Question

Price of oil in international markets has dropped stunningly 60% in the past twelve months. Among the factors mentioned behind this drastic fall is the millions of barrels of oil produced in the US called shale oil.

Look at the supply and demand picture for this commodity and try to analyze its price action. Which is the impact of price elasticity of supply and demand in the short and long term?

Hi I have no pic this is the question that the professor gave me... there is any change to response with no image? I have no background in economics.

Answer 1

Oil prices have seen a drastic decline all over the globe in the past 12 months. The average oil prices were around $64/barrel in 2018 and it has fallen to almost $35/barrel today. With lockdown procedures enacted across the globe, the effect of lowering of oil prices have seen an upsurge. There are many reasons for the fall in the oil prices of which the global variations of demand is the major factor. It causes the production levels to change accordingly and causes the variation in the pricing mechanism. Natural calamities, political turmoil etc affects the demand for oil across the globe. It was in 2010-2012 that the oil prices rose to a very large level across the globe. It was at this juncture that US resorted to researches in the shale oil and began to increase its production rates, since it can be a potential substitute to the crude oil that is being produced at the global level. The production of shale oil has caused the total production level in the US to rise from 8.8 million barrels per day in 2014 to 12.2 million barrels per day in 2019. It is estimated that in 2019, US produced about 2.81 billion barrels amounting to 7.7 million barrel per day of shale oil which contributed to more than 60% of the total oil production of America. Today, US produces about 80% of the world’s shale oil. With rising demand for oil across the globe, alternatives like shale oil would have many impacts on the oil market.

Price elasticity measures the reactivity of a marketplace to changes in price for a given product. The Price elasticity of demand is a reflection of the consumer behaviour whereas the Price elasticity of supply measures the producer behaviour. The following may be analysed as the supply and demand effects of increased shale oil production of the US and the impact of price elasticity of supply and demand in the short and long run

· With increased shale oil production, US has been able to meet 60% of its domestic needs all by itself and it has played a considerable role in reducing the dependence of US on global oil market.

· Oil market is generally elastic which means that the demand across the globe and the prices would have a direct relationship. But with increased shale oil production in the US and utilising it more for domestic consumption would mean that the oil prices in the US market is slowly becoming inelastic considering the global oil market.

· Thus, in the short run, the US market has an added advantage of having most of the world’s shale oil reserves.

· The volatility of the oil prices arises from the less availability of conventional oil and the sudden varying demands across the globe. With the development of similar unconventional sources, the elasticity would decline in the short run.

· In the long run, the oil market is expected to become inelastic due to rise in the supply of shale oil and thus would help in stabilising the global oil market.