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The impact of oil price dynamics on global economy

Hausarbeit 2014 24 Seiten

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Leseprobe

Table of Contents

I. Outline

II. List of figures

III. List of tables

IV. List of abbreviations

1 Introduction
1.1 Research problem
1.2 Course of investigation

2 Oil price dynamics
2.1 Oil price formation
2.1.1 Oil prices as dynamic market prices
2.1.2 Oil supply and demand
2.1.3 Role of expectations and speculation in price formation
2.2 Oil prices from 1970s until today

3 Oil and the global economy
3.1 Usage and relevance of crude oil and refined products
3.2 Importance of oil for transportation
3.3 Oil use in the industrial sector and other usage
3.4 Relevance of oil for emerging markets

4 Economic impacts of oil price dynamics
4.1 Concerns about longer-term fluctuations and sharp price rises
4.2 Consequences for oil exporters and importers
4.2.1 Negative influences on oil- importing countries
4.2.2 Special vulnerability of emerging markets
4.2.3 Positive influences on oil-exporting countries
4.3 Net effect on global economy

5 Conclusion
5.1 Summary
5.2 Critical acclaim
5.3 Outlook

V. Glossary

VI. List of references

Abstract

After oil was discovered in the late 19th century, oil prices were primarily determined first by the major petroleum companies and then by the oil-exporting nations, who joined forces in the Organization of Petroleum Exporting Countries (OPEC). In the 1960s, the market- oriented pricing system was adopted and since then oil prices are primarily formed by supply and demand. Oil prices are characterized by permanent price fluctuations. Especially rapid price rises and longer-term fluctuations are at the focus of many scientific work. Because oil is an indispensable resource for the global economy, the question arises after the economic impacts of such price developments. While oil- exporting countries benefit from strong price rises, oil- importing countries, with emerging countries leading the way, are negatively affected. The interplay of these opposite effects and the global economic situation are crucial for the net effect on global economy.

Keywords: oil price, volatility, oil price shocks, OPEC, emerging markets, global economy JEL classification: E31, Q31, Q41, Q43, N75

II. List of figures

Figure 1: Influencing forces on oil price formation

Figure 2: Spot crude oil prices for UK Brent from 1976 to 2012

III. List of tables

Table 1: Main usage of selected refined products

Table 2: Average oil demand growth per region from 2002 - 2017

IV. List of abbreviations

illustration not visible in this excerpt

1 Introduction

1.1 Research problem

Since most of the oil exporting countries adopted the market pricing system, the oil price is characterized by high volatility and sharp upward and downward jumps. Oil price shocks in the 1970s and 1980s raised the question whether they affect global economy and if so, to which extent. Economics and academics offer diverse solutions and leave the question open. Nevertheless, empirical evidence seem to be given that sharp rises in oil prices as well as long- term fluctuations can have significant effects on market participants, including oil importing and oil exporting countries. Importers can be threatened by several negative effects due to rising oil prices, which is especially noticeable for energy- intensive economies of emerging countries. Volatility in oil prices further raises uncertainty and leads, inter alia, to a decline in investment and demand for long- durable goods. On the contrary, oil exporting nations benefit from rising oil prices due to higher export and government revenues. But the benefits are outweighed partly by decreased demand from oil importing nations. Hence, the net effect on global economy is negative. This mechanism seemed to fail in 2008, as oil prices first raised to new hikes before they collapsed.

This paper aims to analyze the various effects of high oil price volatility as well as sharp upward jumps in oil prices. Further, it aims to answer the question to which extent such price movements can have a destroying effect on global economy.

1.2 Course of investigation

Based upon the research question that has been formulated in chapter 1.1, the second chapter will give an overview about the dynamics of oil prices. First, the mechanism by which oil prices are formed will be described. Then the dynamic character of oil prices will be explained by describing the influencing forces on price formation. Second, an overview about the historical development of oil prices will be given. In addition, historically significant movements in oil prices, also called oil price shocks, will be pointed out. Reference is primarly made to UK Brent.

