Sunday, 13 July 2014

Basic economics: oil markets and expected price changes



OPEC supplies were virtually unchanged in June at 30.03 million barrels per day (mb/d), as lower Iraqi production offset gains in Saudi Arabia, Iran, Nigeria and  Angola. The ‘call’ on OPEC for 2H14 was cut by 350 000 barrels per day (350 kb/d) to 30.6 mb/d  on improved non‐OPEC supply and lower demand, and is forecast to dip to 29.8 mb/d in 2015 from 29.9 mb/d in 2014. 
Non‐OPEC supply is forecast to grow by 1.2 mb/d in 2015, down slightly on 2013 and 2014 forecast levels. Global supplies were largely unchanged  month‐on‐month  in  June,  at  92.6 mb/d,  but  995 kb/d  higher than a year ago. Annual non‐OPEC output growth of 1.7 mb/d  more than offset OPEC declines of 765 kb/d.
Global oil demand growth is forecast to accelerate to 1.4 mb/d in 2015 from 1.2 mb/d in 2014, as macroeconomic conditions improve.  The  estimate  of  2014  demand  has  been  trimmed  by  130 kb/d  to  92.7 mb/d following weaker‐than‐expected mid‐year economic data. 


The International Energy Agency monitors, amongst other things, oil supply and also projects changes in demand. In the article, overall supply of oil in the OPEC nations has not changed from the previous month at 30.03 mb/d although it notes that there was a relative shift in production from Iraq to Iran, Nigeria, Angola, and Saudi Arabia.

OPEC stands for the Organisation of the Petroleum Exporting Countries and consists of Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuala. OPEC played a prominent role in the 1973 oil price hikes that caused the “Oil Crisis” tipping many countries into recession during the mid to late 1970s.

Non-OPEC supplies are set to increase to 1.2 mb/d into 2015. These include Brazil, the US, Azerbaijan, Kazakhstan, China, Canada, Colombia, Norway, the UK, and Mexico.

Demand for oil is expected to increase from 1.4 bn per annum to 1.5 bn per annum, although the increase is less than initially expected due to reduced economic growth expectations.


Oil is renowned for its price inelasticity both in demand and in supply. Modern society is heavily dependent on its use for a range of uses from petro-chemicals through to fuels. When drawing the demand and supply curves, the inelasticity should be reflected in the steepness of the schedules:

As oil demand is expected to increase, we will expect the demand curve to shift to the right from 2014 to 2015. Likewise, we will expect the oil supply curve to shift to the right as non-Opec production is set to increase.


The overall effect on oil prices over the coming year are difficult to predict. From basic theory, we know that both oil demand and supply are relatively price inelastic, so a shift in the demand for oil, say, will have a more than proportionate effect on the price. The same is true for a shift in supply – which helps to explain why oil prices can rise so swiftly when OPEC withholds supplies to the world market.

When both demand and supply are increasing, the overall effect on price will be less predictable than if only one aspect changes – this is because the two effects are countering each other: as demand increases, prices will rise; but as supply increases, prices will tend to fall.


While the overall effects of simple moves in supply and demand are hard to predict, the influence of other issues create further problems analyzing the oil markets – particularly political issues.  The OPEC nations attempt to act as a cartel so that they in effect act together to control the greater proportion of the world’s oil supplies. Concerted action on their part can have a huge impact on oil prices. Similarly, if one or more of the nations is engaged in warfare or undergoing a political upheaval – as is currently (summer 2014) happening in Iraq with the advance of ISIS rebels – then oil production may also be hit. Non-OPEC nations may also contribute to price instability, as recent events (2014) in the Ukraine with Russian intervention and annexation of the Crimea show.

Some analysts believe that the oil industry is heavily influenced by national – political – interests. These interfere with the workings of the market and thereby create unnecessary price distortions. Indubitably, energy production and consumption is heavily politicized with governments taxing, licensing, and controlling oil production and consumption as well as channeling funds and subsidies into complementary energy forms such as wind turbines.

The resulting fluctuations in price are exaggerated by the characteristic price inelasticities but these are not as random as some may fear. Markets are very adept at reducing the risks involved in trading and price fluctuations by engaging in futures contracts (agreeing on a price now for a supply later) and options (agreeing on a right to buy or sell at certain future date), but they would certainly be a lot calmer should there be less state intervention.

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