Question

Extract 1 Oil price changes

“The oil price drop since June 2014 was due to supply and demand factors. USA oil production doubled between 2009 and 2015. Countries such as Algeria, Saudi Arabia and Nigeria used to export oil to the USA but now the USA produces more than enough oil to meet its own needs. Furthermore, in 2014 OPEC producers decided not to reduce production and as a consequence by August 2015 the oil price decreased 40%.

Oil is a non-renewable resource and reserves of oil are finite. However, oil producing countries are massively extracting oil. Investment in renewable resources and in new solar and wind power capacity is being cut as subsidising these activities has become a burden to governments.

Currently, the demand for petrol and diesel is decreasing. Part of the reason for this decrease is the weak economic growth in much of Europe and also in developing countries, causing real incomes to grow slowly. Furthermore, new cars and new trucks are becoming more energy efficient with lower requirement for diesel and petrol.

New cars now burn less fuel causing less air pollution. This contributes to reduce the pressure on healthcare. For example, those with respiratory diseases are less likely to need treatment. Nevertheless, many people in developing countries drive old cars that are less fuel efficient. Also, increased numbers of drivers may offset the gains in fuel efficiency.”

1. Consider the factors that have contributed to the change of oil price according to Extract 1, and explain how they have affected the demand and supply of oil, and the final impact on oil price. No need of drawing graphs.

Answer 1

Ans-1) Factors that contribute to the oil price changes -:

1. Increase in Oil Production by U.S. (This has increased the supply of oil).
2. The joint decision of OPEC of not reducing the oil production (It also increased the supply of oil , thereby pushing the price down)
3. Slow Economic growth and fall in real income. (This has decreased the demand for oil) .
4. Improvement in fuel efficiency of the vehicles . (This efficiency improvement has enabled the drivers to experience a longer mileage by cars , thereby decreasing the demand of the oil).

All these factors i.e. increasing supply in relation to decreasing demand has pushed down the prices of oil to very low levels. Thus , the final impact is a constant decrease in oil prices.

However, this gain in fuel efficiency will probably be balanced by the drivers driving old and inefficient cars (especially in developing countries) which might pull the oil prices in future.