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Oil is one of the most vital commodity in the current world, thus its price can never be stable. Unlike other agricultural and industrial products, whose supply can be adjusted to cater for increased demand, the scenario seems different when it comes to the oil production (Moors, 2011). Oil is a scarce resource and requires colossal sum of money to extract it. The lack of a perfect substitute for the commodity together with the time it takes to move it from the oilfield to the final consumer, invariably makes its supply and demand inelastic (Moors, 2011). The volatility of oil prices has increased basically, due the nature of the market, when the market was disintegrated, the individual producer maximizes its output as much as the reservoir to cover for the immense cost of production and initial capital outlay (Hopkins, 2011). Generally, the operating costs are usually lower than the capital costs, so that producers will continue to produce even when the streams of revenue are surpassed by the total cost. There with the market being competitive the prices in the oil industry will continue to fall to the extent that some producers are eliminated from the industry (Moors, 2011). This will consequently lead to the shortage which then pulls the prices upwards following the law of demand and supply.
How Changes in Supply and Demand Affect Oil Prices
It is apparent that demand and supply remain to be the most influential aspects of the behavior of oil in the market (Moors, 2011). According to Hopkins (2011), the increase in consumption of oil in the developing countries as well as the steady high demand, especially in the United States indicates that the demand will certainly not ease in the near future. As evident from the case, the International agency points out that the increase in oil demand is due to the rapid expansion in a number of countries especially China (Richard and Jason, 2005). It is clear that in 2003, the second largest consumer of the petroleum products after United States was China. Energy Information Administration denotes that China accounts for around 40 % of the total demand growth in the world for the past four years (Richard and Jason, 2005). In the next twenty years, it is estimated that the demand of oil in China will be doubled. In addition, India is also experiencing the increased oil demand with a steady growth of around 75 per cent in 15 years (Richard and Json, 2005).
On the other hand, the supply of oil has been greatly affected by the political unrest within the countries preventing a full production of oil (Richard and Jason, 2005). Examples of such countries include Venezuela and Iraq. In Iraq, for instance, the production of oil has been uncertain since the beginning of Iraq’s second war. Apparently, the most notable reasons are the sabotage of facilities as well as continued violence (Richard and Jason, 2005). According to the United States oil experts, some of the oil reserves in Iraq are so damaged that the recovery rates are lower than normal. In Venezuela the full capacity production was hindered by the December 2002 nationwide strike. It is reported that the strike led to a remarkable reduction of the gross domestic product and production of oil in the country (Richard and Jason, 2005).
The Two Largest Consumers of Petroleum Products
According to the case, the two largest consumers of petroleum products are the United States, which comes at the first place and China, which comes second (Richard and Jason, 2005). Energy Information Administration denotes that China accounts for around 40 % of the total demand growth in the world for the past four years. In addition, it consumes about 5.6 million barrels of oil daily. Besides, Energy Information Administration also predicts a more than double increase in demand over the next twenty years (Richard and Jason, 2005).
What Happens To the Price and Quantity of Oil When
The Price of SUVs Falls
Prices are always responsible for the shifts in the demand as well a supply curves (Hopkins, 2011). When the price of SUVs falls, it is evident that the demand of the SUVs will increase. Having an increase in the demand of SUVs, it will mean that the demand of oil will also increase. Studies indicate that the increased demand results to the increased prices (Hopkins, 2011). Therefore, it is evident that with the reduced prices of the SUVs, the oil prices will definitely go up, due to the increased demand for the commodity. On the other hand, the falling prices of the SUVs will have a significant impact on the quantity of oil supplied (Hopkins, 2011). More people will be noted to purchase the SUVs due to the reduced prices. The more purchhased vehicles will mean an increase in the demand of the oil. As a result, the barrels of oil sold per day will be higher than normal meaning that there will be an increase in the supply of oil. This therefore means that when the price of the SUVs falls, the quantity of the oil supplied will increase.
The Government Approves More Drilling In Alaska
In the event that the government approve more drilling in Alaska, it will mean that more oil is produced; hence the supply of oil will increase. An increase in supply means that the prices will go down. Therefore increased oil supply will result to a reduction in the prices of oil. A reduction in prices will lead to increased demand of the commodity. It is apparent that, when the prices of oil reduce, its demand will certainly be high. This therefore means that the quantities supplied will be higher than normal. Considering a product like gasoline, price control is the best policy, so that people pay less than the current price at the pump. This will ensure that such occurrences as those that took place during the 1973 oil embargo will reduce the industrial powers over the vital commodity hence oppressing the citizens. Evidently, the 1973 embargo caused a negative effect on the United States economy leading to the immediate demands to address the situation (EIA, 2000).
These effects include the rise of the retail price of gasoline from an average of about 38.5 cents to 55.1 cents from May 1973 to June 1974 (EIA, 2000). As a result, the citizens were requested by the state government not to have their Christmas lights on with Oregon banning Christmas and commercial banning as well (EIA, 2000). As a result of this, the politicians called for nationwide rationing program for the gas. Richard Nixon, who was the U.S. president at that time, urged the vendors not to sell gas on weekends. This led to large queues at the gas stations during the weekdays (EIA, 2000). Moreover, it resulted to such incidents as violence, due to the nationwide two-day strike by truck drivers in December 2003 as they opposed to the supplies Simon had rationed for their industry (EIA, 2000).
In conclusion, the prices of gasoline should be reduced to encourage the search of new reserve (EIA, 2000). This will ensure that the supply of the commodity is steady and such incidences as those of the 1973 oil crisis are not recurrent.
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