The Economics Of Exhaustible Resources

Published Date: 02 Nov 2017

ABSTRACT

In an attempt to explain and discuss the drivers of oil prices, it is imperative to consider three main factors; non-organized concept, the demand and supply structure concept and the conventional concept. They all underscore some features of price drivers of crude oil and gas.

Non-structural design is solely from hypothesis of non-renewable natural resources becoming bases to the appreciation of the price drivers,

These relationships rely on structure of behavioral patterns and are connected to varied determining factors such as Oil reserves, gross domestic growth, and pricing.

Finally the non-conventional method basically relies the changes in crude prices at definite areas but in a chronological sequence by crude market account.

INTRODUCTION

The behavior of oil prices has recently been given a lot of attention in recent times, mainly due to fast and noticeable increase in crude oil instability. It is generally the view that high oil prices can curtail a boom in the economy, mainly because it leads to inflationary pressures and hence leading to global imbalances.

Price volatility of oil can also generate a lot of uncertainty and deter investors form engaging in an anticipated investment in this area. Heavily pitched crude prices and close market situations thus raising concerns of scarcity and fearfulness the safety of the producing countries.

The coming forth of fresh and big users; mainly China, and the new geopolitical unpredictability’s in the Arab states following US invasion of Iraq, crises in Syria, Egypt and Libya, but India to a lesser extent as a major consumer, also restoration of oil patriotism in more oil-producing locations have to a large extend contributed to volatile oil and gas prices.

Just like most inputs, the increase in crude price induces output but reduces offshoot of demand. These intend drives crude prices downwards stirring demand and increasing crude price.

Crude price volatility has come under examination by use of the following methods:

Informal approach.

The supply–demand framework

The economics of exhaustible resources

Majority of those who use this concept of non-renewable natural resource making it their cornerstone thus appreciating its market draw a conclusion to the fact that its value must show an increasing pattern.

However this approach mechanism is framed by the use of certain behavioral patterns mathematically and economically inclined enough to relate the relationship between supply and demand and consequently the future effects of changes in one or both on the pricing of the commodity.

PRICING OF OIL

Pricing of oil is mainly undertaken by traders of commodities by a process called bidding. There is normally an agreement between them known as contracts and this allows them to exchange at a particular period of time or date at an agreed amount known as the price.

These traders can be divided into two classes

Majority of members of business units who genuinely utilize oil. These set of people purchase oil but agree to redeem at a later period and for a given price.

Those in the other category are known to be genuine forecasters known as speculators.

DETERMINING FACTORS FOR OIL PRICING

There exist several ingredients that representatives of companies examine when they are forecasting to enable them make bids which eventually create oil prices

The recent supply of crude oil, particularly output limitation imposed by the Organization of petroleum exporting countries. If there is the general perception that output will downslope, crude oil traders due to their activities cause an upward adjustment in price. However, if they believe output will step-up, dealers are very interested in offering so much and that brings price down.

Stocks of oil in refineries in addition to what is stocked in the United States and other important petroleum stockpiles can be recovered quickly and these go a long way to increase supply when prices escalate.

Oil demand particularly that from the U.S. Increased demand is normally experienced in certain periods thus making it seasonal because a lot of holiday makers travel during summer. More so during the cold season more energy especially gas is employed for heating purposes

EFFECTS OF INSTABILITY ON CRUDE OIL PRICES

Nevertheless, likely global uncertainties in countries that produce crude oil will definitely increase oil prices greatly. This is normally so because traders foresee the crisis will restrict supply. For instance the speculation air strikes by Israel have been a major fear.

World agitation also leads to a rise in prices of oil especially during spring in 2011. During the same year in the month of March, stakeholders were apprehensive of the political turmoil in countries such as Tunisia, Egypt and Libya popularly called the Arab spring. The price of crude oil rose to $100.00 and above per barrel in early in the same month of March, stretching to a maximum of about $113.00 per barrel in late April. This led to speculation as many thought the crises were going to interrupt oil production hence output.

But, just when this idea did not see the light of day crude prices were restored to a level less than $100.00 a barrel during the middle of the month of June.

Also, Crude prices stepped up to $10.00 per per barrel in 2006 July during Lebanon-Israel crises leading to worry of an imminent panic of war with Iran. Crude oil increase at $70 per barrel during the month of May sky rocketed to $77.00 per barrel by the middle of July.

THE IMPACT OF DISASTERS ON OIL PRICES

Uncontrolled and artificial catastrophe is more certain step up crude oil prices if they are quite spectacular. Hurricane Katrina caused oil prices to raise $3.00 per barrel, and gas prices to reach $5.00 per gallon in the year 2005.

In 2005 May, floods caused by the Mississippi caused gasoline prices to go up to $3.98 per gallon. Dealers were afraid that the floods would destroy refineries.

