EFFECTS OF

OIL PRICES
ON
ECONOMY

MUHAMMAD JUNAID MUGHAL

ASC 2625
CMS 281144 SEC C 91
 OIL PRICE HISTORY
Trend (2003-2020)
 2003:
In 2003, crude oil was selling for $30/barrel. But due to invasion of Iraq
increased to approx. $35/barrel because Iraq have global reserves and oil
production was decreased.
 2004-2008:
In late 2004 prices jumped up to $50/barrel due to various changes i.e.
change in supply and demand, decreased Iraq production etc. In mid-
2006 crude oil price was all time record for trading for $79/barrel due to
political tensions like North Korea’s missile launch, ongoing Iraq war as
well as Israel Lebanon war. Oil prices fell to $30.28/barrel because of
financial crisis (2007-2008).
 2009-2013:
Oil prices raised to $82/barrel after the financial crisis in 2009.In
2011the oil prices hit $100/barrel because of political unrest in Egypt.
For about three and half years the price largely remained in the $90–
$120 range.
 2014-2015:
In the middle of 2014, price started declining due to a significant
increase in U.S. shale oil production and China and Europe's demand for
oil decreased. And because of oversupply of oil by OPEC. The price of
oil dropped to $62.75/barrel and in 2015 oil prices dropped below
$50/barrel.
  2016-2020
Interactive charts of West Texas Intermediate (WTI or NYMEX) crude
oil prices per barrel back to 1946. The price of oil shown is adjusted for
inflation using the headline CPI and is shown by default on a
logarithmic scale. The current month is updated on an hourly basis with
today's latest value. The current price of WTI crude oil as of June 26,
2020 is $38.49 per barrel.

Crude Oil Prices - 70 Year Historical Chart

A more detailed chart is as under:

Relation between Oil Prices

and Production
Oil provides more than a third of the energy we use on the planet every
day, more than any other energy source. And you can draw a straight line
between oil consumption and gross-domestic- product growth. The more
oil we burn, the faster the global economy grows. On average over the
last four decades, a 1 percent bump in world oil consumption has led to a
2 percent increase in global GDP. That means if GDP increased 4
percent a year -- as it often did before the 2008 recession -- oil
consumption was increasing by 2 percent a year. At $20 a barrel,
increasing annual oil consumption by 2 percent seems reasonable
enough. At $100 a barrel, it becomes easier to see how a 2 percent
increase in fuel consumption is enough to make an economy collapse.

Fortunately, the reverse is also true. When our economies stop growing,
less oil is needed. For example, after the big decline in 2008, global oil
demand actually fell for the first time since 1983. That’s why the best
cure for high oil prices is high oil prices. When prices rise to a level that
causes an economic crash, lower prices inevitably follow. Over the last
four decades, every time oil prices have spiked, the global economy has
entered a recession.

What Determines Oil Prices?

Oil's use in fuels continues to be the primary factor in making it a high-
demand commodity around the globe, but how are prices determined?

The key points are as follows:

 Like most commodities, the fundamental driver of oil's price is

supply and demand in the market.
 Oil markets are composed of speculators who are betting on
price moves, and hedgers who are limiting risk in the
production or consumption of oil.
 Oil supply is controlled somewhat by a cartel of oil producing
nations called OPEC.
  Oil demand is driven by everything for gasoline for cars and
airline travel to electrical generation.

The Determinants of Oil Prices:

With oil's stature as a high-demand global commodity comes the
possibility that major fluctuations in price can have a significant
economic impact. The two primary factors that impact the price of oil
are:

 Supply and demand
 Market sentiment

The concept of supply and demand is fairly straightforward. As demand

increases (or supply decreases) the price should go up. As demand
decreases (or supply increases) the price should go down. 

Production Costs, Storage Have Impact On Oil Prices:

Production costs can cause oil prices to rise or fall as well. While oil in
the Middle East is relatively cheap to extract, oil in Canada in
Alberta’s oil sands is more costly. Once the supply of cheap oil is
exhausted, the price could conceivably rise if the only remaining oil is in
the tar sands.

U.S. production also directly affects the price of oil. With so much
oversupply in the industry, a decline in production decreases overall
supply and increases prices. As of 2019, the U.S. has an average daily
production level of 12 million barrels of oil. That average production,
while volatile, can trend downward. Consistent weekly drops put upward
pressure on oil prices as a result.

There are also ongoing concerns that oil storage is running low, which
impacts the level of investments moving into the oil industry. Oil
diverted into storage has grown exponentially, and key hubs have seen
their storage tanks filling up rather quickly. As of September 2019,
about 50% of storage capacity is being used in Cushing, Okla., one of
these hubs.

