The market for oil
Crude oil has been refined to make fuels,
like petrol and diesel, lubricants, and industrial chemicals since the
1850s. Industrialisation owes its development to oil, and today, the
world's two largest companies -
Exxon Mobil, and
PetroChina - are oil
refiners and distributors. Oil is an essential scarce
resource, and there are still no cost effective alternatives to
oil for producing vehicle fuels like petrol and diesel. World sales of
oil in 2008 were $1,600 billion.
(Sources: Oil Daily, 2008, US
Congressional Research Service, 2009. FT.Com, 2009.)
The demand for oil
The demand for oil has a number of important characteristics.
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Demand is increasing in the advanced, OECD economies, which make up approximately 66% of total world demand. Between 1980 and 2008, world demand increased by 40%, from 60m barrels per day to over 85m barrels. (Source: US Energy Information Administration – EIA, 2009.)
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The demand for oil is relatively inelastic with respect to price, given that oil has few direct substitutes.
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Similarly, demand for oil is relatively inelastic with respect to income in the advanced, OECD economies. However, income elasticity of demand in developing economies like China and India is likely to be higher, with estimates suggesting that YED is close to 1.
World's major oil importers
The supply of oil
The supply of oil has two important characteristics:
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Oil is a non-renewable resource, and oil reserves are finite and must eventually be exhausted.
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Oil production is dominated by OPEC (the Organisation of Petroleum Exporting Countries), who jointly produce around 75% of global output.
OPEC was formed in 1960 and is dominated by Saudi Arabia and five other Middle Eastern producers. The original five members were Saudi Arabia, Iran, Iraq, Kuwait and Venezuela. OPEC has its headquarters in Vienna, Austria, and meets twice a year to agree a common policy. Each member of OPEC is allocated a production quota, based on the relative size of their oil reserves, and the current market conditions.
OPEC and oil quotas
The supply of oil is highly susceptible to supply shocks that disrupt production, such as the Gulf War of 1991. These shocks can make the oil market highly unstable at times, with volatile prices and unpredictable revenues for oil producing countries.
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Increasing oil quotas To help stabilise prices, OPEC regulates output through a quota system. OPEC is a cartel, whose power depends on controlling oil production. If the price of oil is rising too fast, quotas will be increased, and if the price is falling too fast quotas will be reduced. However, cheating by members may limit the effectiveness of OPEC. |
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World oil reserves
According to industry experts, the world has approximately 1.2 trillion barrels of proven oil reserves. Experts estimate that, at the current rate of consumption, and with no more discoveries of reserves, these proven reserves will be exhausted in approximately 40 years.
The world’s four biggest oil producers are Saudi Arabia, Iran, Iraq and Kuwait. (Source BP, 2006.)
US strategic oil reserves
The US Strategic Petroleum Reserve (SPR) is the world’s largest stock of state owned oil. It was established in 1977 as a response to the reduction in supplies from the Middle East going to the USA. The stockpile of crude oil, held in caves and surface facilities in the Gulf of Mexico, acts as an emergency stock that can be used in the event of disrupted global supplies. The current maximum capacity is assumed to be 727 million barrels, and by 2008 capacity was nearly reached as stocks rose to their highest recorded level, at 707 million barrels.
(Source: US Department of Energy, 2008 – link (www.fossil.energy.gov/programs/reserves/)
Recent petrol prices
Petrol prices in the UK and around the world rose consistently between 2002 and 2008. In 2006 it went through the psychological £1-per-litre mark, and by early 2008, prices had risen to over £1.30 per litre. However, prices fell back to £0.90 following the global slowdown in 2009, but rose again to over £1.30p, as world demand increased.
Rising petrol prices reflect increases in crude oil prices. The main factors contributing to the general rise in crude oil prices over recent years are:
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Rising world demand, especially from China
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Cost shocks, such as the War in Iraq and hurricane Katrina (2005)
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The effects of the recession However, during 2008 the price of a barrel of oil fell back from its record high. This was the result of the downturn in world demand for oil, especially from China, as the global recession began to spread. |
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Oil prices and petrol pump prices
An increase or decrease in crude oil prices may not affect prices at the petrol pumps. There are a few reasons for this:
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There may already be existing stocks of petrol at the old prices.
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The cost of refined petroleum represents only around 22% of the retail price of petrol. (Source: UK Petrol Industry Association, 2009)
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In many countries, the retail market has become increasingly competitive in recent years. This is certainly true in the UK, with the entry of the large supermarket chains, such as Tesco and Sainsbury, into petrol retailing in the early 1990s.
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Supermarkets may subsidise the cost of petrol from profits on their other products, hence reducing the retail price.
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Contracts between buyers such as British Petroleum, and sellers such as Venezuelan producers, are often agreed a minimum of three months in advance. These agreements are called futures contracts, or futures for short.
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Around 55% of the price of petrol and diesel at the pumps is government petrol duty and VAT.
(Source: wwwpetrolprices.com)