the Russian oil production facilities along with the problems of transportation. (Oil market reliability: a commercial proposal. 2005.). None of these are going to disappear in the near future and the forecast is that oil prices will remain at these higher levels especially with OPEC believing that they cut production in case oil prices fall below $40 a barrel and maintain price levels between $40 and $50 a barrel. (Kole, J.W. 2005. OPEC Wants Oil Prices To Be More Reasonable). The market price of any product is regulated by competition, except where a single entity or a group of suppliers acts as a cartel. This is the problem with Oil. In his book “Blood and Oil”, Michael Klare very rightly concluded that the problem with oil does not lie in its scarcity but rather on its concentration. (Crude arguments; Oil and geopolitics. 2004). Estimates of the extent of proven oil reserve held by OPEC is to the tune of eighty four percent of the proven oil reserves of the world. That leaves just sixteen percent outside of OPEC and yet oil production outside OPEC has been sixty two percent of the worldwide production in 2003 and sixty percent in 2004. Thus countries outside of OPEC have been fast depleting their resources to make up for the slack from OPEC. (Non-OPEC Fact Sheet. 2005.). This would only add to the concentration of oil reserves within OPEC. Already the forecast is that oil production from countries outside OPEC would start declining by 2010, leaving hardly any direct competition for OPEC. (Bezat & Auzanneau. 2005. IEA:Non-OPEC oil production to decline after 2010). Looking at indirect competition in the form of alternatives to oil as a source of energy is bleak. Coal was the fuel of the world before oil. The use of coal creates environmental problems and technology has not been developed that allows the use of coal in an environment friendly manner. Nuclear energy has its safety and security concerns that restrict its use. Among the renewable energy sources hydroelectric sources have seen maximum use, but have its limitations. Wind and wave power, biomass and solar energy are other sources of renewable energy that show potential but still are a long way off from becoming an effective competitor for oil. That leaves only conservation as a means of reducing demand, which appears bleak in the face of growing consumerism. This means that OPEC and its oil resources would dictate the price of oil in the world market. (Kirby, A. 2000. Alternatives to oil). Conclusion: The price of oil today stands at high levels because of the lack of efficient competition both direct and indirect, which has allowed a cartel monopolising the supply of oil to dictate the price of oil. The price of oil in the future will remain high and yet the saving factor is that should the price of oil be elevated too high, then necessity the mother of all inventions will cause technology to develop and make indirect competition more efficient thereby dragging down the prices of oil. List of References Bezat & Auzanneau. ‘IEA: Non-OPEC oil production to decline after 2010’. 20 Sep, 2005. Le Monde. Energy Bulletin. Retrieved on November 6, 2005. Online. Available at: http://www.energybulletin.net/9073.html. ‘Competition and the Effects of Price Controls in Hawaiis Gasoline Market’. 2003. Testimony of Jerry Ellig, Deputy Director, Office of Policy Planning, Federal Trade Commission, Before the State of Hawaii. Retrieved on November 6, 2005. Online. Available at: http://www.ftc.gov/be/v030005.htm. ‘Crude arguments; Oil and geopolitics’. October 9, 2004. The Economist (US), v373 i8396 p78. Business & Company RESOURCE CENTER. Retrieved on November 6, 2005. Online. Available at: http://galenet.galegroup.com/servlet/BCRC?vrsn=149&locID=nysl_me_tnypl&srchtp=art&c=26&ste=21&tab=2&tbst=tsAS&atp=KE&docNum=A123045807&art=petroleum+history&bConts=0 Fletcher, T & Russell-Jones, N. 1997, VALUE PRICING. How to Maximise Profits Through Effective Pricing Policies. Kogan Page Limited. London. Kirby, A. ‘Alternatives to oil’. September 8, 2000. BBC NEWS. Retrieved on November 6, 2005. Online. Available at: http://news.bbc.co.uk/1/hi/business/916492.stm. Kole, J.W. 2005. ‘OPEC Wants Oil Prices To Be More Reasonable’. TechNewsWorld. Business. Retrieved on November 6, 2005. Online. Available at: http://www.technewsworld.com/story/43784.html. ‘Non-OPEC Fact Sheet’. 2005. eia. Country Analysis Briefs. Retrieved on November 6, 2005. Online. Available at: http://www.eia.doe.gov/emeu/cabs/nonopec.html. ‘Oil market reliability: a commercial proposal’. July 25, 2005. Petroleum Intelligence Weekly. V44 i30 p6 (2). Business & Company RESOURCE CENTER. Retrieved on November 6, 2005. Online. Available at: http://galenet.galegroup.com/servlet/BCRC?vrsn=149&locID=nysl_me_tnypl&srchtp=art&c=2&ste=21&tab=2&tbst=tsAS&atp=KE&docNum=A134814940&art=petroleum+history&bConts=0 ‘OIL - Politics and Economics’. ICFAI UNIVERSITY PRESS. Retrieved on November 6, 2005. Online. Available at: http://www.icfaipress.org/books/Oil_Politics_Ecnmcs_Overview.asp. Sjuggerud, S. Dr. ‘History of Oil: The Single Greatest Prize in All History’. 2004. The Investment U E-Letter: Issue # 360. Investment U. Retrieved on November 6,2005. Online. Available at http://www.investmentu.com/IUEL/2004/20040811.html. ‘The Organization of the Petroleum Exporting Countries (OPEC) Brief History’. OPEC. Retrieved on November 6, 2005. Online. Available at: http://www.opec.org/aboutus/history/history.htm Williams, L.J. ‘Oil Price History and Analysis’. WTRG Economics. Retrieved on November 6, 2005. Online. Available at: http://www.wtrg.com/prices.htm. Read More