Thursday, February 17, 2011

Factors Influencing Recent Movement in Oil Prices

Passport Capitol Sees Oil Prices Holding
WikiLeaks Cables:
Economic Times:
Oil Price Fall on Concerns of China and Demand

Since the beginning of 2011, the price of oil under the Brent Crude classification has risen 7% to over $100 dollars a barrel (there are two major benchmarks for crude oil, Brent and WFI, both of which have risen). While several events last week have brought the price down, commentators anticipate that the price of oil will remain high, as has been the trend in recent years because of higher global demand.

High oil prices are a threat to global economic health and political stability. In countries that have high consumption—particularly emerging economies—high prices can stymie economic growth and disturb political systems. As the cost of production for goods and services increases due to escalating oil prices, so do the prices to consumers. One recent example is that the price of airlines tickets has gone up as a result of higher oil prices. But growing oil prices can have even more alarming, large-scale consequences. For example, rising oil prices were partially responsible for investors pulling out over $7 billion from emerging market equity funds. Most significantly, high oil prices pose can lead to economic instability, which can trigger political unrest.

Several events in the last month have driven the price of oil up—most notably the events in Egypt. Prices of oil rose in response to fears that Egypt might block Middle Eastern countries’ transport of oil through the Suez Canal, but prices stopped climbing when it became apparent that, despite political unrest, the Suez Canal would remain open and that oil companies could use alternative routes for shipping. Oil prices also rose in response to fears that political unrest may continue to spread through the Middle East and North Africa. Furthermore, Wikileaks reports revealed that Saudi Arabia may be reaching its production peak, meaning that oil reserves may be lower than Saudi officials have announced and that Saudi Arabia will not be able to pump supply to offset rising prices in the future. This revelation led to a jump in oil prices.

Despite turmoil in the Middle East, several offsetting events moved the price of oil down last week. First, the price of oil fell on February 8th when China announced that it was increasing its interest rate in an effort to thwart inflation. This kind of announcement sends the price of oil down because investors fear a drop in demand. The price of oil didn’t stay low, however, because investors realized that demand in for oil in China will continue to remain high due to rapid economic development that is unlikely to be affected by an interest rate increase. Second, the price of oil dropped slightly again on February 9th as the United States revealed higher-than-projected domestic oil reserves. High reserves mean that supply is readily available to meet increases in demand, thereby keeping the price down. Finally, last Friday’s announcement that Egypt’s president of 30 years, Hosni Mubarak, has stepped down lowered the price of oil as investors regained some confidence that oil supply will not be disrupted by further political upheaval in Egypt and that the Middle East and that the North Africa (MENA) region is stabilizing.

Discussion Questions

1. Does the price of oil move for justifiable reasons or does it tend to respond to unreasonable fears?

2. To what extent does political instability in the Middle East affect the price of oil? Is the price truly affected only by exporting MENA countries?

3. Should governments, international organizations and private businesses pursue strategies to keep price of oil down, and if so, what should those strategies be?

1 comment:

Scott McKenzie said...

I did not know much about the difference between Brent and West Texas Intermediate (WTI). But, I read this today, and it was both interesting and entertaining;

Also, you fail to address the role of market speculation in driving up these costs. I would argue this is more important than vague concern for the Suez Canal, which the Egyptian military would never allow to be shut.