Oil Prices - Parliament of the United Kingdom

4
1 Why did prices increase by so much in 2007 and 2008?
There are numerous reasons given for the especially rapid price increases since the second
half of 2007. Unlike the more general rise in prices since 2002 they tend not to be based
around single major events such as the invasion of Iraq, the subsequent insurgency or
Hurricane Katrina. Demand had continued to growth throughout the period of rising prices.
This growth is primarily from rapidly industrialising countries such as China and India. The
global credit crunch drew investors and speculators away from poor performing equities and
into the commodities market which further boosted oil and many food prices.
Oil supply is tight and OPEC quotas are frequently singled out as a cause of higher prices.
There have been frequent disruptions to supply over this period due to the political and
security situation in Iraq, attacks on pipelines in Nigeria and the Venezuelan Government’s
dispute with Exxon Mobil. Tensions around the Iranian nuclear programme led to an
anticipation of future supply disruptions and again increased prices. Concerns about the
actual level of oil reserves expressed by the International Energy Agency had the same
effect as have various strikes and other short-term ‘outages’ in oil supply. Many of these
‘lesser’ impacts on supply would ordinarily have a relatively small effect, but combined with
the tight supply situation and an increasingly febrile market their effect is magnified. Finally
the weak US Dollar increases the purchasing power of non-dollar consumers as it makes
dollar assets such as oil relatively cheap. With much of the increase in demand coming from
such consumers the dollar price of oil is further inflated.
1
Why did prices fall by so much in the second half of 2008? Initially some of the factors
mentioned above changed OECD demand is down and is expected to fall further, OPEC
supply initially increased in summer and the US Dollar has been much stronger. In addition
there were no major outages from US Gulf hurricanes in the early part of the season.
2
The
unfolding financial crisis initially led to an increase in oil prices to above $100 a barrel as the
equity markets fell. But as it deepened and a world economic downturn looked more likely
the expectation was of lower oil demand in the future, earlier speculation went into reverse
and the fall in prices continued.
Prices have recovered markedly since their February 2009 lows of less than $40 a barrel.
The various factors behind this increase include cuts in OPEC quotas, stronger global
financial and equity markets and an expectation of strong demand for petrol in the summer.
However, the International Energy Agency (IEA) has stated that:
3
The link between a decelerating economic downturn and a recovery in oil demand
appears to remain tenuous, given current overwhelmingly weak supply and demand
fundamentals.
The biggest movement in prices over the last year was the sharp drop seen in May 2010
when prices fell from above $80 to below $70 per barrel in less than a fortnight. According to
the IEA the Eurozone debt crisis precipitated this sharp drop.
4
Prices have gradually
recovered since then.
Some of the implications of higher oil prices are discussed in the standard note The
Economic Impact of High Oil Prices
1
More on the price of oil ESDS International 23 June 2008; Oil Market Report, various months, IEA
2
Oil Market Report August 2008, IEA
3
Oil Market Report May 2009, IEA
4
Oil Market Report June 2010, IEA
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