Afterwards, the relevance of oil for the global economy will be addressed in the third chapter. Therefore, general information about the usage in various sectors such as transportation will be given. Following, the significant relevance of oil for emerging markets will be pointed out.

Thereafter, the possible impacts of oil price dynamics on global economy will be discussed. For this purpose, the disagreement of academics about such price behavior will be shown in Chapter 4.1. Chapter 4.2 then summarizes the various possible impacts on oil importing and oil exporting countries. Chapter 4.2.2 will respond to the special vulnerability of oil­importing emerging economies. At the end of this Chapter, the net effect on global economy will be discussed.

Chapter 5 consists out of a summary of the findings, a critical acclaim and an outlook.

2 Oil price dynamics

2.1 Oil price formation

2.1.1 Oil prices as dynamic market prices

The first oil was discovered in 1859 (Harks, 2007, p.12). The following 50 years were characterized by the monopolistic position of Standard Oil (ibid.). After Second World War, the seven biggest multinational oil companies at that time, called the Seven Sisters, had a dominant position (Fattouh, 2006, p.43). Because of concession contracts between them and oil producing countries they were able to control oil production and oil price formation (Issel, 2007, p.41). Latter were dependent on a posted price, which was a fixed price set by the oil companies (Fattouh, 2006, pp. 42f). Due to disagreements between the two parties, several oil producing countries decided to coordinate their oil policies in future and established the Organization of Petroleum Exporting Countries, short OPEC (Issel, 2007, p.42).

In the 1970s, production property of the Seven Sisters was nationalized (Harks, 2007, p.12). OPEC replaced the posted price and after several changes in their price policy introduced a reference price (ibid., pp. 45f, 48). The reference price is oriented towards the OPEC- basket- price, which consists of seven OPEC and non- OPEC oil prices (ibid., p.49). Many oil exporters adopted the market- oriented pricing system for oil prices in 1986 to 1988 (Allsopp & Fattouh, 2011, p.21). Since then it is the main method for pricing crude oil in international trade and prices are formed by the interaction of demand and supply (Fattouh, 2006, pp. 52, 94). Oil prices are dynamic and reflect these underlying fundamentals (Askari & Krichene, 2008, p. 2136). They are adjusting to changes in supply and demand (Allsopp & Fattouh, 2011, p.22).The dynamic character of oil prices can be seen in short term changes as well as longer-term fluctuations (ibid.). In the short term, oil prices are characterized by intra-day and inter-day price volatility (ibid.). Despite short term changes, there are changes in price levels between certain periods that are more likely large and sharp price swings (Mabro, 1991, p.15). Big price swings are possible due to jumpy adjustment processes of oil prices and a wide price range in which oil prices can fluctuate (Allsopp & Fattouh, 2011, p.22). The dynamic character of oil prices causes price instability (Mabro, 1991, p.15).

2.1.2 Oil supply and demand

Oil supply depends on various factors such as oil production as well as political and economic events (Thomas, et al., 2010, p.6). The worlds’ oil supply is influenced by production and capacity decisions of oil exporting countries (Issel, 2007, p. 43). For example, OPEC- members can intervene in the market by restricting or increasing their oil production (Harks, 2007, p.12). Also refinery capacities are important (Shihab- Eldin, 2006, p.22). Their current utilization is approaching the peak due to high demand, putting pressure on prices (ibid.). Besides that, the distribution of oil reserves matters, because they are not equally allocated (Allsopp & Fattouh, 2011, p. 22). They are concentrated within a couple of countries, namely in the Mid East (Harks, 2007, p. 15). Many of the oil exporting countries are neither characterized by political stability nor democratic structures and civil disturbances or imbalances can have consequences for the oil market (ibid.). Oil prices are vulnerable to political conflicts within exporting countries, between major exporting countries or exporters and importers (Mabro, 1991, p.10). Moreover, global oil supply is influenced by the discovery and exploration of new oil reserves (Allsopp & Fattouh, 2011, p.5). In recent years, new sources such as deep offshore in Brazil or oil sands in Canada became of importance and will have an increased share in world oil production (International Energy Agency, 2013, p.4). Other factors like oil tank accidents, broken pipelines or natural disasters have implications for the supply side too, e.g. hurricane Katrina in 2004 (Grewe, 2009, p.1; Harks, 2007, p.10).

