Demand and Supply - Oil

Question 1

The Price of Oil is Very Important for an Economy

Answer 1

1. Oil is used in the production of a huge variety of goods and it’s used extensively for transportation. E.g. many goods are made from, or packaged in, plastic and distributed using modes of transport that consume oil.
2. An increase in the price of oil can result in inflation as the price of many goods increases. Recent improvements in energy efficiency and a reduction, in some countries, in heavy industry are helping to reduce the impact of changes in oil prices on the price of goods.
3. Oil prices flucuate widely, with rapid increases and decreases over time.
4. Demand for oil is price inelastic. It’s such an important and widely used resource that a change in the price causes a realtively small change in the quantity demanded.
5. The supply of oil is also price inelastic. This is partly because it’s difficult to increase the supply of oil in the short term - the exploration of new oil and production from new wells takes time. Also, although oil can be stockpiled, producers don’t want to supply lots to the market and cause prices to decrease too much.

Question 2

Lots of factors affect the demand for oil

Answer 2

1. When the global economy is booming the demand for oil increases, but demand falls during a world recession. This is because oil is used in most economic activity, so its demand increases during booms and decreases during recessions.
2. Speculators can affect the demand for oil because they buy and sell oil in the hope of making a profit from fluctuations in its price.
3. The value of the US dollar can affect the demand for oil. This is important because oil is priced in US dollars - if the value of the dollar is low then more oil can be purchased by speculators holding other currencies.
4. If the demand for products made from crude oil increases then derived demand for oil increases
5. The attractiveness of buying oil substitutes, e.g. biofuel, impacts demand for oil. As substitutes to oil become cheaper, more reliable and more readily avaliable, this has a negative impact on demand for oil.
6. Weather conditions in major oil using countries can affect oil demand. E.g. in cold conditions more oil is needed for heating.
7. As living standards improve then the demand for oil increases - this can be linked to an increased consumption of goods and services. Many of these goods and services will use oil in their manufacture and delivery. E.g. ppl with a high income can afford to own a large house and several cars - this involves higher oil consumption than ppl with small houses who don’t own a car.

Question 3

There are several factors affecting the Supply of Oil in the short run

Answer 3

1. Supply-side shocks, such as a war in a major oil producing country, can lead to a disruption of oil supplies. This would cause a contraction in the supply of oil as shown in the DIAGRAM ON PAGE 34
2. This price increase will increase costs to firms where oil is an important factor of production. These firms might increase prices to maintain their profits and this could have a knock-on effect on demand (it would decrease)>
3. The Organisation of Petroleum Exporting Countries (OPEC) also has a major influence on the world supply of oil. This means that it can exert significant control over the price of oil.
4. OPEC members can agree to cut oil production levels (reduce supply), which causes oil prices to increase. Alternatively they can increase production levels to cause oil prices to decrease.

Question 4

Different factors affect the supply of oil in the long run

Answer 4

1. The size of remaining oil reserves - the bigger the remaining oil reserves, the higher the supply of oil will be in the long run. The estimates of the size of world oil reserves vary.
2. The cost of extracting oil from reserves - some reserves are too expensive to extract oil from at the moment, but if demand and oil prices increase then it might become worth extracting this harder to reach oil. Also an increase in price and demand could cause an increase in the exploration for new oil reserves.
3. The efficiency and cost of technology used in exploiting and refining the oil - the cheaper and more efficient the technology, the lower the cost of oil due to the increased level of supply.

Question 5

Examples of changes to Demand and Supply of Oil:

1. A large increase in the demand for oil

Answer 5

1. The growth of emerging economies is driving an increased global demand for oil.
2. This increase in demand can be shown on a diagram.
   - The increase in demand shifts the demand curve to the right
   - The increase in demand can lead to an increase in supply
3. Oil producers might restrict the use of reserves to keep the price high.
4. The signalling effect of the price increase can encourage an increase in production
5. There will be a delay before this additional supply is avaliable on the market.
6. Demand for oil in the short run is price inelastic - so this, with the inelastic supply curve, will lead to a large increase in price.
   * LOOK AT GRAPH HERE*

Question 6

Examples of changes to Demand and Supply of Oil:

2. An expansion of fracking for oil

Answer 6

1. An increase in the scale of fracking activities could lead to a large increase in the supply of oil
2. This increase in supply can be shown on a diagram.
   - The increase in supply shifts the supply curve to the right. This increases output and causes the price to fall.
   - The inelasticities of supply and demand would lead to a larger reduction in price than the increase in quantity.
3. However, shale oil is not a direct substitute for crude oil, so the increase in its avaliability may not have a major effect on global oil prices.
   * LOOK AT DIAGRAM ON PAGE 35*