Oil is a commodity used in various industries and with numerous end uses, and its prices fluctuates due to supply and demand. Until 1973, petroleum had a lower price and the supply was higher than demand, after a cutback on its production, the price dramatically increased, and it became scarce since then. With a lower production and higher prices, industries that usually depend on oil, start to seek other alternatives for this resource, for example, use solar energy, or design smaller cars than use less fuel.
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Analysing the data from the past 20 years, demand and supply for oil has been progressively increasing. Transport and equipment industries are responsible for the demand and producing countries for the supply and also controls price. Even with technology moving forward and developing new petroleum substitutes, oil still necessary to major industries and short-term alternatives are rare.
Oil is used for an extensive range of goods and services, including, plastic products and clothing, also, for transportation, heating and industry. This resource is considered a scarce commodity due to its natural reserve. Even though technology is advancing, oil still one of the most important raw products in the world, and its availability is limited. The exploration is increasing, but scientists and the industry have not been able to discover more oil reserves, and the reserve amount is falling over time. If the demand keeps increasing, with no restrictions, in the long run, petroleum will be an issue, since the product is used in the majority of industries (Banks, 2001).
The price of oil was low before 1973, since there was enough supply compared to demand. After this year, the Organization of Petroleum Exporting Countries (OPEC) decreased petroleum supply, and the effect was a significantly increase in price.
Since oil is a non-renewable resource, when oil prices rise, the industry tries to use less of this product, and starts depending in other kinds of energy resources. For example, chemical companies switch to alternatives for oil input, smaller and more efficient cars are produced, and, the use of solar energy increases. With these changes, OPEC protects oil, while the world develops replacements to petroleum use.
Even when the oil price increased between 1973 and 1980, it decreased in middle 1990s; the reason why price fluctuates is that companies and customers had to change what to produce and to purchase and find alternatives to the use of oil. On the company side, the need to find other kind of energy, or create new chemical energy or even use more fuel-efficient aircraft are ways to solve this problem. As a customer, choose to drive less, or use cars that are more efficient and demand less oil, and even install better insulation in the households are some alternatives to solve this issue. Even though technology grows quickly, and oil substitutes are started being produced, petroleum still the main product from industries.
Part of the increased revenue from oil producers was used to produce goods in the industrialized Western nations. On the other side, some nations had to give up on its petroleum production to import it from another country. Which means that OPEC had the power of oil production and could estipulate the price at any time, and this affected the importation from other countries, such as Germany and Japan. After 1982, OPEC lost some power after the chemical industry created some petroleum substitutes which increased the demand for those oil supplies replacement.
The table below shows the demand and supply of oil and gas in the last 20 years according to OPEC (OPEC, 2017), as well as the price variation for the same period (Tim Mcmahon, 2017).
|Year||Total World Demand (mb/d)||Total Word Supply (mb/d)||Oil Price per Barrel (Nominal Price)||Oil Price per Barrel (Inflation Adjusted)|
Table 1-Oil World Demand and Supply
The above data is represented in the following chart:
Chart 1 – Oil World Demand and Supply Graphic
According to the data and charts above, the demand and supply of oil have been growing steadily for the past 20 years. The growth in demand is driven by the industrial development worldwide, while the supply is largely controlled by the producing countries, which therefore affect the price.
Looking back at Chart 1, between 2006 and 2008, a demand higher than the supply caused an increase in prices. On the other hand, between 2012 and 2016, a surplus drove down the prices.
Elasticity of oil demand between 1998 and 1999:
Nominal Price: ϵ=∆QAvg Q 100∆PAvg P 100 ∴ ϵ= 73,800,000–75,300,00074,550,00011.91–16.5614.235 ∴ ϵ=0.062
Inflation Adjusted: ϵ=∆QAvg Q 100∆PAvg P 100 ∴ ϵ= 73,800,000–75,300,00074,550,00017.89–24.8821.085 ∴ ϵ=0.061
Elasticity of oil demand between 2008 and 2009:
Nominal Price: ϵ=∆QAvg Q 100∆PAvg P 100 ∴ ϵ= 84,800,000–86,100,00085,450,00053.48–91.9872.73 ∴ ϵ=0.029
Inflation Adjusted: ϵ=∆QAvg Q 100∆PAvg P 100 ∴ ϵ= 84,800,000–86,100,00085,450,00060.91–103.6782.29 ∴ ϵ=0.029
Elasticity of oil demand between 2016 and 2017:
Nominal Price: ϵ=∆QAvg Q 100∆PAvg P 100 ∴ ϵ= 97,000,000–95,400,00096,200,00042.74–36.3439.54 ∴ ϵ=0.103
Inflation Adjusted: ϵ=∆QAvg Q 100∆PAvg P 100 ∴ ϵ= 97,000,000–95,400,00096,200,00042.63–37.0239.825 ∴ ϵ=0.118
Based on the calculations above, the demand for oil and gas is less then 1, that means an inelastic demand. Since petroleum products are a necessity which cannot be easily replaced by substitutes in a short term, the demand is not immediately affected by pricing fluctuation.
