Oil is often called the “black gold” and may be the most valuable natural resource today. It often single-handedly supports national economies as evident by several Middle East countries including Saudi Arabia and Iraq. This is why oil prices are watched closely because any fluctuation may have material impact on some of the largest economies including the U.S. Oil prices have negative relationship with oil production which may vary due to several reasons.
One of the factors that lead to greater oil production is technology. Technology doesn’t only help improve drilling productivity but also makes it possible to extract oil from places where it had not been possible before (Maugeri). When supply of a commodity goes up, price goes down, thus, improved productivity or extraction of oil from previously unexplored areas due to advancements in technology drives down prices.
Another factor that may affect oil productivity is the actions of cartels such as OPEC. OPEC’s members are some of the leading oil producing countries in the world, thus, a decision by OPEC to limit or increase oil production also has significant impact on global oil prices. A decision by OPEC to limit production in order to support prices will drive up prices while a decision to increase production will have the opposite effect.
Another factor that may have affected oil production over the last decade is political. U.S. invasion of Iraq War probably led to an increase in oil prices, even if for a short period, because Iraq is one of the leading oil producers in the world. A war disrupts oil operations and also creates uncertainty. Both disruption to oil-producing operations as well as uncertainty regarding future supply help increase oil prices. Thus, some of the hikes in oil prices were also due to Iraq War. Similarly, Iran is also one of the leading oil producers in the world. Iran’s political conflict with U.S. and Israel and the resulting economic sanctions against it also probably has decreased global oil production, resulting in higher prices than would have been the case otherwise. Other political event that might have limited oil production was Venezuela’s conflict with the U.S. when Huge Chavez was President of the country. Thus, Chavez’s conflict with the U.S. probably also contributed to higher oil prices.
Oil productivity is also affected by natural calamities such as hurricanes and earthquakes which sometimes disrupt global supply chain networks. Similarly, hurricanes may also destroy local infrastructure as did happy during the recent Sandy crisis in the U.S. These natural disasters limit productivity or prevent the supply from reaching their destination in a timely manner, resulting in higher gas prices.
The oil production may also fall due to lower demand if there are reliable substitutes and alternative sources of energy may be being embraced by the public. For example, hybrid technology in automobiles is becoming popular which has led to some decline in demand for gas. Electric technology is another substitute that is gradually rising in popularity. All of these substitutes result in lower demand and lower prices as well. Demand for gas also falls during difficult economic climate as a result of higher unemployment rate and falling income levels. This lower demand for gas results in lower gas prices as well.
Consumers do not embrace alternative fuel technologies for economic reasons only. Changing consumer values such as greater concern for global warming also contributes towards the popularity of cleaner alternative fuel technologies. As a result, lower demand for oil also leads to decline in oil production.
Oil demand may continue to fall as a result of improved energy efficiency of automobile products even if alternative energies fail to gain ground. Improved energy efficiency of automobile products mean consumers will have to purchase gas less often, resulting in downward pressure on the gas price. It is also possible that the popularity of alternative fuels may force OPEC to increase production so that the economics for alternative fuel technologies becomes less attractive to customers. Some of the development that has been taking place in alternative fuel technologies has also been due to the fact that higher oil prices due to lower oil supply improved the economics of alternative fuel technologies.
Another factor that leads to higher demand for oil is economic growth among countries. Some of the emerging economies such as India, China, and Brazil etc. have been growing at record rates which are much higher than the developed countries including the U.S. The economic growth has not only led to higher income and, thus, higher demand for oil from the consumers in these respective countries but also the industrial sectors. As a result, this increase in demand leads to higher oil prices on a global scale.
It is clear that oil prices are determined by several factors that affect demand or supply of oil. Oil is probably the most valuable commodity in the world and has low price elasticity of demand. But this may change as alternative fuel technologies are not only becoming more cost efficient but also appeal to consumers due to being cleaner and better for the environment.
- Maugeri, Leonardo. “Oil: The Next Revolution.” Educational Report. June 2012.