REUTERS/Eli Hartman/File Photo
Oil prices rose by more than $1 a barrel on Tuesday after a deal to resume exports from Iraq’s Kurdistan stalled, pacifying some investor concerns that the restart would exacerbate worries about global oversupply. Brent crude futures were up $1.06, or 1.59 per cent, to $67.63 a barrel by 12:46 p.m. EDT (1646 GMT), while U.S. West Texas Intermediate crude rose $1.15, or 1.85 per cent, to $63.43 a barrel, both benchmarks recouping modest earlier losses……Continue reading….
By: Reuters
Source: CNA
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Critics:
Oil prices are determined by global forces of supply and demand, according to the classical economic model of price determination in microeconomics. The demand for oil is highly dependent on global macroeconomic conditions. According to the International Energy Agency, high oil prices generally have a large negative impact on global economic growth.
In 1974, in response to the previous year’s oil crisis, the RAND Corporation presented a new economic model of the global oil market that included four sectors—”crude production, transportation, refining, and consumption of products”—analyzed separately for six regions: the United States, Canada, Latin America, Europe, the Middle East and Africa, and Asia.
The study listed exogenous variables that can affect the price of oil: “regional supply and demand equations, the technology of refining, and government policy variables”. Based on these exogenous variables, their proposed economic model would be able to determine the “levels of consumption, production, and price for each commodity in each region, the pattern of world trade flows, and the refinery capital structure and output in each region”.
A system dynamics economic model of oil price determination “integrates various factors affecting” the dynamics of the price of oil, according to a 1992 European Journal of Operational Research article. Killian stated that, by 2008, there was “widespread recognition” that “oil prices since 1973 must be considered endogenous with respect to global macroeconomic conditions.
Kilian added that these “standard theoretical models of the transmission of oil price shocks that maintain that everything else remains fixed, as the real price of imported crude oil increases, are misleading and must be replaced by models that allow for the endogenous determination of the price of oil.” Killian found that there was “no evidence that the 1973–1974 and 2002–2003 oil supply shocks had a substantial impact on real growth in any G7 country, whereas the 1978–1979, 1980, and 1990–1991 shocks contributed to lower growth in at least some G7 countries.
A 2019 Bank of Canada (BOC) report, described the usefulness of a structural vector autoregressive (SVAR) model for conditional forecasts of global GDP growth and oil consumption in relation to four types of oil shocks. The structural vector autoregressive model was proposed by the American econometrician and macroeconomist Christopher A. Sims in 1982 as an alternative statistical framework model for macroeconomists. According to the BOC report—using the SVAR model—”oil supply shocks were the dominant force during the 2014–15 oil price decline”.
By 2016, despite improved understanding of oil markets, predicting oil price fluctuations remained a challenge for economists, according to a 2016 article in the Journal of Economic Perspectives, which was based on an extensive review of academic literature by economists on “all major oil price fluctuations between 1973 and 2014”. A 2016 article in the Oxford Institute for Energy Studies describes how analysts offered differing views on why the price of oil had decreased 55% from “June 2014 to January 2015” following “four years of relative stability at around US$105 per barrel”.
A 2015 World Bank report said that the low prices “likely marks the end of the commodity supercycle that began in the early 2000s” and they expected prices to “remain low for a considerable period of time”. Goldman Sachs, for example, has called this structural shift, the “New Oil Order”—created by the U.S. shale revolution. Goldman Sachs said that this structural shift was “reshaping global energy markets and bringing with it a new era of volatility” by “impacting markets, economies, industries and companies worldwide” and will keep the price of oil lower for a prolonged period.
Others say that this cycle is like previous cycles and that prices will rise again. A 2020 Energy Economics article confirmed that the “supply and demand of global crude oil and the financial market” continued to be the major factors that affected the global price of oil. The researchers using a new Bayesian structural time series model, found that shale oil production continued to increase its impact on oil price but it remained “relatively small”.
In North America the benchmark price refers to the spot price of West Texas Intermediate (WTI), also known as Texas Light Sweet, a type of crude oil used as a benchmark in oil pricing and the underlying commodity of New York Mercantile Exchange’s oil futures contracts. WTI is a light crude oil, lighter than Brent Crude oil. It contains about 0.24% sulfur, rating it a sweet crude, sweeter than Brent. Its properties and production site make it ideal for being refined in the United States, mostly in the Midwest and Gulf Coast regions.
