ECON 1020 Prices and Markets: Crude Oil Price Analysis (1998-2018)

This report provides an economic analysis of crude oil price fluctuations between 1998 and 2018. It examines the factors influencing these fluctuations, including dynamics of demand and supply, world economic growth, USD appreciation, OPEC policies, and geopolitical events. The report also discusses the trend of price fluctuations, welfare implications, and potential government intervention. It highlights the significant rise in crude oil prices since 1998, the impact of these fluctuations on various industries and exchange rates, and the role of OPEC in stabilizing the oil market. The analysis concludes that government intervention is necessary to control global crude oil prices and ensure a stable global economy.

Running head: PRICES AND MARKETS
Crude Oil Price Fluctuations between 1998 and 2018
Name of the Student:
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1PRICES AND MARKETS
Introduction
Crude oil is one of the most economically important resources of the world. The
economies of many countries are heavily dependent on the production and export of crude oil,
while others need to import the oil for energy production and running the transport and other
industries. According to a report by Majumdar (2016), oil and gas satisfy more than half of the
world’s demand for energies. OPEC, the intergovernmental organization consisting of 14
nations, controls the prices of oil and all the oil trade related activities. The main objective of
OPEC is to supervise and regulate the supply of the oil to the consumers and keeping the market
stabilized (Griffin and Teece 2016).
The price of crude oil has fluctuated significantly in the past two decades. Similar to the
prices of any other consumer good or service, the price of crude oil also depend on the demand
and supply of it. As stated by IMF (2015), if the price elasticities of demand and supply are low,
then the disturbances in either side of the market can lead to sharp fluctuations in the oil price.
During the period between 1998 and 2018, the demand for oil has been affected by negative
revisions of the global economic prospects, while the supply of oil faced disturbances from
armed conflicts, strategic shifts of some parts of the OPEC countries, new discoveries of oil
fields and new extraction technologies.
In this paper, the economic analysis will be done to highlight various aspects of the crude
oil price fluctuations between 1998 and 2018. The reasons for price fluctuations, various aspects
of the exchange process, the pattern or trend of the variations, factors affecting market outcomes
and its impact on the global economy, and if there is a scope for government intervention will be
discussed.

2PRICES AND MARKETS
Economic analysis
Factors influencing crude oil price variations
According to a report in Oil and Gas Financial Journal (Ogfj.com 2017), the major factors for
crude oil price fluctuations are as follows:
 Dynamics of demand and supply: In the period between 2010 and 2014, the rise in oil
prices can be attributed to the supply crunch from the conventional oil production fields.
This resulted in higher income for the upstream organizations and investors. This extra
capital was invested for exploration and development of new and unconventional sources
of energy, like the shale and tight oil. Success in those ventures led to a fall in the
conventional oil prices in 2015 and onwards.
 World economic growth: Since, the demand for oil is dependent on the growth of many
important industries in a nation, such as, electricity, transportation, shipping and
manufacturing, hence, the global growth in the industries resulted in higher demand for
the oil, which has caused the prices to soar high (Sodeyfi and Katircioglu 2016).
 Appreciation of USD: The oil trade is done using the global currency, that is, the USD.
The USD has appreciated significantly during this time, resulting in increasing the cost of
oil imports and decreasing the price of exports.
 OPEC policies: To stabilize the oil market, OPEC has decided to cut down production of
oil, with effect from January 1, 2017 and this is expected to help the price move upward
slightly in 2018.
 Geo-political events: This is an important factor that can affect directly the supply and
distribution of oil across the globe. World crisis in the oil producing countries not only
increase the price of the oil, but such events can also result in loss of output, disruption of

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supply, and inefficient market. For example, Arab Spring, that is, unrest in Libya, Tunisia
and Egypt, is to some extent responsible for the oil price hike in 2011-2012 (imf.org
2015).
It has also been highlighted that, the oil futures contracts on the goods market determine
the prices of crude oil, which implies that commodity traders have the power of controlling the
oil prices. Since 1974, this trend is still continuing. The regulatory authorities, such as the OPEC,
can only affect the bidding decision of the traders but they cannot set the price in the market
(Kilian and Murphy 2014). OPEC controls the supply to keep the prices at $70 a barrel, but
during the time of excess supply and declining price in 2015, it let the price fall because it would
not lose money till the price is $20 a barrel (Ogfj.com 2017). During 2011 and 2014, the shale oil
production of the USA had doubled, which contributed the fall in oil prices in 2015 and onwards.
Trend of price fluctuations
It has been a significant rise in the crude oil prices since 1998. In that year, the average
price for a barrel was only $12.28, while in 2012 it was $109, almost a 10 fold increase.
Although the price dropped since then, but it never went down at the level it was near the 2000s.
The major reason identified for this huge jump in the prices of crude oil is that, the resources of
easy-to-get oil are exhausted and only the hard-to-get oil resources are left, such as, the
continental shale in the North Sea region (Cobb 2012). New technologies and more capital
investment are required to carry out the exploration and production activities in those regions. At
the same time, the rate of production is important, irrespective of the size of the oil reserve. In
the two decades, from 1998 to 2018, the demand for oil has increased more rapidly after 2000s,
leading to sharp price volatility, and its role in transportation is still critical. The rate of