There are some substitutes for oil and gas nowadays, such as electricity, which is used to power up electrical vehicles, and biodiesel, which is made of vegetable oils, animal fats, or even recycled grease from restaurants. Biodiesel is safer and cleaner to burn (Armbrecht, 2015). Ethanol, solar power, and wind power are also considered substitutes. About 90% of the vehicles in the world run from oil-derived products (Petroleum.co.uk, 2015), although in 2017 alone, there was an increase of 54% in the market for electric vehicles (DiChristopher, 2018). There are many reasons why consumers would choose a substitute, such as environmental and financial perks.
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Despite the above-mentioned substitutes, it does not represent an immediate threat to oil products, due to its currently limited production. According to a recent report by Chevron Corp., oil and gas currently represent 54% of the world’s energy use, and even under the most pessimist scenario for oil producers, these fossil fuels will still account for 48% of the energy mix by 2040 (Crowley, 2018). However, there are some concern for the future as for oil and gas prices, inaccurate reserve estimates, inability to expand reserves and general economic concerns.
Despite being a scarce resource, petroleum is used in numerous industries. After a phase where oil was abundant and with low price, the production increased rapidly, and it became a scarce commodity. Over the last 20 years, oil reached a steady demand and supply, at a cost of a higher price.
Petroleum has an inelastic demand, which implies that its products are essential, and it does not have a short-term alternative, therefore price variation does not affect demand. The oscillation of prices and the uncertainty of production made industries develop solutions for the oil issue, such as electricity and biodiesel.
Regardless the substitutes, oil does not have a direct threat, even with a limited production. On long term, oil reserves and production might not be enough for the demand, and prices would increase, due to its non-renewable nature, then industries would be forced to seek for alternatives to petroleum.
- Armbrecht, A. (2015, Dec 1). 6 alternatives to petrol. Retrieved from World Economic Forum: https://www.weforum.org/agenda/2015/12/6-alternatives-to-petrol/
- Banks, F. E. (2001, June). OPEC Bulletin. Retrieved from OPEC: https://www.opec.org/opec_web/static_files_project/media/downloads/publications/OB062001.pdf
- Crowley, K. (2018, March 1). Chevron Says Climate Change Fallout No Quick Threat to Oil. Retrieved from Bloomberg: https://www.bloomberg.com/news/articles/2018-03-02/chevron-says-climate-change-fallout-no-quick-threat-to-oil-gas?fbclid=IwAR3T38WLR_sVOkyfrFpkLTIT2i6dmzj3BguK0tHLRfPdv0LiDD7pj_KxQR4
- DiChristopher, T. (2018, May 30). Electric vehicles will grow from 3 million to 125 million by 2030, International Energy Agency forecasts. Retrieved from CNBC: https://www.cnbc.com/2018/05/30/electric-vehicles-will-grow-from-3-million-to-125-million-by-2030-iea.html?fbclid=IwAR1wak4xhgRf3Virpz-bSDH-4kCjKoBtrJNqWhZSjwp6U5p9bKWStDprSY0
- OPEC. (2017). Annual Report 1998-2017. Retrieved from Organization of the Petroleum Exporting Countries: https://www.opec.org/opec_web/static_files_project/media/downloads/publications/AR%202017.pdf
- Petroleum.co.uk. (2015). Alternatives to Petroleum. Retrieved from Petroleum.co.uk: http://www.petroleum.co.uk/alternatives-to-petroleum
- Tim Mcmahon. (2017, August 27). Historical Crude Oil Prices . Retrieved from Inflation Data: https://inflationdata.com/Inflation/Inflation_Rate/Historical_Oil_Prices_Table.asp