Zi Ling

Essay 1
ECON 209 Money Banking

Impacts of Recent Oil Price Rising

Crude oil price is so important that it is closely related to the whole commodity
market. In the past few weeks, because of the wide spread protests in North Africa
and the Middle East, crude oil price has gone up dramatically, hitting over $100 per
barrel. Amid the turmoil in Libya now, the production of oil is expected to be further
down. The high oil price in recent days is a negative sign for the global economy
recovery, which is just revived from the 2008-9 economy recession. Thus, it is
worthwhile to discussing the high oil price on global economy and what we might
expect if the oil price keeps going up.

Oil price has advanced for a few days in New York because of the output cut down in
Libya, which also spreads to Oman that the production in Middle East is expected to
be disturbed more. The crude flow in Libya is estimated to be cut almost two-thirds.
Libya was pumping 1.6 million barrels of oil a day before the unrest, which is the
ninth-largest producer among the 12 members of the organization of Petroleum
Exporting Countries. Most of its oil is shipped to Europe. Now, it is believed that the
output of oil in Libya has been cut by more than 1 million barrels a day, or at least
850,000 barrels according to Barclays Capital.

According to the report from New York Times, in electronic trading on the New York
Mercantile Exchange, crude increased as much as $2.08, or 2.1 percent for April
delivery, which is $99.96 a barrel. The contract increased 60 cents, or 0.6 percent, to
$97.88 on Feb. 25. Prices rose 14 percent last week. Oil rose to $103.41 a barrel on
Feb. According to data from Bloomberg, the spread between New York futures
and London’s Brent April contract narrowed to $13.66 a barrel from $19.54 on Feb.
21.

Now, the whole region is amid the concerns from spectators that the instability would
be continuing and fear is among the market. Obviously, the unrest among the North
Africa and Middle East is inflamed by the turning down of Tunisia’s president and the
regime falling of Egyptian president Hosni Mubarak. Now Oman is also affected,
which produces 800,000 barrels of oil a day.
Adam Sieminski at Deutsche Bank says oil prices are affected by two factors, current
conditions and future expectations. The oil price is believed that has not been pushed
up by supply disruptions. The falling of Mr. Mubarak and the uprising in Libya, Iran,
Yemen, Algeria and Bahrain has caused the oil price to go up by more than twenty
percent in the last week. The expectation of the market remains to be a shortfall of oil
supply and the future is not clear because of the turmoil in the region right now.
People are passive about the market which also contributes to a higher oil price.

If the supply of crude oil from Libya is still falling down, countries especially
European countries, which are the main importers of Libya, would look to Saudi
Arabia to make up the shortage of oil supply. Looking from the supply and demand
relationship, if the supply curve is shifted right and the demand curve remains the
same level, the new equilibrium point of oil supply and demand will result in a higher
oil price and lower oil consumption.

However, OPEC has already claimed that it has 6 million barrels per day on tap for
the shortfall, which is trying to prevent the supply curve shifting to the left too much.
That would be enough to make up for Libyan gap. But, from the view of long term, it
would accelerate the diminishing of spare production capacity along with the rapidly
growing world demand, especially from developing countries like China, Brazil and
India. The fear of unrest in Saudi Arabia itself is also among spectators. The uprising
in Bahrain which is connected with Saudi has made the concern livelier. The
expectation of instability of oil supply also disturbed the oil market, contributing as a
factor of high oil price.

The world has built stockpiles in some countries. U.S. has stored 727 million barrels
of crude oil as strategic petroleum reserve, which is going to be used in the event of
sudden supply shortfalls from Middle East and elsewhere. China also has its own
strategic reserve. The reason why countries like U.S. and China are reserving oil is
that these countries’ economies rely too much on oil. And right now, there’s no other
proper energy substitute for oil. The effect of sudden up and down on oil price would
be magnified on the country’s economy performance. The reserve of oil is being used
as a cushion to buffer the effect of decreasing oil supply in short term.

The impact of the recent oil crisis would depend on two factors, how much oil
production would be cut and how long it would last. The situation before and after
Iran revolution in 1970s is a typical example. After the revolution, Iran cut down the
oil supply to western countries, which is a long term effect to the world. There are
also expectations about the new regimes emerging from Egypt and Tunisia, probably
Libya as well, whether they would be more hostile to westerners. So now, in the oil
market, uncertainty is enormous and it partially reflects on the recent rise of oil price.

The world is thirsty for oil. The balance between oil demand and supply is so delicate
that it’s easily fluctuated with current conditions. The expectation of oil demand in
future is growing continuously because of large oil consumption in Asian countries,
while the supply is not expected to be growing as much as the demand grows in the
following years. Therefore, the room for disruptions in supplies, like the unrest in
North Africa and Middle East is little. Even though OPEC members claim to commit
to produce “in a pinch” about five million barrels a day which is six percent of the oil
that the world consumes every day, the cushion is still seen as worryingly thin. And it
has not taken into account the one million barrels loss from Libya.

Some experts hold the opinion that it is not the falling regimes in Egypt and Tunisia
brought the oil price to $100 per barrel, it is the fear that uprising might spread to
other OPEC members like Saudi Arabia which is the main exporter of oil. Again, the
people’s expectation and uncertainty about the current situation make a larger
contribution to the rising of crude oil price.

The global economy is recovering right now. The major stock markets around the
world have stepped out from the economy recession gradually. The demand for oil is
going to rise by about 2 percent in 2011 predicted by market spectators. And the oil
price would be around $120 to $150 because money would be back into the
commodity markets. However, the current situation in the region has caused the main
stock index down heavily.

Economists now worry that sudden rise of oil price would hurt the economy too much
as it is about to begin to recover. It is reported that gas price in U.S. now is averaged
at $3.28 per gallon, up from $3.11 a month ago. It is not a positive signal to the
market as investors are just about to have confidence back. If the price keeps growing,
consumers would hold tight to their budget, which is also not good to a recovering
economy.

Overall, the recent rise of oil price has a big impact on the global economy. The main
factors contribute to the rise can be summarized as two. One is the actual short supply
from countries trapped in the unrest, like Egypt, Tunisia, Libya and some Middle East
countries. The other one is the expectations of potential risk of uprising in Saudi
Arabia which is a main exporter of oil to the world. The uncertainty and instability in
the market right now has caused the main stock markets a big loss in a trading day
last week. Moreover, it is also harmful to the recovery of the global economy. The
principle of supply and demand curve is helpful to analysis the oil market.

References:
CHRISTINE HAUSER, Feb. 4 2011, Wall Street Wanders as Oil Prices Ease, New York
Times.http://www.nytimes.com/2011/02/25/business/global/25markets.html?scp=9&sq=oil%
20price%20impact&st=cse

Ben Sharples, Feb 27, 2011, Oil Rises for Second Day as Middle East Turmoil Spreads to
Oman, Bloomberg. http://www.bloomberg.com/news/2011-02-28/oil-extends-gains-amid-
concern-disruption-to-middle-east-output-may-spread.html

Finance and Economics, Feb 24th 2011, Oil pressure rising, The world is badly placed to
cope with another oil crisis, The Economist, http://www.economist.com/node/18233452/print

FLOYD NORRIS, February 25, 2011, Two Directions for the Prices of Natural Gas and Oil,
New York Times,
http://www.nytimes.com/2011/02/26/business/global/26charts.html?scp=1&sq=oil%20price
%20impact&st=cse

Laurence Knigh, 24 February 2011, Oil price: Should we fear the latest rises? BBC
http://www.bbc.co.uk/news/business-12566016