More so, the Exxon oil spillage failed to induce crude prices to go up. Fortunately in 1989 crude price was at $20.00 per barrel and only about 250,000 barrels got lost through the spillage.

Demand and supply conditions

This is relationship between supply for crude and demand which eventually influence crude pricing in future.

The existence several types of suspense when predicting future crude oil demand and supply. Most of those misgivings are due to unforeseen later on happenings like geo-political causes, environmental catastrophes and modern technology inventions as well as supply disruptions.

Doubtfulness may also be as a result of information concerning future price and income elasticity of demand, the reactions of non-OPEC supply and more so, OPEC conduct. Even though the demand role maybe graduated simplistically as a function of price and income, uncertainties about current and future run price as well as income elasticity can yield large gap of demand curve shapes. But then for supply portion, the challenges intend to be more composite as there exists reserves, technology, depletion effect, lags and leads and market structure.

Demand of Oil and gas

The speculations cannot be with a guess as it is very certain: Because of the fact that there is a boost in the activities of businesses leading to a boom in the economy, there comes with it increased crude oil demand alongside increased crude prices but with an aggregated reduction in demand.

Price Elasticity of Oil Demand

Typical of commodities, thus a rise in crude price has a corresponding drop in demand for the commodity. However, this is not always the case especially if a rise is price provokes investment inclined in the direction of efficient equipment that are likely to bring down demand for the crude. However a reduction in price may not necessarily alter the corresponding reaction.

It is important to note that the reaction of crude to a rise in the highest earlier price will not be equal in measure to the rise as a result of recovery of price

Income Elasticity of Crude Oil Demand

Also, an interaction between oil demand and GDP normally evaluated during the setting of income elasticity of demand, which meters the interaction between the change in quantity of oil demanded and the change in income. Just as in the case of price elasticity of demand, the forecasts differ greatly by the system used; it is possible to arrive at the following blanket resolution.

First, oil demand is more reactive to income than prices.

Secondly, the long term income elasticity for oil demand is higher than the short term income elasticity.

Thirdly, there is a bigger heterogeneity in forecasted income elasticity across countries and/or regions.

In general, it is likely that for a change in oil price to be part of either a price increase or change in price increases, causing to new historical prices reckoning on the period under consideration and the beginning date of the data.

For developing countries showing higher income elasticity than OECD, the responsiveness of oil demand to income has been declining over time in OECD.

Elasticity of Gasoline Demand

Instead of evaluating crude oil demand, many studies have modeled different groups of finished petroleum products. For this reason, many have been concerned with approximating the price and income elasticity of demand for gasoline.

Despite its draw back in most other sectors, crude oil and its by-products; gasoline and diesel oil remain the major fuel in the transport sector.

The fact that taxes form a greater proportion of amount paid by the final buyer or user of crude products, an increase in its price is likely to trigger a corresponding rise of gasoline by just a portion of the rise in price.

The connection between crude oil price and its demand as well as income may be deployed to a great extend to predict world crude demand changes.

First, forecasts are very responsive to the conditions created about growth in the economy.

Secondly, these are also very responsive to price elasticity and income employed.

Thirdly, the forecasts are much more responsive to the path of the crude oil selected.

The conduct of OPEC, The Non OPEC Supplies and Stock

Studies and modeling the output of crude is very challenging. This is due to the conduct of producers, bulk stock. Here it is very important to distinguish between the non OPEC producers and that of OPEC.

FACTORS AFFECTING OIL SUPPLY

The organization of petroleum exporting countries known as OPEC is made up of 12 countries all of whom are engaged in oil production which makes up 46.00% to global crude produced. They formed is group in the year 1960 to control the production and subsequent supply of crude leading to a possible control in its pricing. There reason being the fact that the crude is nonrenewable and if they were to be in competition with each other may result in low pricing as well as running out of the resource.

Their aim by then was to keep the price of the commodity as about $70.00 a barrel. In any case increase in prices was going to be an inducement for them to explore producing more from new areas which were very costly to start.

It is worth noting that the United States of America stocks close to over 700.00 billion units of crude as an important bulk stock. This can be relied upon to bring down prices of the commodity by releasing it to the market during natural disasters, political conflicts and crises and threats from the oil producing countries.

The bulk of their imports are from non Opec crude oil producing countries such as Mexico since they have a trade agreement with them called NAFTA which keeps the price low because of reduction in trade tariffs.

THE FACTORS THAT INFLUENCE DEMAND

These factors may include

A rise in crude oil usage

Crude oil bulk storage

Difference in exchange rates

Uncontrolled Environmental factors

Uncertainties in the political world

The work of forecasters or speculators

Non-OPEC Supply

Here we have two major systems

Crude oil supply

Geographical and Economic

Any factor, geographic in nature that affects non-opec crude oil supply is classified under the geographical approach. This is an approach that believes output is governed by past aggregate production and final depletion of bulk stock

Oil Reserves

It is important to stress that despite regular discussions of looming oil shortage, the proved reserves to production ratio has increased over the last thirty years indicating strong growth in reserve volumes.