Various Effects on Economy

Oil Prices & Economy of Pakistan
Pakistan is semi-industrial economy which is mainly in chemical, textile,
agriculture, food processing etc. Pakistan has imported oil from Middle
East. Pakistan import crude oil and refines the oil locally for the
consumption. Our economy totally depends on oil import to run its
economic mechanism. Falling price of oil in international market should
be seen as a blessing for a country like Pakistan.
Declining prices encourages OGRA to issue new licenses to 13 new oil
marketing companies. It brings new investment in the Pakistan. Pakistan
produced 80,800 barrels/day in 2013, it increases to 110,000 barrels/day
in 2015. Increase in production help to cut the import for Pakistan.
Reduced import bill helped to maintain the foreign reserve to reduce
trade deficits of Pakistan.
State Bank of Pakistan is enjoying fall in oil prices by saving foreign
reserves. It is also reducing pressure on the declining value of the
Pakistan’s Rupee. In February, IMF noticed GDP growth of 4.7% for
Pakistan. It happens due to saving of $4billion saving in oil import bill.
It help to control Inflation Rate & Foreign Reserves. Pakistan is
agricultural country and its agriculture contributes 24% of GDP. Falling
oil prices also helped the farmers to pay less (40%) for the fuel and
electricity bills. NEPRA reduces the Rs3.24 per unit of electricity, it is a
big relief for people. Decline in oil prices also influence the stock market
of Pakistan especially for the PSO.
 Crude Oil Consumption and Production in Pakistan

The Impact of Higher Oil Prices on the

Global Economy

Over the past two years, oil prices have increased very sharply, with the
Fund's reference price rising from a 25 year low of $11 per barrel in
February 1999 to a peak of close to $35 per barrel in the first week of
September 2000. After easing somewhat in early October, oil prices
increased again in late October and November to an average of about
$32 per barrel. At the same time, futures markets indicated that average
oil prices in 2001 would be about $5 per barrel higher than projected in
the most recent World Economic Outlook (WEO) published in late
September.

We will now discuss the impact of oil prices:

1. Developed countries.
2. Developing countries.
1. The Impact on Industrial (Developed) Countries:
For the industrial countries as a group, real GDP falls 0.3 percentage
points below the baseline in 2001 and 2002 before recovering
subsequently, while real domestic demand follows a similar profile but
with a somewhat greater short-term loss of 0.4 percentage points
because of negative terms-of-trade effects. The impact on activity and
demand in the United States and euro area are somewhat larger than the
industrial country average, while the impact on the group "other
industrial countries" is smaller than the average because the largest two
members of this group-the United Kingdom and Canada-are net oil
exporters.

Headline CPI inflation rises in all countries in the short run, with
particularly large impact in the United States and euro area, resulting in
an increase in real and nominal short-term interest rates as monetary
policy responds to counter second round wage and price increases (as
noted earlier, the monetary authorities are assumed to target core
inflation).

The financial impact of the increase in oil prices is quite muted.

Exchange rates remain relatively stable, with the dollar appreciating
slightly relative to the yen and euro because the United States faces a
smaller terms-of-trade shock. Lower expected future profits result in a
fall of 1-2 percent in equity prices in the advanced economies. If adverse
confidence effects were to magnify these effects, the corresponding
effect on the real economy would also be larger. Financial market
considerations are discussed in more detail below.

2. The Impact on Developing and Transition Economies:

The impact on individual developing countries would likely be at least

as large as for many of the industrial countries. On the one hand, oil
exporting countries—which suffered seriously from the decline in oil
prices in 1997-98—benefit substantially (this includes a number of
countries that have recently experienced financial crises, such as
Ecuador, Indonesia, Russia, and Venezuela).
On the other hand, there is a significant adverse impact on oil importing
countries, especially as dependency on oil has not fallen to the same
extent as in industrial countries. Figure 6 illustrates how the impact of a
$5 per barrel oil price hike will affect developing countries differently.
For example, in the top right quadrant the square marked United Arab
Emirates shows that country has a large current account surplus and that
the oil price increase is expected to further increase that surplus by more
than 5 percent of GDP.
A number of countries also face additional pressures from weak non-oil
commodity prices, and have limited access to capital markets, which
will further increase the adverse impact on domestic absorption.
By contrast, many of the oil-importing HIPC and transition economies
are expected to be adversely affected. For example, Belarus was
expected to be running a current account deficit of over 7 percent of
GDP. The oil price hike would add to the current account deficit by
about 1.6 percent of GDP.
How Pakistan Is Coping With
the Challenge of High Oil
Prices
Impact on Pakistan’s Economy:
Pakistani economy is struggling with slow economic growth rate 4.14%,
high inflation rate 7.7% and circular debt is 2% of total GDP $236.62
billion. “Power shortages cut GDP by 2%” according to ADB (Asian
Development Bank). Pakistan is not a major oil producing country.
Pakistan import crude oil and refines the oil locally for the consumption.
Declining prices encourages OGRA (Oil and Gas Regularity Authority
Pakistan) to issue new licenses to 13 new oil marketing companies and
brings new investment in the Pakistan. In year 2014 Pakistan spend
almost $6.7 Billion on the import of crude oil from August,
2014December, and 2014. In 2013, Pakistan was producing only
15.81% (68,000 barrels per day) of its crude oil domestically and its
total oil consumptions were 430,000 barrels per day. Now in 2015
Pakistan increases it local oil production 110,000 barrels per day.
“Pakistan said to have large reserves of oil”.
The reserve contains more than nine billions of barrels of oils in
Pakistan. If Pakistan starts local oil production at its full pace, than it can
produce 247,500,000 bbl. /day in coming years. The oil import bill is
35% of the total import bill for Pakistan in the previous year
2014.Declining oil prices helped to cut the import bill for 7.6% in the
current fiscal year 2015. IMF (International Monetary Fund) predicted
the import bill in the beginning months of, 2015 will reduce to $14.6b
instead of $15. Reduced import bill helped to maintain the foreign
reserve to reduce trade deficits of Pakistan. The total trade deficit of
Pakistan in year 2014 was $16.54 billion.
State Bank of Pakistan is enjoying fall in oil prices by saving foreign
reserves and it is also reducing pressure on the declining value of the
Pakistan’s Rupee (Currency).
Falling oil prices also helped to reduce and control the inflation rate of
the Pakistan.
Inflation Rate in Pakistan

