shifting global oil prices to examine the models of demand and supply

shifting global oil prices to examine the models of demand and supply

Abstract

This paper examines demand and supply determines the prices of products in the market. The demand and supply models focus on two major groups, the sellers and the buyers. Demand refers to the amount of service or goods consumers are willing and able to purchase at each price. Demand is based on an individual’s wants and needs by which customers can differentiate, but according to economists, wants and needs are the same thing. Supply refers to the quantity of service or goods a producer is willing to supply at each price. Price relates to the amount received from each unit of service or goods sold by the producer. The price increase will always lead to an increase in the supply of services or goods, and subsequently, the decrease in price will lead to a reduction in quantity supplied. This paper has focused on shifting global oil prices to examine the models of demand and supply. Three recent newspaper articles have been utilized in the literature review section and illustrate the current market condition. Scholar works have been used to illustrate the elements within the literature review.

Demand and Supply

Introduction

The demand and supply system is a model for understanding how to determine the price of the number of goods sold on the market. This model focuses on two major groups, sellers and buyers.  Demand refers to the amount of service or goods consumers are willing and able to purchase at each price. Demand is based on an individual’s wants and needs by which customers can differentiate, but according to economists, wants and needs ae the same thing (Buchanan, 1968). On the other hand, supply refers to the quantity of service or goods a producer is willing to supply at each price. Price relates to the amount received from each unit of service or goods sold by the producer. The price increase will always lead to an increase in the supply of services or goods, and subsequently, the decrease in price will lead to a reduction in quantity supplied (Whelan et al., 2001, pg 5). Together, demand and supply determine the price and the quantity that would be bought and sold in the market. This essay will analyze the global oil prices in terms of demand and supply.

Literature Review

Increased output from the United States’ shale and other rivals lead OPEC to a decision to lower its production in the next five years. This is despite the growing energy need fueled by global economic expansion. The organization announced a decline of crude oil production and other liquids to thirty-two million eight hundred thousand barrels per day (bpd) by 2024 compared to thirty-five million bpd in 2019 (Lawler, 2019, par 1-2). Increased climate change activisms in the West and the expanding use of alternative fuel, is putting the long-term demand for oil under more scrutiny. The organization, which supplies almost a third of global oil output, further projected a lower demand for oil wherein 2023, oil consumption will be one hundred and three million nine hundred thousand bpd. This was down from one hundred and four million five hundred thousand bpd projected in 2018 (Lawler, 2019, par 6-8). The lower demand can be attributed to decreased economic growth forecasts and the use of other alternative fuels. However, in the long-term, oil demand is expected to increase by twelve million bpd and reach one hundred and ten million, six hundred thousand bpd by 2040.

A report by Layek (2020) states that Barclays is expecting oil demand to increase in 2020 by one million four hundred thousand bpd up from nine hundred thousand bpd (par 1). The growth in demand will be contributed by emerging economies in Latin America and Asia. In 2020, India will be the biggest contributor with the increased demand of two hundred and fifty thousand bpd from 2019. The Phase 1 trade deal signed by China and the United States will also increase these countries’ oil demand. This will lead to increased investor confidence, thus fuel growth. Moreover, Layek’s (2020) report states that “the bank maintained its 2020 forecasts for Brent and West Texas Intermediate (WTI) prices at $62 per barrel and $57 per barrel, respectively”. Despite the calm in the oil market, there is an underlying shifting dynamics such as production cuts by OPEC, increasing tension between Iran and the United States contributing to geopolitical risks and the growing United States shale oil output. There was an increase in oil prices earlier this month as Iran retaliated after the United States killed top Iranian military commander through a drone strike in Iraq. This erupted fears that an escalated conflict in the region could disrupt global oil supplies (Layek’s, 2020, par 7-10)

Oil prices fell on January 27, 2020, to the lowest since October last year, where fears ignited by the coronavirus outbreak breeds possibilities of a slowdown in the demand of crude oil.

