The rise and fall of

black gold:
Reasons and
Impact
1/9/2009

Submitted By:
Phalguni Aneja(4801)
Nipun Matreja(4814)
Devanshu Shivnani(4817)
Tejas Kapoor(4827)
Few commodities impact the world economy like the price of oil. Oil powers cars,
trucks, boats, airplanes, and even power plants that make up the backbone of
the global economy. Until 1970s, oil was like any other commodity, but with the
formation of OPEC and thereby, the emergence of a consolidated cartel which
exerted control over major portion of oil extraction and supply-crude oil was
suddenly thrust into the limelight. Crude oil soon became an influencing factor in
making and breaking economies and with the depression during 1973-74, it only
served to highlight the havoc that can be caused due to permutations and
combinations in oil demand-supply and corresponding prices. As oil prices rise,
costs go up for transportation companies, squeezing their profit margins and
forcing them to raise prices, similarly affecting all the other companies that rely
on them to transport products and people. By contrast, most energy companies
benefit from higher oil prices, either from higher revenues for oil, or because of
increased demand for substitute energy sources such as ethanol and natural
gas. These rising oil prices also have an impact on individuals as well in the form
of increasing transport costs and energy bills as seen from the latest diesel and
petrol hikes and spike in petroleum prices in India. Consequently, it directly
affects consumer spending as individuals will have less cash to spend on the
products and services offered by the various industries.

Thus it is evident that, contrary to the beliefs that crude oil prices affect only big
industries and conglomerates, the rippling effects of crude oil prices are far
reaching and can easily affect the lifestyles of the common man.

Therefore, with the oil prices showing the see-saw effect throughout the year
2008 and consequently leading to many upheavals in different sectors and
countries, it becomes imperative to analyse the whys and wherefores of the
phenomenon and what it implies for the glocalized world.

In our project, we will be discussing:

 The highs and lows of oil prices in 2008

 The reasons behind it
 The three-fold impact in the global, Asian and Indian context
 The role of OPEC
  The future prospects
 Solutions and conclusion

Dates Crude oil prices

July 14th, 2008 $147
July 30th, 2008 $127.10
August 13th, 2008 $113.77
September 15th, 2008 $97
October 13th, 2008 $81.19
November 18th, 2008 $54.50
December 10th, 2008 $43.25
January 3rd, 2009 $45.59

The above table gives a glimpse of the haywire movement exhibited by crude oil
prices in 2008, from rising to a record $147 and then tumbling down to about
$40 in the month of December.

Basically, two theories have been propounded that claim to explain the erratic
movement of oil prices during the year. The first, a favourite of Arab oil sheiks
and non-conformist financiers, holds that market speculators are to blame. It’s
been estimated that if the speculation in the financial markets is limited, the
price of crude oil would drop by $65 to $70. In this scenario, people were looking
for someone, anyone, to blame for a market that seemed to have turned ugly.

In contrast to this theory, are government officials and oil industry executives,
who say that prices are simply responding to economic fundamentals. With
reserves shrinking rapidly and consumption growing strongly, particularly in
developing countries like China and India, they say the market is indicating that
we need to economize on oil use and discover some new supplies. The
supporters of this view are of the opinion that making speculators the
scapegoats is shying away from the actual problem of searching for alternative
uses of energy, or limiting the use of existing sources and at the same time
searching for new ones. On the other hand, the sudden fall in prices is attributed
to the global recession, in simple terms-due to liquidity crunch, halt in expansion
plans of major industry players and the effect rippling down to the common man,
whose reduction in purchasing power led to diminishing demand for oil. The
bottom-line is that the outlook for supply and demand at this moment is
extremely varied and jumping from one extreme to another; many oil traders
don’t know what to think, which is the main reason that prices are so jittery.

Given that crude oil is a universal input used in the production of virtually
everything, it would be surprising if oil prices did not have a tangible effect on
consumer price index (CPI) inflation in different economies, especially a
developing Asia. For instance, transportation costs affects such large numbers of
firms and individuals that it is bound to affect the performance of the economy
as a whole. If producers cannot pass on their higher transportation costs to
consumers, they have to reduce the number of workers and their investments.
The higher unemployment rate and lower investment rate will have an adverse
impact on aggregate output in the short run. In addition, for a region as highly
dependent on imported oil as Asia, the escalation of oil prices on a consistent
basis represents a long-term deterioration of the terms of trade. This loss of
international purchasing power amounts to a loss of real aggregate income and
output. According to a study, the oil price volatility has a bigger impact on
inflation than growth in both the short run and the long run. Inflation has already
risen sharply throughout the Asian region such that regional inflation rose from
about 4% in 2007 to nearly 8% in 2008.

The forecast for oil prices in 2009 remain conservative, as the actual brunt of the
recession triggered off in 2008 is borne in 2009, and experts across the world
peg it to stay under $50.

Until the credit crunch saw global markets freeze, demand for oil had been
rocketing, mainly because of rapid development in countries such as India and
China. However, the financial crisis changed that. Demand plummeted in the
latter part of 2008. For instance, in the third quarter of 2008, US oil consumption
shrank by about 1m barrels per day (bpd) – or around 5pc.

World over, countries have put in place or are in the process of implementing
various fiscal policies, in a measure to curb the global recession tendencies and
pull out the economies of the financial distress. Depending on how well these
policies work, the demand for oil will gradually rise as production capacities start
to increase yet again and liquidity rises. As for the current year 2009, prices are
expected to remain subdued.