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Oil and world Economy

Oil and world Economy Question: Examine the oil industry in relation to the world economy, utilising any economic theory / theories you think appropriate. One of the most important energy resources since human invested the machine is oil and its products. But as all resources scarce, oil is limited even more. Only few countries in the world have oil fields and produce oil for the rest. Therefore, in nowadays where factories, cars and oil-fired central heating increased significantly, oil has become a necessity for the society. People’s demands for oil and its products, fuel, gas and oil for central heating is unlimited, but supplier countries produce a fixed number of barrels of oil everyday so as to maintain a technical shortage and, of course, higher profits. These few countries are the oligopoly of the industry, have a market leader and there are barriers to the entry of new countries (Sloman 1997 : p.124). These countries are dominating the market of oil and created the Organization of Petroleum Exporting Countries (OPEC) in 1960’s. OPEC is an intergovernmental organisation that offers stability and prosperity to the petroleum market. Membership is open to any country which is a great net exporter and which shares the same ideas of this organisation. OPEC has now 11 members and supplies more than the 40% of the worlds oil market. The price of oil over the last year has increased approximately over 100%, reaching the highest levels over the last decade. Consequently all oil products : fuel , oil for central heating and gas become more expensive. Furthermore transportation expenses increased and several imported products became more expensive, for consumers as well. Inflation rises too, affecting the economy of the whole world and the income of the households. This large increase in the price of oil estimated to decrease the demand of all its products but mostly of the oil for central heating. In Greece, for example, truck drivers, fishermen and farmers protested for fuel prices, asking for subsidies from the government. The Greek government decreases every winter the tax of oil for central heating, to help households, but this year the price of oil is doubled comparing to last years price. OPEC at the beginning, denied to increase production, in order to cover the exceed demand, but finally increased production as much as the cartel’s price adjusted mechanism allowed. As this did not help, Greek government gave subsidies for central heating to the low income households. Although the subsidy given, this could not help much as journalists estimate. Then again a crisis in Middle East, between Israel and Palestine gave a new bust to the oil prices once again. United States and European countries trying to stop this oil crisis by using the oil stocks into the market but that didn’t help, either. According to Sloman at al (1997: p.p. 124-127), OPEC is probably one of the best-known cartels. A formal collusive agreement that has one purpose, to maximize industry’s profits. The interdependence of those countries make them to collude with each other and make them act as a monopoly. That way they avoid price and advertising competition which would have made the prices to fall and therefore make them lose profit. Every country produces a certain quota according to their total production or market share. The market leader country is Saudi Arabia which has the highest production of oil in the world. The cartel though, throughout the years could have invested in new technology to find new ways of oil refining so as to be more efficient and perhaps more profitable, has done nothing to achieve that. That would have led to lower prices for consumers and yet even more profits for these countries as demand would have increased. The price of oil is then determined by the cartel and affects not only consumers but the economies all over the world. Over the last years, the price of oil jumped over 100%. This rise in price of oil did not decrease consumption too much, because oil has no close substitute. So the rise in price resulted in only a slight fall in the quantity demanded. People continue to drive their cars, but some of them switched to smaller ones or use more often public transportation than before, trying to adjust their income to the situation arose. For the most people this rise will make a little difference to how much they will use their cars (Sloman, 1997: p.42). Furthermore the oil for central heating became more expensive as well, and because people, especially during the winter, need central heating, they either use it less or use air-conditioning, as electricity eventually became cheaper! Then again this concerns only few people, thus reduction of oil consumption is not so large. This can be explained through the price elasticity of demand for oil which is relatively inelastic. So what can we do to stop being depended from this cartel ? The history has shown in the previous oil crisis, that development of energy saving technology, taxes and new fuel efficient cars or maybe new oil fields may decrease consumption and make oil more elastic so as to lead prices down. Another hope is that the countries that are members of the cartel, will start to cheat each other and offer more than the agreed quota so as to break this collusion. Certainly the solution so as the price of oil together with the economies all over the world to be stable, is to find a close substitute to it or –better more- a new source of energy supply! Bibliography:

Word Count: 926