How Pakistan Is Coping With This Issue

As discussed earlier, the direct effect of high oil prices on an economy
(in the developing countries) is felt through the worsening of the balance
of payments and the resultant contraction of the economy. The use of
foreign exchange reserves and increased borrowing or grants may give
short term relief for net oil importers. However, this is not a sustainable
option. There is a need to explore those policy options that gradually
reduce the impact of the price shock and will strengthen the future
capability of the country to handle such crisis.
1. Demand Management and Supply Side Strategies:
GDP growth is regarded as the driver of oil demand besides its price. It
has the tendency to reduce vulnerability as the share of oil imports
decline as income rises. This however, is a weak effect. A substantial
and sustained growth performance is required to have a long term effect.
In Pakistan, oil intensity has declined along with rising GDP growth
over the last few years but its vulnerability measured in terms of oil
imports share in GDP has increased because of the rising value of
imports. As discussed in the previous section, current macro scenario
has weakened the chances for high growth trend, at least in the recent
future.
2. Ministries and Government Are Doing What?
Ministries and government agencies were encouraged to undertake
proper maintenance of vehicles (including correct tire inflation); and
driving of government vehicles was reduced. An administrative order
signed in August 2005 directed all government offices to implement a
mandatory 10 percent reduction in their fuel consumption. Government
agencies and offices were prohibited from using vehicles, aircraft, and
watercraft for purposes other than official business.
That is, first of all the government itself is economizing on fuel
consumption, setting an example for the general public. As a result of
these energy conservation programs consumption of petroleum products
in Philippines declined by 8 percent in almost two years.
There are so many examples of energy saving programs employed in
developing countries of energy, e.g., government vehicles are used by
their families.

Impact of Political
Development on International
Oil Price
The oil market currently suffers serious contradictions. In terms of
supply and demand, it is possibly oversupplied. This is not least because
higher prices to final consumers are beginning to bite. At the same time
prices since June 2012 have increased by around 30 per cent, driven by
geopolitical concerns. The future price trajectory depends upon
politicians. Failure to manage the Eurozone crisis could lead to much
lower oil prices while an Israeli attack on Iran would cause a major price
spike. A key outcome of the Arab uprisings has been a significant
increase in the prices needed by the producers to manage their fiscal
position.
This is a serious indictment of producers’ failure to diversify their
economies away from dependence on oil revenues over the last 20 years.
If the oil price goes much lower, three scenarios could ensue
sequentially: a price war forcing prices even lower, a period of internal
repression as revenues fail to buy compliance among populations, and
internal unrest among producers, which could lead to supply disruption
followed by prices bouncing back. Underlying all this is a fundamental
dilemma for OPEC. Its members need higher prices, but these will cause
demand to fall and other supplies, including unconventional resources,
to increase. This will force prices lower. Thus OPEC members need the
golden eggs at a rate that may well kill the goose that lays them.

