Low Oil Prices and Their Effect on World Economies

Summary

The article deals with the issue of low oil prices and explores its effect on world economies. According to the author, the majority of the models offered by economists regarding the decline in the oil supply are based on the oversimplified premise and do not predict the development of events accurately. The central issue lies within the fact of diminishing opportunities to acquire crude oil through cheap sources and the resulting decline of the petrol supply. The article presents an argument that contrary to the conventional approach, the situation will not be resolved through the rise of prices for oil and petrol. Most of the models extend the setting to the shift to substitutes, the optimization of the technological processes of oil extraction, the decrease of the amount used by the customers, and the new equilibrium will eventually be established. However, the author points to the important issue of the dynamics of the expected change in prices associated with diminishing returns, which renders these models inaccurate (Tverberg).

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Analysis

The contents of the article indicate several important aspects of the oil market segment. First, it confirms the unintuitive statement that despite the noticeable and predictable decline of supply the price of oil rises relatively slowly. According to the data from the article, this fact can be explained by the pattern of change in cost associated with the diminishing returns. The rise in costs is counterbalanced by the development of more cost-efficient methods for some time, resulting in a relatively smooth increase that can be ignored on the stage of pricing policies. Thus, the current low oil costs are unaffected by the lowering supply, but this situation is expected to change in the nearest time. The main cause of the predicted change is the switch to “alternative” oil, which is associated with tremendous expenses and, by extension, the inevitable increase in price (Tverberg).

The second issue that can be derived from the suggestions made in the article is the low price elasticity of the oil. This can be seen primarily in the projected outcomes of the diminishing demand. Since the customers are expected to seek for ways to cut the use of oil-related products, and economists expect the economic balance is to be resolved through the increase of prices, the initial assumption is that oil is essential and not easily substituted. This assertion can be corroborated by the fact that most of the world economies are dependent on energy sources, and this dependence is expected to increase over time. Therefore, the inelasticity of prices makes the issue of the diminishing returns a problem of paramount importance.

Geopolitical Implications

It should also be acknowledged that the most evident policy of adjusting oil prices by the expected growth of demand described in the article may lead to adverse effects extending far beyond the economic domain. Most importantly, such a policy may decrease geopolitical and social stability on a global scale.

According to the consensus, the price of oil is conclusively and directly linked to the political climate of most of the major players on the international scene. All of the previous economic crises, including the most recent recession of 2008, were accompanied by a drop in oil price. However, it is possible that correlation, in this case, does not necessarily mean causation, and the reverse effect can be anticipated. Since oil currently remains the most popular source of energy for both the developed and the developing countries, its price determines the availability of energy sources. By extension, we can conclusively link the availability of energy to most of the manifestations of technological, scientific, and social development demonstrated by the countries on the international scale. Therefore, the anticipated growth of fuel prices will inevitably restrict the pace of development for most of the countries and result in stagnation.

Judging by these conclusions, it is tempting to view the current decline of oil price as having a positive effect on the economy. This assertion is partially confirmed by the observations of benefits experienced by several European countries as a result of current low oil prices. Nevertheless, the favorable effect can only be sustained in the short run while the long-term outcomes would likely be disruptive enough to negate the advantages earned by the current pricing policy. For instance, a rapid change in any direction (e.g. the surge in demand suggested in the article) will destabilize the state of the countries suffering from a resource curse – a combination of financial prosperity resulting from oil abundance, high level of corruption, and a poor state of governance. Regardless of the direction of change, the rapid turn in the economy will intensify internal issues and may trigger international tensions. Another risk associated with the decline of oil price is the necessity to account for the inevitable change of the status of oil as a chief energy source in the world. The current intensification of the search for alternative sources of fuel as well as the investment into innovative ways of oil extraction indicates the proximity of the shift in priorities of energy sources. While no definitive model is predicting the possible development of events, existing historical evidence suggests major geopolitical changes and deterioration of stability.

Environmental Implications

Another effect of the current oil price policy is the pressure experienced by the oil sellers from environmental agencies. Since oil is essentially a commodity, the threat of shifting to alternative sources of energy prompts oil companies to increase sales to sell their assets before they are left with an obsolete product. The effect is further intensified by the increasing number and severity of environmental laws and regulations. Since it becomes increasingly difficult for oil suppliers to find markets, they are expected to keep prices down to attract buyers. Admittedly, such an effect is only noticeable on a relatively small scale but should be acknowledged in the case of developing interventions.

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In addition to the predicted increase in prices associated with the switch to new methods of extraction, several adverse effects are expected to occur after the decline of oil supply. First, the rise of energy cost production will create a situation where employees will become relatively less efficient – i.e. they will generate less supply for the same unit of input. Therefore, their wages are expected to decrease respectively. Second, being a high-priority market sector with low price elasticity, the oil industry will likely utilize the outputs of other economic segments to maintain sustainability and productivity. Third, the decrease of affordability combined with the diminishing buying capacity of the population will inevitably lead to debt saturation that is already becoming an issue for governments (Tverberg). In all, the effect of an unaddressed decline of oil affordability is cumulative and needs to be addressed before the steep decrease in demand takes place.

Work Cited

Tverberg, Gail. “The Real Problem Behind Low Oil Prices.” OilPrice, 2015, Web.

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