Discuss whether demand or supply determinants would be more important in determining whether a fall in the price of crude oil will be persistent.

Question 1b

b. Discuss whether demand or supply determinants would be more important in determining whether a fall in the price of crude oil will be persistent. [15]


Essay Breakdown

Key terms: More important, fall in price, persistent

Factors: Any 2 likely demand factors and any 2 likely supply factors that may cause a fall in price of crude oil.

Markets Involved: Crude oil, related goods and final goods.

Concepts Required: Demand & Supply: Factors, Single and Simultaneous Shifts, Price Elasticity of Demand, Income Elasticity of Demand and Cross Elasticity of Demand

 

Introduction

Demand refers to the degree to which a consumer is willing and able to purchase a specific good or service, ceteris paribus. Supply refers to the ability and willingness of a producer to sell goods and services at various price levels, ceteris paribus.

Demand factors affecting the price of crude oil would be the weak global economy, availability of close and cheaper substitutes to oil and the preference for environmentally friendly energy sources. Supply factors would constitute a deliberate rise in the supply of crude oil and technological advancements.


Demand factors:

 Weak global economy

1.      Incomes around the world are stagnant or falling -> Lower Demand for Goods and Service.

·       Oil (important factor input in production for most goods & services) -> Lower Demand

·       Unlikely to be a persistent factor as global economy seems to be picking up in 2017

 

Availability of close and cheaper substitutes to crude oil

1.      For example, the increasing viability of shale & other renewable energy sources such as solar power

·       Cheaper substitutes like shale gas

·       Substitutes are goods in which can be considered replacements or alternative choices of each other.

·       Technological advancements have made it cheaper to produce shale gas -> Lower Prices of shale gas -> Lower Demand for crude

·       Close substitutes -> more than proportionate fall in Demand

·       Likely to be a persistent factor, with increased take-up rate for such alternatives, increasing economies of scale will continually lower costs

 

Preference for environmentally friendly energy sources

1.      Changing tastes and preferences, exercising corporate social responsibility

·       Environmentally friendly sources of energy e.g. biofuel

·       Higher Demand of biofuel -> Lower Demand for crude oil

·       Likely to be a persistent factor as countries and corporations are moving towards that direction


Supply factors

 Deliberate action by the OPEC

1.      Higher Supply -> Lower Prices

·       Form of predatory pricing – drive competitors that produce substitutes e.g. shale gas

         i.     However, shale gas has thrived – efficient drilling technologies -> oil thus must be competitively priced

·       Not likely to be a persistent factor, in fact, (RWA)prices have already started to go up in 2017


Technology advancements                                                           

1.      Lower cost of production -> Higher Supply

·       Likely to be a persistent factor, as technological advancements are likely to improve


Figure 3c: Market for Crude Oil

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Combined effects

Combined effects of supply factors and demand factors – increase in supply and fall in demand     

With reference to figure 3c, which shows the market for crude oil,

·       Supply curve shifts from SS0 to SS1

·       Demand curve shifts from DD0 to DD1

·       Prices of crude oil fall from P0 to P1


Conclusion

It is challenging to decide on whether the fall in crude oil prices will be persistent considering so many factors are at play.

 

(RWA) However, the demand factors seem to be more entrenched in nature, with a shift in tastes and preferences for environmentally friendly energy unlikely to change, and the prices of alternatives to crude oil like shale gas are likely to remain low.

 Supply factors such as the OPEC action to increase supply is hard to predict, while OPEC will want to keep oil prices low at least for the immediate to mid-term to fend off shale gas, it may be hard to continue to do so for a prolonged period of time.

 A global economic recovery can however spark an increase in demand for crude oil, hence a fall in price may not be persistent at all. 

 

Comments

The price of crude oil will only be claimed to be persistent if the essay seeks to disregard the possibility of the mentioned point of a global economic recovery.