The rising price of oil

Posted by Allison on 4 April 2009, 10:16

In May 2008 the price of oil actually topped $130 a barrel. In June it rose to $140 per barrel. The results of this could be felt all over the world and anywhere that people filled up their cars, buses, coaches, lorries or aeroplanes. Gas prices suddenly escalated and everyone started to feel the effect of the rising price of oil.

So who is responsible for the rise in price? Well the UK blamed OPEC.
In the United Kingdom, the Prime Minister, Gordon Brown said that it was a scandal that over 40 per cent of the oil produced in the entire world was controlled by OPEC.

OPEC is the association of oil-producing countries and it is currently made up of Iraq, Iran, Saudi Arabia, Kuwait, Venezuela, Libya, Qatar, Indonesia, Algeria, Ecuador, Nigeria and Angola.

OPEC is seen by many as being responsible for the rising price of oil and many lay the blame for the increase, directly at the door of OPEC.

But is it fair to do this? Has OPEC caused this increase or is it merely a combination of circumstances that has caused the price of oil to rocket?

OPEC's history

In 1973 OPEC decided that it would be a good thing to restrict the oil that it produced, so that it could inflate the price of oil, throughout the world. In October 1973 OPEC actually stopped producing as much oil and it put an embargo on exporting oil to the West. It specifically decided that the United States and to some extent the Netherlands should be inconvenienced the most.

It was against the Netherlands and United States, because both these countries had had some involvement in supporting Israel. This greatly annoyed the Arab states in particular and as a result they decided to flex their muscles and let the west, specifically the Netherlands and the United States, start to realise who was really in control of the situation.

The embargo caused significant problems in the West as the cost of a barrel of oil actually quadrupled in the USA. In other parts of the world, the effects were not felt so dramatically, but in the United Kingdom, there was a coal strike, which further exacerbated the situation.

France, who had opposed the Israelis during this period, were lucky enough to be in receipt of most of the oil that they needed. Yet the fact that its neighbor, the Netherlands was crippled and the USA had been severely affected, took its toll and most of Europe was hit by the crisis, since imports and exports were affected.

Inflation soon impacted because oil prices had risen and businesses were hit because they could not afford the fuel that they needed to produce their products. This led to significant problems throughout Europe, as trade was hit and companies really bean to feel the pressure. In the UK, things got so bad that the working week was actually reduced and businesses found that they couldn't actually keep their offices or factories going, so workers had to go home early. As a result, production levels dipped significantly.

So the reduction in oil was causing significant problems to the US
and the effects of this action would shape OPEC's relationship with the rest of the world for subsequent decades afterwards. The main impact in Europe was inflation and this has resulted in a deep distrust of OPEC, throughout the European Union.

This situation was not eased until March 1974 after a lengthy set of negotiations had been undertaken and an agreement was eventually reached. However, the price of oil continued to rise until 1975 at which point it started to stabilise.

Since this point there has always been a fear that OPEC will hold the rest of the world to ransom, over the price of oil. This fear is exacerbated by the fact that the US and the UK have gone to war with Iraq, twice since 1990, much to the disapproval of the other OPEC countries. They perceive this as being aggressive and anti-Islamic.

Many people have a perception that OPEC is actually a monopoly, which controls the price of oil. However, many countries that are part of the OPEC agreement actually feel that they're doing is much as they can to export oil. So, they argue that it is not actually their fault that the price of oil is going up and up.

The United States has recently blamed India and China for using up too many resources and as a result pushing up the price for oil.

The price of oil has been steadily increasing since 200, usually the price of oil fluctuates meaning that it goes up as well as down. But this has not been the case since 2001 and many people are concerned that the price will continue to escalate and there will be a significant impact on every country, with some unable to run businesses or produce items, or even move items around the country. It is likely that if the price of oil continues to rise to record levels, inflation may soon take hold of most economies within the West and this will result in even more financial problems that may soon eclipse the credit crunch.

So who really is responsible for the increase in the price of oil?

One possible explanation for the rise is the fact that there are some serious political problems in the world and these are all affecting the price of oil. Nigeria, which produces oil has experienced some significant unrest and this may impact on how efficiently Nigeria can export oil, in other words, she may not be able to export as much oil as she would like to. This led to some unease on the oil markets and consequently the price seemed to start to rise.

Iran and the US have also been quite bullish in their negotiations and there is a genuine fear that the US may actually go to war with Iran. If this were to happen, the price of oil would be severely affected and would possibly simply go through the roof.

There have also been some harsh words exchanged between Venezuela and the US, with Venezuela saying to the US that it will simply stop exporting oil to the US unless the US toes the line. Obviously if Venezuela stopped exporting oil to the US, there would be more available for the rest of the world, but given that 15 % of all the crude oil imported to America comes from Venezuela, this would be a huge problem for America.

One of the main problems with regard to the oil market is that oil is usually produced in countries where there is a significant risk of political upheaval. This means that the countries that produce oil tend to be quite volatile and do not have stable democracies to back them up.

The result of this is that there is always a danger that any particular oil-producing country, will either suddenly stop production of oil, or restrict the oil that is exported or they will suddenly demand a huge increase in price for the oil that they produce.