WTI has an API gravity of around 39.6 (specific gravity approx. 0.827) per barrel (159 liters) of either WTI/light crude as traded on the New York Mercantile Exchange (NYMEX) for delivery at Cushing, Oklahoma. Cushing, Oklahoma, a major oil supply hub connecting oil suppliers to the Gulf Coast, has become the most significant trading hub for crude oil in North America.
In Europe and some other parts of the world, the price of the oil benchmark is Brent Crude as traded on the Intercontinental Exchange (ICE, into which the International Petroleum Exchange has been incorporated) for delivery at Sullom Voe. Brent oil is produced in coastal waters (North Sea) of UK and Norway. The total consumption of crude oil in UK and Norway is more than the oil production in these countries.
So Brent crude market is very opaque with very low oil trade physically. Brent price is used widely to fix the prices of crude oil, LPG, LNG, natural gas, etc. trade globally including Middle East crude oils. There is a differential in the price of a barrel of oil based on its grade—determined by factors such as its specific gravity or API gravity and its sulfur content—and its location—for example, its proximity to tidewater and refineries.
Heavier, sour crude oils lacking in tidewater access—such as Western Canadian Select—are less expensive than lighter, sweeter oil—such as WTI. The Energy Information Administration (EIA) uses the imported refiner acquisition cost, the weighted average cost of all oil imported into the US, as its “world oil price”. The rising oil prices could negatively impact the world economy. One example of the negative impact on the world economy, is the effect on the supply and demand.
High Oil prices indirectly increase the cost of producing many products thus causing increased prices to the consumer. Since supplies of petroleum and natural gas are essential to modern agriculture techniques, a fall in global oil supplies could cause spiking food prices in the coming decades. One reason for the increase in food prices in 2007–08 may be the increase in oil prices during the same period.
Bloomberg warned that the world economy, which was already experiencing an inflationary “shock”, would worsen with oil priced at $100 in February 2022 The International Monetary Fund (IMF) described how a combination of the “soaring” price of commodities, imbalances in supply and demand, followed by pressures related to the Russian invasion of Ukraine, resulted in monetary policies being tightened by central banks, as some inflation in some countries broke 40-year-old record highs.
The IMF also cautioned that there was a potential for social unrest in poorer nations as the price of food and fuel increases. A major rise or decline in oil price can have both economic and political impacts. The decline on oil price during 1985–1986 is considered to have contributed to the fall of the Soviet Union. Low oil prices could alleviate some of the negative effects associated with the resource curse, such as authoritarian rule and gender inequality.
Lower oil prices could however also lead to domestic turmoil and diversionary war. The reduction in food prices that follows lower oil prices could have positive impacts on violence globally. Research shows that declining oil prices make oil-rich states less bellicose. Low oil prices could also make oil-rich states engage more in international cooperation, as they become more dependent on foreign investments.
The influence of the United States reportedly increases as oil prices decline, at least judging by the fact that “both oil importers and exporters vote more often with the United States in the United Nations General Assembly” during oil slumps. The macroeconomics impact on lower oil prices is lower inflation. A lower inflation rate is good for the consumers. This means that the general price of a basket of goods would increase at a bare minimum on a year to year basis.
Consumer can benefit as they would have a better purchasing power, which may improve real gdp. However, in recent countries like Japan, the decrease in oil prices may cause deflation and it shows that consumers are not willing to spend even though the prices of goods are decreasing yearly, which indirectly increases the real debt burden. Declining oil prices may boost consumer oriented stocks but may hurt oil-based stocks. It is estimated that 17–18% of S&P would decline with declining oil prices.
It has also been argued that the collapse in oil prices in 2015 should be very beneficial for developed western economies, who are generally oil importers and aren’t over exposed to declining demand from China. In the Asia-Pacific region, exports and economic growth were at significant risk across economies reliant on commodity exports as an engine of growth.
The most vulnerable economies were those with a high dependence on fuel and mineral exports to China, such as: Korea DPR, Mongolia and Turkmenistan—where primary commodity exports account for 59–99% of total exports and more than 50% of total exports are destined to China. The decline in China’s demand for commodities also adversely affected the growth of exports and GDP of large commodity-exporting economies such as Australia (minerals) and the Russian Federation (fuel).
On the other hand, lower commodity prices led to an improvement in the trade balance—through lower the cost of raw materials and fuels—across commodity importing economies, particularly Cambodia, Kyrgyzstan, Nepal and other remote island nations (Kiribati, Maldives, Micronesia (F.S), Samoa, Tonga, and Tuvalu) which are highly dependent on fuel and agricultural imports.
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