The oil demand side depends on a wide range of factors as well, for example world economic activity or the relative price of competing energies (Allsopp & Fattouh, 2011, p.9). Demand is driven by economic activity and world economic growth (ibid.). Additionally, it is dependent on the season, because demand increases during the travel season in summer (Natural Resources Canada, 2010, p.4). Very cold winters lead to a rising demand for heating fuel, but mild winters have the opposite effect and depress oil prices (ibid.). Amongst other things, oil demand depends on the possibility to substitute away from oil (ibid.). In doing so, the relative price of other energy sources is of relevance (ibid., p.7). There are still a lot more factors to mention, i.e. technological developments that offer possibilities for the promotion of oil alternatives (Foote & Little, 2011, p.8), oil prices themselves and energy policies of the consuming countries (Shihab- Eldin, 2006, p.20).

2.1.3 Role of expectations and speculation in price formation

Changes in supply and demand are therefore responsible for changes in oil prices, but also changes in expectations about the fundamentals influence oil prices (Allsopp & Fattouh, 2011, p.24). Changes in expectations are translated into movements in prices (ibid., p.2). These movements represent concerns regarding the future development of oil supply and demand rather than the actual real situation on oil market (ibid., p.24).

Figure 1: Influencing forces on oil price formation

illustration not visible in this excerpt

Source: own illustration based on Jäger, 2008, p. 59

An appropriate example is the “peak oil theory”: because oil is a nonrenewable resource, concerns about the future availability of oil supply are rising (Thomas, et al., 2010, p. 3). The theory became popular when people started fearing that oil demand will still increase while oil production is going to its maximum level (Foote & Little, 2011, p.14). As a matter of fact, the output from explored fields in many countries lessens and the size of oil fields is getting smaller on average (International Monetary Fund, 2008, p.56). Oil will increasingly come from unconventional sources (ibid.). But besides that, there is no evidence for the assumption that the world is running out of oil (ibid.). It is more likely the producers’ unwillingness to share information about their stocks which is why nobody actually knows how much oil is in the underground (Oxford Institute for Energy Studies, 2009, n.pag.).

Also the role of financial speculation has been discussed lately due to sharp price swings in 2008 and 2011 (ibid.). The main part of trade in commodity markets, including the oil market, is conducted through future contracts that are traded in several mercantile exchanges (Spargoli & Zagaglia, 2011, p.170). The New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE) in London offer the major trading platforms worldwide (ibid.). The reason for the current discussion is that such contracts are often not designed to buy and sell oil as a physical commodity, but to offer an arbitrage opportunity and are hence traded for financial purposes (Lee & Zyren, 2009, pp. 113f). In 2008, less than 3 percent of the NYMEX oil futures contracts resulted in physical delivery (ibid., p.114). But the exact role of speculation is not clearly defined yet (Foote & Little, 2011, p.36).

Nevertheless, recent oil prices are considered to be driven mainly by fundamentals rather than by financial speculation (Krichene, 2006, p. 14). The natural character of oil prices is volatile and even without speculation on international commodity exchanges it would fluctuate over time (ibid., p.12). The main difficulty when explaining oil prices is to clarify the impact of the factors that influence its formation (Allsopp & Fattouh, 20011, p.3). Due to the unpredictable behavior of oil prices and uncertain fundamentals, many longer- term analyses of oil prices turned out to be wrong in the past (Oxford Institute for Energy Studies, 2009, n.pag.). Hence, it is difficult for anyone to give a forecast about future prices (ibid.).