Other factors may include;

Economic-Based Drivers

Hybrid Models

Projections of Non-OPEC Supply

Given the different models and the wide range of elasticity estimates, it is no surprise that non-OPEC supply projections differ considerably across studies and over time. The large difference in the projections is mainly due to differences in the estimates of the responsiveness of non-OPEC supply and unconventional liquids to oil prices and whether non-OPEC oil supply reaches a peak during the projection period.

CONCLUSION:

The trend of crude oil supply and demand in 2014, 2019 and 2029 may go up or drop depending on the following factors:

However before any prediction is made the following assumptions should be taken into consideration.

That construction cost and pipeline cost escalation continues until 2030

That new power plants drilling and pipeline construction in the oil and gas industry remain constant

Refinery costs remain constant

Capital costs in LNG supply chain are also constant

Cost escalating factor be held constant until 2030

Recovery price and deck for exploration and production companies remain constant

Natural disasters do not hugely affect the operations of the oil and gas sector

But the following factors actually push the prices of oil and gas to a very large extend. They include;

Supply cutoff

Expanding demand

Lack of spare capacity

Slowdown of Investment

Dollar losing its value

Conditions of the weather

Demand from investors

Conflicts and war in producing countries

Activities of speculators

Ability to readily release bulk oil stock reserves

Ability to increase production especially from NON-OPEC countries

However it is important to note that the above price assumptions represent only baseline approximations and not forecasts.

Equally important is it to note that it is generally a challenge making accurate forecasts or predictions of oil and gas prices simply because of its volatile nature.

Finally, the world economy has not come out of the recession and that makes it really more challenging to predict since the prices of oil and gas played a major role in the recession just as the financial crisis.

But that is not to say predictions cannot be made. The problem is how reliable they are likely to be and to what extend they can be relied upon for decision making and financial planning.

In making a forecast for 2014 it is important to note that the factors to include are short run factors.

The United States shale boom is anything to go by, in 2014 there would be increase in oil production coming from that region. Currently production which stands at about 6.4 million barrels is projected to rise to 7.9 million barrels a day in 2014

This trend in output will in the long run cause prices to drop as supply will exceed demand as the price gets narrow in 2014 for the same reason. Between demand and supply a balance is crucial to crude prices. Stocks tell how supply is balanced with demand.

Also Production from non-OPEC countries and unconventional sources are increasing. Willingness of OPEC countries to produce more within their capacities which is politically determined is envisaged.

After considering the above factors and a few more factors, I forecast that crude oil output will shoot up further in the year 2014 compared to the year 2013. There is likely to be a gap between demand and supply leading to a fall in the price of oil and gas.

Five from year 2013 leads us to the year 2018 which is still short term and the forecast is likely to remain the same because of the same factors as above.

Low expectation from oil and gas producing countries of Algeria, Indonesia and Iraq and Moderate expectation from producing countries like Iran, Nigeria, Venezuela, Kuwait and Libya. More so, high expectation from countries producing oil and gas including Angola, Qatar, Saudi Arabia and The United Arab Emirates testify to this fact. With the above expectations supply will exceed demand in the short run and this will either keep prices stable or decrease.

In 2028 which is fifteen years from now the dynamics in the price of oil and gas are not expected to remain the same.

This is because it is considered a long run. This brings to its wake spatial difference between demand and supply as well as oil reserves

Now depending on the following a forecast can be made;

Depending on the level of investment in the oil and gas chain

Capability of domestic finance or attracting foreign capital or a combination by various governments.

Institutional performance of various economies

Stability of the oil and gas framework

Internal stability

External relations in as geopolitics

Supply is likely to decrease causing a short fall and a gab due to the following

Reduced crude oil production

Concerns over stated oil reserves

Control over supply of crude oil and gas

Price of oil and gas

Timing of peak oil in various oil producing countries

Possible recession in the global economy

Oil fields discovery timing

Other opportunities in undiscovered oil fields, new technologies helping to challenging problems leading dominant supplies to very steady ones, new approaches heavily reliant on resource and technologies that have not yet be advanced or even deployed, more production from the united states reducing its purchase of the commodity outside its borders and the increasing consumption of china and India cannot be overlooked in this forecast.

Prices are more likely to increase as a result of all the above factors barring any major changes in the economic conditions in the world and industrial players. As to whether OPEC can regain its muscle to be able to cause a shortage in supply in order that its member countries can enjoy higher prices and Major consumers can use their reserves to overcome this bid time will tell. If alternative energy sources will be discovered as close substitutes and more environmentally friendly energy sources made use of to reduce the dependency on oil and gas, it remains a political decision and with time these would play out.