Key Drivers of Oil Price Changes in the Past Paper Example

Introduction

Oil prices are not static. In the past two decades, the global market has witnessed fluctuations in oil prices. For instance, between 2003 and 2008, there were increased oil prices while between 2014 and 2016, the price of oil dropped. The rise and fall of oil prices have been attributed to different factors. First, the increased cost of fuel that took place between 2003 and 2008 can be attributed to a surge in global oil demand. According to Aastveit, Bjornland, and Thorsrud (2015), the price of oil increased in the period 2003-2008, due to increased demand from emerging economies which thus made the cheap unconventional oil fields profitable. Aastveit et al. (2015) used the factor-augmented vector autoregressive model (FAVAR) that identifies shocks from diverse world regions to explore the role played by a surge in demand from emerging and developed economies on prices of oil. The findings of the FAVAR model showed that there was elevated demand from emerging Asian economies in period 2003-2008. The demand in these economies, which led to increased oil production and price, was found to be more than two-fold compared to the demand from developing countries. The increase in demand from the new markets had differential impacts of global prices across the world, with Europe and North America reporting the higher oil price than Asian and South American countries.

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In a related study, Knut, Hilde, and Thorsrud (2012) noted that even though increased oil demand was associated with a surge in price in both the developed and emerging countries, normalized-emerging country demand shock was associated with a 20% increase in oil prices in emerging countries as compared to a 10% increase for the developed-country demand shock. Secondly, increased oil prices have been linked to oil supply and oil-specific demand shocks. More specifically, a 1% increase in oil production was associated with a 5-10% increase in oil price. However, it was noted that despite decreased oil production, some of the oil consuming countries did not experience rapid response in oil price. The delayed increase in oil prices in these countries were attributed to accumulated oil inventories that they the countries used during periods of decreased oil production.

Thirdly, increased oil price have been linked to expectations about oil supply shortfalls. This phenomenon is referred to as precautionary oil-specific demand and has been reported to lead to a sharp hike in the price of oil.

Fourth, fluctuations in oil prices have been technological advances in the United States shale industry (Covert, 2015). According to Martiningrum (2016), improved technologies for oil exploration has led to lowered costs of production. These technologies have also enabled oil explorers to reach previously hard to reach oil deposits. Some few years ago, many observers predicted that there would be a shortage of oil globally. This shortage did not happen in part because of the increased production of shale oil in the United States. The shale oil is produced with the help of advanced drilling technology which is comprised of both horizontal drilling and fracking of underground rocks having crude oil deposits found inside the rock. Horizontal drilling and fracking make it possible to obtain crude oil that would have been difficult to extract using conventional drilling techniques used to extract oil from permeable rocks. The use of this technology led to an increase in shale oil production in the US from approximately 0.4 million barrels on a daily basis in 2007 to over 4 million barrels per day in 2014. Increased production of US shale oil has been linked to the rapid decline in the global price of crude oil in 2014 thus showing that the rising production of shale oil has an impact on oil price. It is worth noting that even though shale oil is not for the export market, it is a substitute for US crude oil imports, thus decreasing the demand for crude oil in the world market (World Economic Forum, 2015).

2014-2016 Decrease in Oil Prices and Effect on Global Economy

Decreased oil prices between 2014 and 2016 were expected to lead to global growth windfalls. Global estimates of the impact of the plunge in oil prices done in mid-2014 showed that decreased cost of crude oil would be accompanied by a 0.8% increase in global GDP over the medium term. At that time, the projected rise in GDP was attributed to coming from transferred income and wealth from countries that export oil to countries that import oil, where there is a higher propensity to spend. And although decreased oil prices were expected to result in reduced investment in the oil industry, it was anticipated the plunge in investment would be counterbalanced by reduced energy costs for consumers and sectors which consume a lot of energy such as agricultural, manufacturing, and transport sectors. Instead of leading to increased GDP, plunge in oil price slowed down global economic growth.

According to the World Bank, the global economic growth averaged 2.8% between in 2014 and 2015. However, at the peak of decreased oil price (2016), global economic growth declined to 2.4%. In 2016, slowed economic growth was attributed to weakened world trade, reduced capital flows to emerging market and developing economies (EMDEs), and a general decline in the prices of goods and services.

When examining the impact of the recent global decline in crude oil price, it is essential to determine whether or not it affected oil-exporting countries. According to the World Bank, the 2014-2016 drop in oil price had a broad and long-lasting impact on the economies of all oil exporters. Most of the EMDE oil exporters registered slowed economic growth in 2015 and 2016, with 70% of them facing a collapse in investment and consumption. In most of the EMDE exporting countries, there was deteriorated terms of trade which negatively affected investment growth. According to the World Bank (2017a), investment growth is strongly influenced by worsened terms of trade leading to decreased total factor productivity growth and weakened capital deepening.