U.S. West Texas Intermediate crude fell 1.9%, or $1.05, to settle at $53.14 per barrel, for the fifth straight session of losses, and the lowest closing price since October 15. At its low, WTI dipped more than 3% to hit $52.13, a price not seen since October 10. International benchmark Brent crude fell 2.5%, or $1.53, to $59.16. It’s also coming off its third straight week of losses, and its worst week since Dec. 2018. (Stevens, 2020, par 2-3)

The coronavirus with flu-like symptoms was first identified in Wuhan, China, on December 31, 2019. As of January 27, 2020, the virus had killed eighty-two people, whereas two thousand nine hundred cases had been confirmed worldwide. The virus spread to ten more countries, including Japan, South Korea, and the United States. The virus risks slowing down the Chinese economy, thus affecting the demand for oil is that China is the world’s largest importer of crude oil, wherein 2019, an average of ten million, one hundred and twenty thousand barrels were being imported every day. The seriousness of the potential impact of the virus has been compared to the 2002 SARS outbreak, where oil prices fell to five dollars a barrel. However. The events are not yet a global demand story. (Stevens, 2020, par 4-7)

Discussion

Economic theory assumes that the ability to buy and taste are the two factors of demand. Ability to buy means that the purchase of a good at a particular price will depend on a person possessing sufficient income and wealth (Whelan et al., 2001, pg 6). Taste concerns the willingness to purchase the good at a particular price. The markets determine both factors of demand. Demand is low when the market price for a particular product is high, and a high number of people will purchase a product when the prices are lower, thus high demand. However, in the real world, other factors can affect demand. Just as in the above-reviewed articles, uncertainties about the future prices of oil have an impact on its demand. For instance, climate change activism and the current upscale of the coronavirus have led to a decrease in oil prices. Thus, lower oil prices build opposite incentives as companies may shut down projects while others declare bankruptcy (Jadidzadeh & Serletis, 2017, pg 71). Lower costs of energy mean that people will be driving more and caring less for the environment.

This inverse relationship between the quantity demanded and the price is what economists call the law of demand. This law assumes all other factors affecting the demand are to be held constant. The table figure below shows a graph of an instance of a gasoline market and forms a demand curve showing the relationship between quantity demanded and price.

Seller’s actions are determined by their ability to supply goods for the market. Buyers will get more of the products at higher prices; this is because sellers maintain profits despite high costs of productions (Whelan et al., 2001, pg 7). For instance, an increase in gasoline price by OPEC will encourage corporations to take several actions such as drill for more oil, build new oil refineries, open more gas stations and keep the stations open for longer hours. For instance, in 2007 and 2014, a period during which crude oil prices soared above one hundred dollars per barrel, there were massive investments and establishments of new companies (Jadidzadeh & Serletis, 2017, pg 69). The positive relationship between the quantity supplied and price, whereas price increases, also supply increases, has been termed by economists as the law of supply. The law assumes all factors affecting the demand are held constant. The figure below shows a graphical representation of the law of supply.

Conclusion

The model of demand and supply illustrates that prices are not only set by supply or demand but through the interaction between the two. The laws of demand illustrate buyer behavior where they will purchase more services or goods at lower prices. The law of supply describes seller’s behaviors, where they will supply more products into the market if prices are high.

References

Whelan, J., Msefer, K., & Chung, C. V. (2001). Economic supply & demand. MIT. Pg. 1-35

Jadidzadeh, A., & Serletis, A. (2017). How does the U.S. natural gas market react to demand and supply shocks in the crude oil market?. Energy Economics, 63, 66-74.

Buchanan, J. M. (1968). The demand and supply of public goods (Vol. 5). Chicago: Rand McNally.

Lawler, A. (2019, November 5). OPEC sees its oil market share shrinking, lowers demand view. Reuters. Retrieved from https://www.reuters.com/article/us-oil-opec-outlook/opec-sees-its-oil-market-share-shrinking-lowers-demand-view-idUSKBN1XF105

Layek, S. (2020, January 21). Barclays raises the 2020 oil demand forecast on expected global economic recovery. Reuters. Retrieved from https://uk.reuters.com/article/oil-research-barclays/barclays-raises-2020-oil-demand-forecast-on-expected-global-economic-recovery-idUKL4N29Q1U3

Stevens, P. (2020, January 27). Oil tumbles into a bear market hit more than 3-month low on fears coronavirus will slow global growth. Retrieved January 29, 2020, from https://www.cnbc.com/2020/01/27/oil-tumbles-to-more-than-3-month-low-on-fears-coronavirus-will-slow-global-growth.html