Azerbaijan State University of Economics
International School of Economics
Subject: Price and pricing
Topic: Fluctuations in the oil prices affect world economy
Mentor : Farid Amirov
Submitted by: Nurlan Zeynalli
Introduction and General Information
What causes oil prices to fluctuate?
Impact on biggest producers
Impact of oil price fluctuations on developing countries:
Impact of oil price fluctuations on developed countries:
Conclusion and References
Oil is a necessary raw material in industrial production. Oil has the 2nd place in the global primary energy consumption, furthermore BP’s Statistical Energy Outlook states that it will continue to keep its current tendency until 2035. It is obvious that oil remains one of the biggest drivers of the global economy. For this reason, crude oil demand – supply dynamics has a great impact on price. History displays various occasions of crude oil price fluctuations. 40 years have passed since first ever oil price shock was took place in 1973. In this period, global demand of oil rose drastically, while at the same time brand-new energy – related technologies and new energy resources made consumers more resistant to oil shocks. After 1970’s oil shocks, emerging economies became to play larger role in global consumption of energy. For example, nowadays, China’s share in this sector is 5 times larger than in 1970’s. On the other hand, 2 largest oil consumer’s (USA and Japan) shares decreased respectively from 32% to 21% and from 10% to 5%. When such fluctuations occur, both oil – rich and oil – deficient countries face challenges. So, fluctuations in oil prices have played a crucial role in driving economies into recession and collapsing in regimes. Therefore, changes in oil prices are closely watched by economists, investors, and policymakers globally. Throughout the past decade, the price of oil has increased from $60 per barrel to the top of $146 in 2009 and subsequently diminished again to under $50 in 2015. Because of oil is sold in a world market, the effect of increasing or decreasing prices may be very different for importing and exporting countries.
In the graph above you can observe all important historical fluctuations and reasons of them.
The Organization of the Petroleum Exporting Countries (OPEC) is an intergovernmental organization established at Baghdad conference in 1960 by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. OPEC, or the Organization of Petroleum Exporting Countries, is the primary actor who influence to the fluctuations in oil prices. There’re 14 countries in OPEC: Algeria, Angola, Gabon, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. This organization has authority on 40% of worldwide oil supply. Therefore OPEC can influence the price of oil and gas by increasing or decreasing production. OPEC intended to keep the price of oil above $100 a barrel for a long time to, however in mid-2014, the price of oil started to decrease. It tumbled from a pinnacle of above $100 a barrel to underneath $50 a barrel and in current year it was above 50$. OPEC was the real reason for cheap oil. It declined to cut oil production, leading the tumble in oil prices. From the graph below you can see the OPEC basket crude oil price trend.
In this paper, I will discuss the reasons of oil fluctuations and impact of them on developed and developing countries.
What causes oil prices to fluctuate?
Demand and Supply
Similarly as with any ware, stock or bond, the laws of demand and supply cause oil price to change as well. At the point when supply surpasses demand, price of oil fall and the inverse is likewise valid. The decrease in oil prices can be tied to a lower demand for oil in Europe and Far East (especially in China which is the 2nd largest economy in the world), combined with an enduring supply of oil from OPEC. The abundance supply of oil caused oil prices to fall forcefully. Between 2010 and 2014 a spike in oil price could be ascribed to many components, including a supply smash from the traditional oil fields. An increase in price ended with higher incomes for upstream organizations and individual investors. As a result, the surplus assets were utilized to improve not conventional sources like shale and tight oil. Fruitful investigation and business production of unconventional sources pushed the cost of traditional oil descending. From the graph above you can observe price trends of oil.
But this graph shows balance between oil and supply.
While demand and supply influence oil prices, it is indeed oil futures which set the price of oil. A prospects contract or future contracts for oil is an authoritative contract that gives a purchaser the privilege to purchase a barrel of oil at a set price later on. As spelled out in the agreement, the purchaser and seller of the oil are required to finish the exchange on the particular date.
Natural Disaster may be considered as another factor that can affect oil price fluctuation. We can give Katrina Hurricane as an example. When south part of United States struck by Hurricane Katrina in 2005, it affected 19% oil supply of USA and caused increase in price of barrel by 3$. Another example may be the flooding of the Mississippi River in May 2011. It also led to price fluctuations in oil.
Costs of production is crucial factor as well that can cause oil prices decrease or increase. Extraction of oil in Middle – East is relatively cheaper. Once the supply of cheap oil is depleted, the cost of oil could possibly rise if the main oil left is in the tar sands.
