By Krutika Kshirsagar
The obscurity in forecasting of oil prices is primarily because of high sensitivity of the prices to shocks with respect to global demand and supply dynamics. Four decades ago, historic interruptions to global oil supplies destabilized the world economy for over more than a decade. When the oil producing countries of the Middle East nationalized their oil industries and formed the OPEC cartel, they effected the steep recession of the mid-1970s. And when Iran’s oil supplies were disrupted by the overthrow of the Shah of Iran by Muslim clerics in 1979, a new surge in oil prices led to a second round of even deeper recessions. The price of oil fluctuated acutely between $15 and $35 a barrel, which indicated a steep decline in the real price of oil. The rapid development of China, India and Brazil has resulted in an increase in the world GDP grand oil demand which has thus pushed the oil prices from $25 to $125 a barrel between 2001 and early 2008. The Great Recession brought oil prices to below $50 in 2009. However, oil prices have more or less stabilized themselves at around $ 100 since 2011. The supply side dynamics too need to be considered. The development of technologies for getting oil and gas out of oil shale has reversed a long decline in North American oil production. Hydro-fracking technology has proven to be a one to reckon with in times of despair. Shale oil has been hailed as a move to energy independence for the region and a major step in reducing the US trade deficit. The development of shale oil has already raised North American production by nearly 5 million barrels a day, which is over 5 percent of today’s total global demand. Had shale oil not come along, oil prices would be much higher today. The success of any market depends on the liquidity of the benchmark instruments. Successful markets need standardized trading instruments in order to generate liquidity and improve price transparency, and oil is no exception. But, since oil is an inherently non-standard commodity, the industry has chosen a small number of “reference” or “marker” grades of crude oil and refined products to provide the physical basis for a much larger “paper” market which trades derivative instruments such as forward and futures contracts. Any commodity being traded is governed by a string of factors from the physical and the financial markets. The factors from the physical market that imminently determine the game of prices, requirements, etc include demand and supply transactions. And the ones in the financial markets consist of the OTC trades or exchange traded options and arbitrage opportunities. This financial picture came into existence in 2000s when hedge funds started pumping in large amounts of money and oil was being treated as another asset which is a source of profit. These investments beefed up the oil prices that were managed by fundamentals armed by the ones beyond demand and supply. These new set of contemporary participants who traded in oil derivatives were responsible for driving the prices during the 2007-08 period of economic turmoil. Relatively high inventories and ample surplus production capacity served to limit the oil price fluctuations in the 1990s. The futures that required delivery in the distant months traded at about $20 per barrel while the spot prices moved up and down. Whenever a price gets circulated in the market it is commonplace knowledge that the price is essentially
consistent with a market sentiment that the producers of crude oil shall ensure the return of spot prices to that level. However, the tables turned as the OPEC members tightened their inventory policy and the global demand recovered from the slowing effect of Asia’s economic crisis. Thus, the global market balance became uptight and the inventories declined piercingly. This led to what was supposed to become the beginning of a start of the rise of oil prices at full tilt. In the long run, the future of oil prices will depend on the race between burgeoning demand in the emerging economies and growing supplies from shale oil deposits around the world. Political change, like the recent decision to replace the state oil monopoly in Mexico with private industry does bear an implication. Considering the shorter picture, decampment from the long-run movement are vulnerable to political changes in unstable parts of the world. The oil embargo on shipments from Iran into the world market has led to plummeting oil production from Iran. If the new government in Teheran improves relations with the US, the lifting of the embargo would restore that production. On the other hand, in Iraq, where oil production has been expanding, experts fear that a civil war could erupt. A surmise at every step, no fool’s paradise this!
Krutika Kshirisagar: After completing B.Tech from Institute of Chemical Technology (UDCT), I’m currently pursuing MBA in Energy and Infrastructure from School of Petroleum Management, PDPU. I have been working as a co-ordinator of CII-Young Indian for the last one year. My strengths are good analytical ability, proficiency in public speaking, good writing, oratory and communication skills, zest and determination to explore new ideas and working in unison with various groups as a group member as well as a leader.
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