4PRICES AND MARKETS
consumption increased exponentially until 2005 when the advancement of technology has
brought revolution in every aspects of life and in the industries (Bodenstein, Guerrieri and Kilian
2012).
Figure 1: Average crude oil prices, 1998-2018
(Source: statista.com 2018)

5PRICES AND MARKETS
It is seen from the chart that, the oil prices were increasing over the years but the sharp increase
and price fluctuations started to happen since 2008. While the oil price came down in 2009, it
came to a peak in 2012 with $109.45 per barrel, which suddenly came down to $40.68 in 2016. It
has been increasing again since then. Hence, it can be seen that prices of oil were more or less
stable during the period of 1998 to 2004 and it experienced sharp fluctuations afterwards.
The OPEC has changed its strategy for defending the market share than the price by
producing more oil at lower prices. The oil prices surged very high since 1998 due to an
unexpected international economic boom, especially, from the emerging economies like China
and India, and the oil producing countries failed to meet the sudden rise in the demand. In 2007,
the traders increased inventories in anticipation of further rising demand and this made the oil
prices to shoot up in 2008 (Kilian and Murphy 2014). The fall in oil prices occurred due to
increase in supply from the new oil fields. Advanced technologies in the USA have led to
increased production from the oil fields of the USA and other countries have also contributed in
increasing the oil supply (Sodeyfi and Katircioglu 2016).
Welfare implications and government intervention
Since oil is one of the most important sources of energy to the world and determinants of
economic growth, the volatile nature of its prices affects almost all types of industries as well as
exchange rates. There are few aspects, by which the oil prices affect the exchange rate and
market. In terms of purchasing power parity (PPP), when the demand and supply dynamics
results in increased oil prices, the currencies of the oil-dependent countries depreciate due to
high inflation (Brahmasrene, Huang, and Sissoko 2014). Hence, it affects the exchange rate of
the countries as well as the level of international trade. A sudden rise in oil price is usually

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compensated by labor adjustments and hence, there is a structural impact on the employment (Le
Coq and Trkulja 2015). Currency devaluation for the oil importing countries leads to a fall in the
exchange rate, influencing them to create import substitution and export expansions, such as, in
the case of Russia. The commodity composition needed to be diversified in Russia to improve
the international trade.
The welfare implications follow from the above discussion. As the oil price affects the
exchange rate and currency valuations of the nations, it will have an impact on the economic
growth. During the oil price rise, the wealth is transferred to the oil exporting nations (in USD
terms) and is reflected as the improvement in the current account balance and export revenue in
domestic currency (Wang and Chueh 2013). This appreciates the currency of oil exporting
countries and depreciates the currency of oil importing countries. Thus, the government of the
nations should intervene in keeping the system stabilized. The prices of oil should be maintained
at a rate where all the countries could afford it and inculcate the growth.
Conclusion
According to Oil and Gas Financial Journal, 80% of the fuel for the world’s transport
system including all types of transportation is derived from the petroleum, while the number is
93% in the USA. As oil is one of the major sources of energy for almost all industries in an
economy, volatility in the crude oil prices has a major impact on all the economies of the world.
In past two decades, due to the uncertainty in demand and supply side factors, the crude oil price
has not only increased significantly, but also fluctuated majorly. This had impacts on the
businesses of the oil producing companies; and on the exchange rate and currency values of the
oil exporting and importing countries. The oil exploration technology has improved over the

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years, new and difficult-to-explore oil fields were discovered, OPEC had taken decision about
not curtailing the production, global economic growth has happened, USA has started oil
production and has been contributing considerably, and high importance is given to the
alternative, that is, renewable energy sources. All these factors have contributed in oil price
volatility over the years. Measures have been taken to stabilize the market, and to regulate the
production and supply of oil to all the economies of the world. However, the oil exporting
countries are benefitted when the prices are high and the importing countries are benefitted
during the lower price. To keep the global economy stable and influence an equal growth, the
government intervention is necessary in controlling the global crude oil price.

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References
Bodenstein, M., Guerrieri, L. and Kilian, L., 2012. Monetary policy responses to oil price
fluctuations. IMF Economic Review, 60(4), pp.470-504.
Brahmasrene, T., Huang, J.C. and Sissoko, Y., 2014. Crude oil prices and exchange rates:
Causality, variance decomposition and impulse response. Energy Economics, 44, pp.407-412.
Cobb, K., 2012. Why Oil Prices are 10 Times More than in 1998. [online] OilPrice.com.
Available at: https://oilprice.com/Energy/Oil-Prices/Why-Oil-Prices-are-10-Times-More-than-
in-1998.html [Accessed 23 Apr. 2018].
Griffin, J.M. and Teece, D.J., 2016. OPEC behaviour and world oil prices. Routledge.
imf.org, 2015. Oil Prices and the Global Economy. [ebook] IMF. Available at:
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