Oil Industry: Profitable Yet Volatile Global Market - Essay Sample

Introduction

The oil industry is considered to be one of the most profitable sectors due to the extensive consumption of its refined commodities. Most countries in the Middle East rely on oil production as the bedrock of their economies, with nations such as Qatar, United Arab Emirates, Kuwait, and Saudi Arabia being in the frontline. As oil products are widely used across the globe as vital energy, there exists a steady vast and growing market for raw power. However, the global oil market and international prices are complicated as it is dependent on a multitude of factors. As a result, the majority of global factors impact the oil industry that eventually affects the economic systems within the industry. This paper explores different global factors and how they affect the economics within the oil industry.

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The Organization of Petroleum Exporting Countries (OPEC) is considered amongst the monopolistic organizations that determine the supply and price of oil in the industry. Made up of thirteen nations, the OPEC constitutes a total of 40 percent of oil production consumed by the entire world (Aastveit, Bjornland, & Thorsrud, 2014). The organization exercises its power by drafting systems and policies that govern the consumption of oil products across the globe. The oil industry hence operates on mercies of OPEC to increase or decrease the production of oil depending on their convenience. Eventually, prices of crude oil are affected depending on demand and supply market forces. Colgan (2014) deems the OPEC as cartel set forth by powerful oil production counties to aid in political advantages to its associates. The scholar further argues that being a member of the OPEC arrives with international recognition by other powerful countries and states (Colgan, 2014). Furthermore, members of OPEC have additional gains support from world financial institution such as IMF and WTO, due to the position the organization hold in controlling the industry. All these factors prove beyond doubt that the future of the oil industry is somehow at the hands of the organization.

The ability of OPEC to control demand and supply forces always puts the organization in a position to dictate the industry. Even though there exists 60% of oil production constituted by other countries, OPEC has a strategic advantage of extensive production reserves that fellow competitors do not enjoy (Colgan, 2014). As a result, the organization maintains an inventory in the global oil stores that dictates the supply and demand of crude oil. In cases the production exceeds demand, the excess is stored in the reserves. On the other hand, when the demand exceeds supply than inventories in the store have to be tapped. Therefore, OPEC is always in a position to control the oil produced by the world, especially when other groups tend to produce less.

Variation in the oil inventories affects the stability of demand and supply forces and consequently, the prices of oil commodities. Cashin, Mohaddes, Raissi, and Raissi (2014) suggest that speculation in demand shocks are root factors that contribute to differences in oil inventories. Research indicates that speculative demand shock provides 27% of oil shocks, while the explanatory power constitutes 15% of the effect (Fang & You, 2014). Additionally, the variation of oil inventories is viewed as a measure that reflects speculative trading within the industry. As a result, in studying the behavior and evolution of oil prices, various decompositions in oil prices become useful. Additionally, Cashin et al. (2014) argue that speculative demand shock was the main factor that resulted in the surge of oil prices in 2003. From 2007 to 2008, risky demand shock caused variations in the oil prices only that this time it led to a significant increase. Scholars argue that the sharp rise in prices was a result of a massive influx of financial investors in the oil market (Aastveit et al. 2014). As a result, inventory demand significantly rose up, which eventually results in the growth of oil industry prices.

Differential shocks in the supply, demand, and oil prices tend to affect the crude oil industry further. Furthermore, shortages in supply result in a high order that subsequently increases the costs of crude oil in the industry. A growing literature indicates that a fast-growing demand accompanied by a projected fall in production in the coming few years will affect the prices of oil in the industry (Kilian & Murphy, 2013). As critics and experts bring the concept of depletion of oil resources that do not match the growing demand for oil, the economics in the oil industry is subject to turmoil. Fang and You (2014) argue that recently grown demand from economic giants such as China and India has brought about unexpected demand that results in an oil-supply disturbance. The growing trend in oil prices is an indicator of a fast-growing market that does not match supply whatsoever. However, often short term increases are only subject to temporary supply fluctuation. The instability in demand and supply eventually affect economic indicators such as inflation, interest rates, price inequity, and real output.

In conclusion, the economic system in the oil business is subject to several global factors that affect the industry. The essay explored OPEC as amongst the critical factors that affect the demand, supply, and eventually, the prices of oil in the industry. Additionally, it is through global factors such as variation in oil inventories, deferential demand shocks, and supply and demand forces that affect the oil industry. Considerations such as restrictions and systems imposed by the OPEC plays a crucial role in determining the progress and future of the oil industry. As some factors such as inflation, equity rates, production output, and interest rates affect the economic systems of major industrialized and developed countries, the oil industry traverses across such economic indicators. Therefore, in having a promising future for the oil industry, leaving it at the hands of a monopolistic organization may not be the best idea.

References

Aastveit, K. A., Bjornland, H. C., & Thorsrud, L. A. (2014). What Drives Oil Prices? Emerging Versus Developed Economies. Journal of Applied Econometrics, 30(7), 1013-1028. doi:10.1002/jae.2406

Cashin, P., Mohaddes, K., Raissi, M., & Raissi, M. (2014). The differential effects of oil demand and supply shocks on the global economy. Energy Economics, 44, 113-134. doi:10.1016/j.eneco.2014.03.014

Colgan, J. D. (2014). The Emperor Has No Clothes: The Limits of OPEC in the Global Oil Market. International Organization, 68(3), 599-632. Doi: 10.1017/s0020818313000489

Fang, C., & You, S. (2014). The impact of oil price shocks on the large emerging countries' stock prices: Evidence from China, India, and Russia. International Review of Economics & Finance, 29, 330-338. doi:10.1016/j.iref.2013.06.005

Kilian, L., & Murphy, D. P. (2013). The role of inventories and speculative trading in the global market for crude oil. Journal of Applied Econometrics, 29(3), 454-478. doi:10.1002/jae.2322