Oil Price Expectation and Volatility †Free Samples to Students

Question: Discuss about the Oil Price Expectation and Volatility. Answer: Introduction The Organization of Petroleum Exporting Countries (OPEC) is one of the biggest oil exporting nations. In September 1960, OPEC was created in Baghdad by its founding members: Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Currently, OPEC Membership group consist a total of 14 Member Countries: Algeria, Ecuador, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela. Main objectives of OPEC is to coordinate the petroleum policies of its members, and to provide member states with technical and economic aid. OPEC aims to manage the supply of oil in an effort to set the price of oil on the world market, in order to avoid fluctuations that might affect the economies of both producing and purchasing countries. The oil market sentiment and prices can be strongly affected by all the decisions made by OPEC and how they implement its deal and agreement with other members. OPEC agreement usually consist setting up different level of ceiling for individual members total production and distributed through a quota system. Production ceiling is being adjust and change from time to time based on the latest assessment of world oil market fundamental. However, all members are expected to comply and abide with the agreement once the ceiling is set. It is important for all members to comply with the agreement as the level of compliance can strongly influence the price of crude oil. Hypothetically, the higher level of compliance often resulted in higher crude oil price whereas lower level of compliance usually decrease crude oil price and leads to more volatility. This paper will be divided into four parts: Part One. of the paper will outline the hypothesis at the back of this research analysis. Definition of compliance and formula in how to calculate the rate of compliance will be discussed in Part Two. Part Three. will testify the assumption behind the analysis by analyse compliance level during OPECs production cut. Part Three. is outline possible alternative cause and disprove the cause. Lastly, the result will be given in Part Four. OPEC productions cut drive crude oil price. The compliance rate from all OPEC members and crude oil price have a correlation. The decision of compliance level from all OPEC members have an effect on crude oil price. While compliance level are high, crude oil price are going upward whereas while compliance level are low, crude oil price are facing downward. In order to testify the hypothesis and address the key question How much control does OPEC have over the crude oil price?, we will examine on OPECs members actual production level; production ceiling and compliance rate. Since 1980 until now, OPECs has made a decision on production cut in 2016, 2008, 2001, 1998, and 1970s) (Wurzel, Willard and Ollivaud 2009). However, different time period will have different level of compliance. Figure 1. shown a graph of OPECs total actual production and total production ceiling during the year of 1980 to 2016. According to the graph, we can see the total actual production level is showing a strong upward trend. On the other hand, the total production ceiling is showing a downward trend. As is evident from the above figure, which plots the changes in the nominal price levels of oil and the compliance rate of the countries simultaneously, there is roughly a positive relation between these two variables. The overall nominal price levels of oil is seen to be remaining more or less constant with very moderate fluctuations between 1983 to 1999. The prices however fell a little in the year 2001, with the level consistently rising after that, the levels reaching a striking high in the year 2008 (Colgan 2014). The price however fell drastically in 2009 before rising again from the next period. The rise in nominal price of oil is seen to be consistent till 2013and the price fell moderately in 2014. However, there was a huge shock in the price levels as the price drastically fell in the year 2015 and till the recent times the nominal price level of oil is keeping near this relatively lower level (Key and Villarroel). However, unlike that of the nominal price of oil, which shows substantial fluctuations over time, attributed to different factors playing in the global oil market scenario, including both the OPEC and the Non-OPEC players, the compliance rate, as shown in the above figure, has maintained a rough positive trend with time, barring several exceptions. One of the major drops in the compliance rate in this case, was observed in 2002, which was also accompanied by a decrease in the nominal price of oil during that time. In general, before and after this period, the compliance rate has maintained a more or less steady rise in its trend, the rise being more consistent in the last six to seven years (Griffin and Teece 2016). However, though in a general framework, the two variables, the compliance rate and the nominal price of oil have been seen to be broadly related but there are instances of deviation of the former from the latter in their trends. As can be seen in 2008 and between the time period of 2011 to 2014, the rise in the nominal prices of oil has been higher than the increase in the compliance rate of the OPEC countries. On the other hand, during the years 1993, 1994 and 1995, though the compliance rate of the OPEC countries was rising the nominal price of oil was falling and this trend was observable in few other instances. Thus, it can be seen from the above figure that though in some cases, the compliance rate has been increasing , the nominal price of oil has decreased in the same time span, in general the trend of both the variables are showing roughly an upward movement (Schmidbauer and Rsch 2012). The decision of cutting the production of oil by the OPEC, as discussed above, did have considerable impact on the rise in the nominal prices of oil in the years of 1970, 1998, 2001, 2008 and 2016, did have significant impacts on the nominal prices of oil. However, the changes were not always at par with the dynamics in the compliance rate of the countries. There can be several causal factors which may influence the fluctuations in the dynamics of the two variables, the nominal oil price and the compliance rate, in the instances where they are moving towards the opposite directions. This section of the report tries to analyze the plausible causes of the concerned fluctuations and tries to discuss on the basis of the empirical evidences the feasibility of these factors and their current and future potential to influence the supply and the supply price of oil in the global framework (Hallwood and Sinclair 2016). The international oil market, as has been speculated and analyzed by the speculators and the economists, is currently experiencing huge dynamics due to the entry of new players in the supply side especially. One of the most notable phenomena in this context is the oil revolution which the United States of America, is expected be experiencing. Named as the shale oil revolution, this incident portrays the increase in the production of oil in the country in the recent period, which is not only expected to have implications on the domestic demand, supply and price, but also on the international oil market. According to a considerable section of the speculators and economists, this increase