2.2 Oil prices from 1970s until today

The past years can be divided into several pricing episodes: before 1973, the market prices fluctuated around $2-4/barrel (bbl) (Mabro, 1991, p.15). In 1973, there was a price jump of over 400 percent from $2.7/bbl to $11.2/bbl in 1974 (Backus & Crucini, 1998, p. 190). From 1974 to 1978 prices were around $ 11- 12/bbl (Mabro, 1991, p.15). They rose another 200 percent to $34.4/bbl in 1981 and fluctuated until 1985 between $27 to 30/bbl (Backus & Crucini, 1998, p.190; Mabro, 1991, p.15). In the late 1980’s they collapsed and moved between $16/bbl and $19/bbl after 1986 (ibid.). During the mid-2000s, the crude oil prices reached a stable level (Thomas, et al., 2010, p. 3). From 2002 to 2008 people could notice an episode of the most sustained increase in price for seven following years (Allsopp & Fattouh, 2011, p.1). While price were about US$75/bbl in 2007, they rose to a new peak of more than $140/bbl in July 2008(ibid, p.5). In December 2008 they fell to less than $40/bbl, namely caused by the global financial crisis (Chen & Hsu, 2012, p.2). In the following years, oil prices recovered and moved within a narrow price band from $70-80/bbl which caused certain price stability (Allsopp & Fattouh, 2011, p.2). After an episode of stability, they broke out of this band mainly because of a rising global oil demand, boosted by unexpected high demand from emerging countries like China, India and Brazil (International Monetary Fund, 2008, p. 19; Shihab- Eldin, 2006, p.20). In 2013 the oil price for UK Brent averaged $ 108.5/bbl (Sachverstandigenrat, 2013, p.26).

Figure 2: Spot crude oil prices for UK Brent from 1976 to 2012

illustration not visible in this excerpt

Source: own illustration based on BP p.l.c., 2013, p. 15

Even though future oil prices are uncertain, average oil prices in 2014 are assumed to be around $106/bbl (ibid.). Furthermore, the International Energy Agency assumes a rising oil price during the next two decades (International Energy Agency, 2013, p.7).

3 Oil and the global economy

3.1 Usage and relevance of crude oil and refined products

Previously oil was primarily relevant for the arm industry, but evolved into an important raw material for the world (Issel, 2007, p. 3). Crude oil and its refined products are the most traded physical commodities worldwide, so that the main sections of modern economy are dependent on them (Allsopp & Fattouh, 2011, p.4). Furthermore, crude oil is the leading source of primary energy (Issel, 2007, p.34). In 2010, its share in global energy consumption was around 34.4%, followed by coal and natural gas (Allsopp & Fattouh, 2011, p.4). Crude oil is refined and split into numerous products (Jäger, 2008, p.60). These products “are either used for directly for final consumption or are in turn further processed” (ibid.). The refined products are differentiated into three groups: Light distillates include gas, naphta and petrol (Dreesmann, 2000, p.42). Gases and naphta are used, inter alia, in the chemical and petrol chemistry for the production of plastics (ibid.). The second group consists of middle distillates such as diesel, kerosene and light fuel oil (ibid.). Kerosene, for instance, is used as transportation fuel for the aircraft (ibid.).

Table 1: Main usage of selected refined products

illustration not visible in this excerpt

Source: Dreesmann, 2000, pp. 42ff

Heavy fuel oil and bitumen belong to the group of heavy distillates (ibid., p.44). Power plants use heavy fuel oil to generate electricity while bitumen is predominantly used for road construction (ibid.). There are several sorts of crude oil with different qualities and different prices (Harks, 2007, p. 11). Popular sorts are the American leading grade West Texas Intermediate (WTI) as well as the European leading grade UK Brent (Issel, 2007, p.51).

3.2 Importance of oil for transportation

The development to a consumer society required the transportation of goods over long distances whereby plains and trucks were used (Issel, 2007, p.3).

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Details

Seiten
24
Jahr
2014
ISBN (eBook)
9783668702943
ISBN (Buch)
9783668702950
Dateigröße
567 KB
Sprache
Englisch
Katalognummer
v419568
Institution / Hochschule
Hochschule für Angewandte Wissenschaften Hamburg
Note
1,7

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Titel: The impact of oil price dynamics on global economy