Another important economic impact of oil price plunge is depletion of oil revenues. According to Medas, Salins, and Danforth (2016), exhaustion of oil revenues led to a sudden cut in government expenditure that led to slowed private sector activity in the affected countries. Decreased government spending was more pronounced in oil-exporting nations which recently experienced reduced oil price at a time they were having increased private sector debt and weakened fiscal positions compared to previous episodes of oil price decline. It is also crucial to note that the impact of the plunge in oil price was further made worst by idiosyncratic factors such as political conflicts in Northern Africa countries and the Middle East as well as the sanctions imposed on Russia. In small countries like Sudan and Chad, the effects of price shock were worsened by conflicts and insecurity. These factors were associated with a rapid rise in public debt and depletion of oil reserves.

It is, however, important to point out that even though decreased oil price negatively affected the economies of oil exporting countries, those with diversified economy recovered more quickly from a plunge in oil price compared to those with under-diversified economies. Examples of these countries include Qatar, Malaysia, Ghana, and Bahrain. Similarly, oil exporting countries with floating exchange rate regimes recovered faster from decreased oil prices compared to those with non-diversified economies. Examples of these countries include Russia and Albania. According to Grigoli, Herman, and Swiston (2017), greater resilience was also manifested by countries with larger foreign reserves and those which have proved to be less volatile to inflation in the past.

Even though economists expected that oil importers would have increased economic activities following decreased prices of oil, it has been established that the fall in prices of oil did not result in increased economic growth in oil importer countries. Instead, these countries registered decreased economic activities in 2015 and 2016. Most of the oil importer countries which did not economically benefit from reduced oil prices are EMDEs, except the US which also showed declined economic activities during the same period. Jo (2014) noted that decreased economic activities were associated with uncertainty linked to an unexpected decrease in oil prices.

The Prospects for the Oil Industry and Resource Rich Economies Going Forward

Following the 2014-2015 global fall in oil prices, oil prices rose again in 2017. With the fluctuations in oil prices happening from time to time, it is essential to examine the future of the oil industry and those of oil-rich countries going forward. According to Fellows (n.d.), oil-related businesses are cyclical. That is, prices shoot up when there are higher supplies compare to the demands, become stable for some few years, then plunge as more supply sources are discovered, and demand reduces. To examine the prospects for the oil industry and resource-rich economies, Norway will be used as an example. Norway's first oil findings can be traced back to 1969. Since then, the oil industry has become one of the most critical sectors of the country's economy with about 25% contribution to Norway's GDP as well as approximately 50% of the country's exports.

In Norway, oil price is a crucial determinant for investments. There is a strong correlation between oil production or exploration activities related to oil and investments in this country. At the Norwegian continental shelf (NCS), oil and gas production levels are currently are at the highest levels in history. Also, it is now estimated that 48% of the oil and gas deposits in Norway have been produced and sold and that production and sales will be at their high for the next 50 years. As shown in Figure 1 below, Norway's oil production has followed a cyclical pattern of rapid increase in oil production, followed by stabilized oil production, and a gradual decrease in production.

In a study conducted to examine the factors affecting future oil and gas prospects in the Arctic regions, such as Norway, Harsem, Eide, and Heen (2011) investigated the anticipated development in the region's oil industry by examining how both environmental and geographic factors, as well as the political and economic factors, would affect the oil prospects. Findings of this study showed that climate change would bring forth opportunities in challenges in the oil industry in arctic regions. Because of the predicted ice-free summers, which are likely to occur by 2040, the drilling seasons will become longer. Additionally, the predicted increase in hurricanes and polar storms will result in longer drilling seasons. Also, it is projected that the key driving forces of the oil industry in the future will include the state of the global economy, government regulations, oil prices, and climate change.

The outlook of the Norwegian economy is projected to be headed for turmoils in the future. According to Olsen (2015), Norway will soon leave behind the past 15 years of economic growth which were characterized by the country's ability to make use of favourable tailwinds and seize the opportunities offered. The predicted difficulties in the Norwegian economy are associated with the fact that the country's economy has become too much dependent on oil. Consequently, the country is becoming more vulnerable to changes in oil prices and oil revenues. That is, a global fall in oil prices will negatively affect the economy of the country. The high vulnerability of the Norwegian economy to fluctuati...