in the production of oil is expected to make the economy of America emerge as one of the game changers in the oil market in the international market (Kilian 2016). There has also been speculations that in the near future (by 2020) the United States of America will surpass the productions of even Russia and Saudi Arabia and will emerge as the biggest oil producer in the world and by the end of 2030 it will even become self-sufficient and sustaining in terms of energy resources. This is mainly due to the presence of the huge amount of unused oil reserve in the country. This expected increase in the supply of oil is also anticipated to have implications on the supply of oil in the global markets. The projected increase of the oil production from being 1 million per day in 2012 to about 2 million of barrels per day by the end of 2020, if actually happens in reality, is expected to effect the oil prices in the international market as the increase in the supply is expected to bring down the oil prices. This trend is to some extent observed in the falling levels of nominal prices in between the period of 2015 to 2017, when the compliance rate was surprisingly seen to be high (M?nescu and Nuo 2015). However, as per the recent research and the empirical evidences, the recent phenomenon of divergence of the rising compliance rate, in the global oil market, cannot be robustly explained by the increase in the production of oil in the United States of America, as can be seen from the following figure: As can be seen from the above figure, the increase in the shale oil has been to the extent of 1.27 from 1, between the period of 2012 to 2016. This in the near future is expected to increase to 2 (by 2020) and 3 by (2025), which after that is projected to remain at that level till 2030. If seen from the perspective of the contribution of the country in the global oil supply in the recent period, it can be seen that the country has only contribute d 1% of the global oil supply till 2016. By the year 2020, this is expected to reach to the level of 2% and to 3% by the end of 2025. There is no increase in the percentage of the same that has been projected in the above figure. By 2030, the percentage is expected to be only 3%, which is evidently nominal in the face of the consistently rising demand for oil in the international scenario, both in the current and in the coming periods. Thus, from the above figure, it is evident that though the shell oil revolution is being considered by many economists as one of the game changing supply side phenomenon in the global oil market, it does not show the potential make the USA the primary oil producing country in the world in the near future period, at least till 2030. This is turn indicates that the nominal contribution of the country in the global oil supply cannot be the primary reason behind time and again diverging trends of the compliance rate and the nominal oil price in the global market (Aguilera and Radetzki 2013). Changes in the structure of demand: There has been the development of a notion that with the increase in the innovations and transformation in the renewable energy industry, more and more options are evolving, which can potentially be substitutes for the oil usage in the international market. With the alternative sources coming up and the concerns regarding the adverse effects of the extensive usages of the fossil fuels on the overall environmental conditions of the world and the deterioration of the overall quality of life, is expected to decrease the demand for crude oil and other fossil fuels more and more in the coming years. The countries are also expected to take steps towards improvising and transforming their energy sector such that in future the global energy scenario become more sustainable and the problem of global warming can be averted (?osi?, Kraja?i? and Dui? 2012). These measures, if actually get effectively implemented by the countries and if the world is actually moving owards sustainable energy production and consumption to considerable extent, then as a result of that the demand for the crude oil in the international market is expected to decrease considerably and consistently with time. This in its turn, if true, is expected to have implications on the price levels of the global crude oil and if this assertion is true then much of the unexplained diversions between the rising compliance rate and the falling oil prices in the current period can be explained. However, the figures and data evidences does not provide robust support to the above expected outcome: The above figure shows that the supply as well as the demand for crude oil has been more or less increasing consistently from the year 2012 till the recent period, barring several exceptions. The demand for oil, thus, can be seen to be maintaining an increasing trend in spite of the fact that the countries are moving towards making renewable and eco-friendly energy resources more usable and potential substitute for the non-renewable oil and fossil fuels. Thus, it can be seen that many economists and strategists suggest that in the current period as well as in the coming future, the sustainable energy resources and their proper implementation are expected to pose as potential replacement for oil and fossil fuel. This in turn is expected to be decreasing the demand for the latter and lowering the price of the same in the global market. However, the current empirical and data evidences are not in favor of this assertion. Conversely, the trends in the demand as well as the supply dynamics in the international oil market shows that in the current as well as in the near future the demand is not expected to fall considerably. From the above discussion it is therefore, evident that the changes in the demand structure and preference pattern in the international oil market, though can be one of the rising events in the international scenario, is not one of the primary causes behind the fluctuations in the dynamics of the compliance rate and the nominal prices of oils (Atabani 2012). The prices of oil are heavily influenced by the supply and demand of the same in the global market, which in turn is subjected to the political instability, economic and social unrest and war situations in different economies, especially in the OPEC countries. In this context, the constant political and social unrest in the Middle Eastern countries are expected to have implications on the demand and supply of oil in the global framework. On one hand, where the unrest decreases the supply of oil, it also decreases the demand for oil on part of the international citizens from these countries as the consumers become unsure of the reliability of these producers. Thus, the fall in the demand can lead to a drastic fall in the prices of crude oil. However, these unrests are temporary by nature and though they do have effects on the global dynamics on oil prices and make fluctuations in the same, this can be considered temporary cause and not one with long term implications on the price levels of the crude oil in global scenario (Baffes et al. 2015). Thus, it can be asserted from the above discussion that the above factors, though may have small and short-term effects on the oil prices and may cause temporary deviations in the oil prices from the compliance rate, these are not considered to be primary causal factors. 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