From history we can notice plenty of evidences that geopolitical events really effects price of crude oil. Political instability, especially in the Middle East, has huge effect oil price fluctuation. This is because this region contains the biggest share of the worldwide oil supply. For example, barrel price of oil reached 136$ in July 2008, that’s why consumers were frightened because of war both in Afghanistan and Iraq. Another example is Arab Spring in 2012, which increased oil prices as well.
Growth of World Economy
Development of the worldwide economy is connected to energy sources, and oil has an important connect to worldwide development. An increase in energy – intensive sectors also increases demand for energy. As it were, demand for oil is based on the increasing of many other sectors such as electricity, transport, shipping and etc. So, we can say that, higher growth in global economy brings higher demand for energy product and therefore higher demand for oil.
Monetary and Fiscal policies
Different countries/trading block have different monetary and fiscal policies. The biggest ones; especially USA, Japan, European Union, China have an impact on investment, flow of capital, and of course demand for oil. All of those countries/union have influence on price of crude oil in global market. For example, increase in the interest rate of US dollar may affect negatively to the investments in oil industry. The reason is, this increase in interest rate will be observed as increase in cost of capital.
As I mentioned above, Organization of the Petroleum Exporting Countries (OPEC) approximately controls 40% of supply of crude oil in global market. In 2017, they stated that daily demand for crude oil is about 95.6 million barrels per day. OPEC countries currently supply 32.1 million barrels per day which is approximately 33.6% of total demand for crude oil. From this statistics it is obvious that global oil market is mainly controlled by OPEC. Therefore, policy of this organization on oil production has critical role in the demand – supply balance. For example, in January of the current year they made a decision that to cut production; and this showed its effect, that is, price of oil exceed 50$ for the first time since 2015. Here we can see power of the policy of OPEC.
Appreciation of United States dollar
In all over the world, trade of crude oil is done through 1 unique currency, the United States dollar. So, when there is an appreciation is US dollar, oil becomes expensive for importing countries outside the US and they have to offer out additionally. This may cause lazy demand for oil bringing about supply overabundance and a descending price amendment.
Impact of oil price fluctuations.
Before beginning, I wanted to add this graph to may work. This graph shows us relation between oil price and GDP of 144 countries for the past 2 decades – from 1970 to 2000.
Impact on biggest producers – Middle East
If we look at statistics we can observe 57% decrease from June 2014 till January 2015. It resulted with a noticeable decrease in the revenues oil exporting nations. Middle East economies, which are highly depended on oil export, were faced with sustainable losses in revenues resulting in vigorous pressures on budgets. During this process, countries like Saudi Arabia, Kuwait, UAE, and Iran started to have crumbles in trade balances.
In the graph above, trade balances of those countries is illustrated.
Saudi Arabia is the biggest producer of oil and other oil products in the world. 89% of country’s total revenue is gained from oil export. Between 2011 and 2015, a decrease in global oil prices pulled the value Saudi Arabia’s petroleum exports downward and it lead to pressure on budget. Noticeably, fall in revenue negatively had impact on social programs, projects, and support to other countries. The current restoration of oil prices is probably going to enhance net import acknowledgment, bringing about the strengthening financial sphere of country.
Kuwait’s economic growth also depended on oil export. During the 2011 and 2015 nation’s revenues fell sharply from $128.4 billion in 2011-12 to $76 billion in 2014-2015, because of fall in oil price. Also during this period, value of oil export fell from $97 billion to $49 billion. Therefore, it brought decrease in trade balance from $77 billion to $23 billion. In the graph below you can see it.
UAE and Iran also had same destiny. Their revenue decreased from $131 billion to $68 billion and from $67 billion to $10.7 billion respectively.
Impact of oil fluctuations on developing countries
Today, Nigeria is the largest oil-producer in Sahara region. It is also noticeable that, Nigeria is the fifth largest exporting country in the Organization of Petroleum Exporting Countries (OPEC). If we want to understand effect of oil on country’s industry, we have to look at the statistics. From history, it is noticeable that in last 25 years Nigeria received over 300 billion dollars of oil revenue. In 2015, economy of Nigeria grew by 2.7%, significantly below its growth of 6.3% in 2014. Because of diminishing oil prices in mid-2014, growth has a downward spiral, and the economy is currently suffers from recession. However, the oil and gas sector is about 35% of gross domestic product. From the graph below, we can see impact of oil on budget.
So, it is obvious that there is a dependency on oil. Therefore we can say that its economy isn’t well diversified and it will be affected from upcoming price fluctuations as well.
