Explain some of the economic reasons behind the recent rise in global oil prices?

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The Rise in Global Oil Prices

a) Explain some of the economic reasons behind the recent rise in global oil prices?

        The price of oil, being one of the most crucial and demanded commodities in the world, fluctuates significantly not only due to excessive aggregate demand but also to sustained increase in costs. In short, if the global demand for crude oil is increasing and the supplies of the international markets cannot keep up, inflation will result. The effect on the price however is emphasised by the fact that both the demand and supply of oil is price inelastic.

        In recent months the cyclical demand for oil has increased noticeably following a strong recovery in global GDP growth because oil is a major input into many industries, for example the production of kerosene for cooking and heating. Up and coming market economies like China have had a seriously influential role in the rapid increase in demand. As shown in this diagram, China’s energy-intensive sectors are using approximately 6 million barrels of crude oil a day and account for over 7% of world demand. It is this growth of the Chinese economy that is responsible for a third of the increase in global oil demand in 2003.

        On the supply-side of the economy, The Organization of Petroleum Exporting Countries (OPEC) currently provides about 40% of the worlds oil supply, hence have a pivotal role in moving the price of oil. In April earlier this year, OPEC made a decision to limit their production levels, decreasing the supply yet this increases the price elasticity of supply (although still very inelastic), meaning that changes in global demand will not have such a volatile affect on the price. However this is only a very small point, because as can be seen in the graph below, OPEC producers are very close to their short run production limits, i.e. have little spare capacity.

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        However, one of the most recent reasons for a surge in oil prices is ‘market speculation’ i.e. purchasers buying now believing in a future rise in the price on world markets. Due to oil stocks being low and the panic about future supplies given the political turbulence in the Middle East, speculators are buying up any available stocks and in doing so driving up the price even higher. The major oil consumers are very keen to secure their supply and are buying forward contracts, hoping that by the time the contracts are fulfilled a significant profit will have been ...

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