Explain why oil prices have been rising. Use a diagram to illustrate your answer.
The main reasons for oil price increase are:
- Higher demand for oil caused by population growth and technological development, especially in the developing countries (e.g. China).
- Weather conditions, such a heavy snow falls or low temperatures, not only increase demand, but also result in more difficult delivery conditions, which causes an increase in oil prices.
- Increased fuel duties and the higher VAT rate
- Declining dollar encourages people to buy oil as an alternative investment.
- Political situation, mainly in the OPEC – 40% of oil production, because they can easily control the market and prices.
- Natural disasters (e.g. earthquake and tsunami in Japan)
How can the concepts of price elasticity of demand, income elasticity of demand and price elasticity of supply help to explain the magnitude of oil price movements?
PED (Price elasticity of demand) – Demand for oil is inelastic because there is no common substitute of this resource. If the price of oil goes up, people will still buy it.
YED (Income elasticity of demand) – Higher oil prices would affect people on a low-income. If the income falls people are more likely to buy less oil or to choose public transport.
PES (Price elasticity of supply) – The oil resources are limited (peak oil theory) and the lower is supply, the bigger is the price. However, the current oil prices are not cause by the shortage of this resource, but by the reasons mentioned above and speculations.
Examine what is likely to happen to oil prices over the coming months. What are likely to be the most important factors in determining the direction and size of the price movements? Distinguish between demand-side and supply-side effects in your answer.
Demand-side: The oil prices will depend on weather conditions. Many people will pre-buy oil to ‘be prepared for the cold winter’ and, consequently that will increase oil prices. It also will depend on current situation in the Eurozone, because oil often becomes a ‘safe investment’ in bad times.
Supply-side: Oil prices depend on OPEC forecasts, i.e the situation in the Middle East.
What are ‘crude futures’? Explain how actions in the futures market are likely affect spot prices.
Spot price - the current price at which a particular commodity can be bought or sold at a specified time and place (investopedia.com)
“Futures contracts are financial instruments and carry with them legally binding obligations. Buyer and seller have the obligation to take or make delivery of an underlying instrument at a specified settlement date in the future. ”
Excessive speculations have a significant impact on oil prices.
WATCH: Playing the oil prices money game
WATCH: Playing the oil prices money game
To what extent can OPEC control oil prices?
OPEC controls production levels (i.e. has a possibility to increase production to avoid a surge in oil prices or the other way around). Moreover it prepares demand forecasts, which are also very influential.
If crude oil prices go up by x%, would you expect petrol station prices to go up by approximately x%, or by more than or less than x%? Explain.
If crude oil prices go up by x%, I would expect petrol station prices to go up more than x%. Crude is the primary raw material used to produce gasoline and other petroleum products. If its price would go up the petrol station would rise more due to transportation costs and the cost of refining the oil into gasoline.
Why have central heating oil prices risen by around 70% of over the past three months? What are the implications of your answer for the type of market structure in which central heating oil companies are operating?
In the last months of 2010 oil prices have risen by around 70%, which was caused by the profiteering from the cold weather. Central heating oil companies increased their prices in the consequence of higher demand due to cold winter. They knew that people would still buy it to heat their homes. People with oil heating suffered from the lack of close substitutes and the oligopolistic oil market.
That's what I think,