So whereas it would be nice for the US and other Western countries, if oil could be produced in nice stable democracies, this is not the case and as a consequence, there will always be some instability within the oil markets.

This is a given fact and that there is little that the US or other Western countries can do to alleviate this situation. Some experts liken it to living with some kind of a medical condition, it may not be pleasant and it may be uncomfortable, but really the only thing to do is to live with it.

However, this is of little comfort to the US and other countries. The instability with regard to oil production means that even when oil is being produced and it is being exported from the oil-producing countries, there is always a risk that this situation will not continue and that there will be a problem with oil production at some point in the future. This means that when everything is actually going well, there is always a pessimistic fear that this will not last and the world will soon be plunged into yet another oil crisis.

Some experts believe that this fear of a problem with oil actually leads to increased instability and fluctuations with regard to the oil markets. But to some extent this is a hypothetical argument, because it is unlikely that oil in significant amounts will ever be produced in countries that have stable democracies. As a result we have to live with the situation and the instability.

The weak dollar also seems to have some kind of impact on the price of crude oil. The dollar is used to price oil, that means that the price of oil is always referred to in terms of dollars. Yet in real terms the value of the dollar has actually fallen by more than 30% since 2002. Effectively this means that imports actually cost 30% more than they did in 2002. OPEC have turned around and blamed the US for the increase in the price of oil and they have said to the world at large, that oil has become so expensive because the US economy has been mismanaged for such a lengthy period of time.

In some ways this is hardly a constructive approach, OPEC blame the US and the US blame OPEC. It is a bit like each side is simply pointing the finger at the other side, but in the meantime the price of oil continues to escalate.

There has also been an increase in the number of investors who are actually buying up oil because they think that the price will continue to go up, at which point they can sell their oil and make a substantial profit.

Again, part of the reason for this is actually the falling value of the dollar.
Because the dollar is so weak and inflation has been on the increase, investors are looking for new ways to hedge their bets and make sure that they continue to make profits: oil would seem to be one way that they can do this.

But on the other hand, this actually makes the situation worse. When oil prices are high then inflation will also become higher. So the fact that investors are buying increased amounts of oil means that the price of oil gets higher, inflation gets higher and so the investors need to buy more oil to be sure that they will get at least some form of profit. So the whole thing actually becomes a vicious circle.

Some economists feel that the price oil will actually be stabilised as a result of the natural laws of economics. These state that products and demand for products is governed by laws relating to the elasticity of demand. The demand for oil tends to be quite inelastic. This means that there are no major reductions in demand for oil, in the immediate aftermath of a price rise.

However, when the price of oil continues to be high for a long time, people start to try and find alternatives to using gasoline, so for example they may start to use public-transport instead of driving their own cars to work. People may also start to cut back on car journeys that are not necessary and so on. This reduces the demand for oil and as a result ensures that the price can at least be stabilised and hopefully, it will go down and then the markets can recover.

However, although during the oil crisis of 1973, America managed to reduce her oil consumption by a staggering 13 %, it is unlikely that this will happen now.

Things are different now and the fact needs to be faced that India and China are both consuming a lot more oil than they have done. It is estimated that they will actually have a need for a oil that is so substantial that it will quadruple by 2030.

Indeed, India and China have been responsible for a 70 % increase in terms of energy demands and a lot of the demand is centered around oil.
If India and China continue to consume in this way then the world will need to produce around 55% more oil to meet these needs. Thus it is unlikely that we will actually be able to reduce the amount of demand for oil that the world needs in order to bring the price down.

This makes the oil crisis that the world is facing today, potentially less easy to resolve than the oil crisis of 1973.

What is the answer?

The oil crisis that we face today is a potentially very serious one. There are no easy solutions, because if there were easy solutions to the crisis, these would have been discovered before now.

One possible but only partial solution, is to look for new ways of reducing energy consumption. India and China are being encouraged to look at ways that they can slow down the amount of energy they consume and so reduce the amount of oil that they consume. However, China in particular is quite a secretive country and many people feel that China will simply go on using oil, whilst perhaps telling the world that a reduction in oil consumption has been achieved. One thing is clear and that is that if China continues to use energy in the way that she does now, by the year 2010 she will be the biggest consumer of energy on the planet and this is quite a scary prospect in terms of how this will impact on the price of oil.

Alternative energy may also be part of the way forward. Many experts in energy field state that innovation is actually the key to ensuring that we can meet our energy needs for the foreseeable future. Increasingly countries are also looking to nuclear fuel as being the way forward. The production of nuclear fuel tends to be quite controversial however, experts who are in favour of nuclear fuel state that it is the only way that we will be able to meet our energy requirements and so it may not be palatable for everyone, but it is the only answer to the global energy problem.

It is likely that the production of alternatively fuelled automobiles will also increase dramatically and the world will see many more battery-powered automobiles for sale and their use will no longer be seen as something that is out of the ordinary; they will be seen as the standard mode of transport. Since India and China are both getting into the automobile market, if they were to start buying battery-powered cars, then this would greatly help the situation in global terms. However, people in Western countries also have a responsibility to ensure that they also address the issue, not just leaving it to India and China.