Article of: Doyin Salami, Economist and Professor, Lagos Business School
The collapse of oil prices (below $50 per barrel) since the late last year was beneficial to the countries which consume oil, gasoline, and other oil products but hurt the oil producers by decreasing their sales income. In Mexico’s case, this circumstance is exacerbated by the proceeding with decrease in oil production by PEMEX (Petroleos Mexicanos). It is Mexico’s state – owned oil company alike SOCAR in Azerbaijan. In 2014 PEMEX had its lowest oil extraction since 1986. Mexico would feel negative impacts of oil price collapse more than other exporters. The reason is, low oil revenues decisively affect Mexico’s finances which are 30% of them depended on oil revenues. Majority of the analysts forecast that GDP growth of Mexico may decrease by a half point because of drop in oil prices. But there is also good news for Mexico, that is, the Energy Reform which is approved by government last year, already in place. Government hopes that this reform will make more attractive to investors.(Julia von Maltzan Pacheco, Professor and Associate Dean for International Relations, FGV Escola de Administração de Empresas de São Paul)
Impact of oil fluctuations on developed countries
German economy highly depended on car manufacturing, therefore, oil price may be considered as a determinant factor for wealth of Germany.
A lower oil price quickens purchasing of cars the developing worldwide white collar class. Due to the predictions of BP Energy Outlook 2035, the global vehicle volume will be doubled until 2035. Based on the OECD, middle class of Asia will rise from 600 million to 3.5 billion by 2035 – 2045. So, there is a massive potential for German automakers in Asia regions. A higher oil prices increase interest in fuel – efficient cars. German car industry is at the forefront of innovation, in this field. In particular, biggest car producers are intended to invest in new technologies because European Union has binding emission targets for cars. In long term, oil prices are less relevant, because global vehicles are turning from combustion engine vehicles to electric vehicles which can use solar and wind energy as fuel rather than petrol. Majority of the German automakers understood this technological revolution and take actions to enter this newborn market. (Source: Jens Weinmann, Program Director at ESMT)
The US is the largest and technologically most advanced economy of the world. Currently GDP per capita is $49.800. The imported oil consists more than 50 per cent of consumption in the US. This makes it vulnerable to changes in the oil price markets. When the oil prices climbed 50 per cent between 2006 and 2008, Gross Domestic Product of USA was $16.72 trillion (2013 EST.) and oil production 11.11 billion barrels per day. But when the oil prices decreased over 70% between June 2014 and January 2016, new oil fields and advancing technologies gave US oil producers advantage to increase production. In the graph below you can see increase that mentioned.
GDP of the USA also being affected from these processes. Below, you will see 3 graphs:
The figure above is oil price change and the GDP of the USA. There is a noticeable growth trend
The graph below, used the simple calculations to understand change in GDP growth rate(percentage) for USA based on changes in oil prices; and indicated that, with the increase in oil price, GDP growth decreased.
(Source: World Bank 2014, IMF 2014 and Analysis)
From graph we can see negative correlation. That is, when oil prices increase, GDP growth rate decrease and when oil price decrease there is much more increase in GDP growth rate. (Source: Master thesis of Mr. Farid Amirov, Department of Entrepreneurship Development Policy Ministry of Economy and Industry of the Republic of Azerbaijan)
To finish my work I want to notice that in this work I firstly discussed reasons for oil price fluctuations and tried to find its impact on biggest producers, developing countries and developed countries. So, we found out that the decrease in oil prices has negative effect on developing oil exporter countries like Mexico and Nigeria. On the other hand it has positive effect on importers. Biggest exporters like OPEC countries are not hugely affected from price collapses like Nigeria because of the governing policies.
For Middle East Countries:
Sanjay Kumar Kar, professor and head of the Department of Management Studies at Rajiv Gandhi Institute of Petroleum Technology (RGIPT)
Yash Pathak, Department of Management Studies, Rajiv Gandhi Institute of Petroleum Technology (RGIPT)
For Mexican Economy:
Julia von Maltzan Pacheco, Professor and Associate Dean for International Relations, FGV Escola de Administração de Empresas de São Paulo
For German Economy:
Jens Weinmann, Program Director at ESMT
For Nigerian Economy:
Doyin Salami, Economist and Professor, Lagos Business School
For USA economy:
Master thesis of Mr. Farid Amirov, Department of Entrepreneurship Development Policy Ministry of Economy and Industry of the Republic of Azerbaijan