Prospects for Oil Prices:

During the summer of 2012, there were growing concerns that, faced
with global economic upheaval originating in the problems of the
Eurozone, there was increasing oversupply in the oil market, which
threatened prices. At the same time, geopolitical concerns in the context
of the Iranian nuclear programmer were helping to provide upward
support for prices. This paper attempts to consider possible future paths
for crude oil prices and their implications.
Before considering future prices it is worth trying to explain recent price
history. Figure 1 provides an analytical framework to do so. Based upon
data from the International Energy Agency’s Monthly Oil Market
Report, it shows on a quarterly basis the call on OPEC-12 crude, OPEC-
12 production and the average price of the OPEC crude basket.
What If Prices Go Lower?
If oil prices were to fall in an oversupplied market, producers would be
put in an awkward position. Obviously they would have to try to push
prices higher, or would need to run down financial surpluses and/or cut
expenditure, but assuming we are entering a sustained period of lower
prices, this could lead to what we see as three sequential developments.
The first will be an international price war across all producer states to
force Saudi Arabia to take assertive action to tighten the taps and firm
prices. That could be a difficult prospect given that Riyadh has its own
strategic objectives, based upon a sustained period of moderate prices.
 Factors Responsible For
Current Dip in Oil Prices
OPEC is widely seen as the most influential player in oil
price fluctuations, but basic supply and demand factors, production
costs, political turmoil, and even interest rates can play a significant role
in the price of oil.
Crude oil, or “black gold,” is one of the world's most precious
commodities. Price changes in the commodity can affect the economic
ecosystem at every level, from family budgets to corporate earnings to
the nation's GDP. Indeed, sudden price drops or unexpected spikes can
send global financial markets into a tizzy.

Crude oil prices change quickly in response to news cycles, policy

changes, and fluctuations in the world's markets. Since 2014, oil prices
have experienced a downward journey, falling from highs of around
$105 per barrel. In February and March of 2020, crude prices
accelerated their decline in reaction to the coronavirus pandemic and an
expected sharp drop in demand for oil. In addition, major oil producers
failed to come to an agreement on production cuts, exacerbating the
problem. By mid-March 2020, the price of U.S. crude oil was fluctuating
just around $30 per barrel.

So, what causes these dramatic swings in the price of oil, and what
can we expect going forward?

1. Supply:
For several decades, the Organization of Petroleum Exporting Countries
(OPEC) has been the elephant on the world's trading floors, with its oil-
producing member nations working together to determine prices by
boosting or reducing crude oil production. While OPEC's grip on the
market has loosened some in past years, its decisions continue to play a
dominant role. OPEC's every move is watched closely by governments,
oil companies, speculators, hedgers, investors, traders,
policymakers, and consumers.

KEY TAKEAWAYS

 Crude oil prices can vary greatly, with a price near $105 per
barrel in 2014 and $30 in 2020.
 Crude oil prices react too many variables, including economic
news, overall supplies, and consumer demand.
 OPEC is an international oil producing cartel that plays an
important role in determining global oil supplies.
 Economic growth and increased industrial production can
drive up the demand for crude oil.
 Key reports that affect crude oil prices in the short term are
weekly inventory statistics from the American Petroleum
Institute and U.S. Energy Information Administration.
 2. Demand:
Strong economic growth and industrial production tend to boost the
demand for oil—as reflected in changing demand patterns by non-
OECD nations, which have grown rapidly in recent years. According to
the U.S. Energy Information Administration,

“Oil consumption in the Organization for Economic Cooperation and

Development (OECD) countries declined between 2000 and 2010,
[while] non-OECD oil consumption increased more than 40%. China,
India, and Saudi Arabia had the largest growth in oil consumption
among the countries in the non-OECD during this period.” 
Other important factors that affect demand for oil include transportation
(both commercial and personal), population growth, and seasonal
changes. For instance, oil use increases during busy summer travel
seasons and in the winters, when more heating fuel is consumed.

3. Derivatives and Reports:

More and more, market participants are buying and selling crude oil, not
in its physical form, but in the form of contracts. For example, airlines
and oil producers use derivatives, like futures and options, to
a hedge against swings in the price of oil, while speculators drive those
prices upwards or downwards when there are waves of buying or selling
amid incoming news.

The Bottom Line

Oil has long been the engine of the world's economy, and even today—
as the search for alternative energy sources gains ground—life without
crude oil is hard to imagine. Carbon-based fuels are used in heavy and
light manufacturing, in the production process (chemicals, textiles,
detergents, and medicines), and in every sector of our transportation
industries. For now, at least, oil companies and oil-rich nations will
surely weather dips, deeper plunges, and sudden spikes in crude oil
prices.
 Analysis and
Recommendations
Analysis:
The overall effect of changes and uncertainties in oil prices on the
economy as a whole depends on many parameters, including a country’s
position in the oil market, its degree of competitiveness, the very
composition of its competitive advantage, as well as the specific nature
of the oil price shock.
Importantly, the effects of severe oil price changes do not have to be
only negative. Low oil price opens up for the opportunity to “correct
course” through investments in greener technology and energy systems.
In this way, economies might be able to hedge themselves from the harm
that oil price fluctuations make to their markets and economies —
irrespective of their stand as oil consumers or oil importers — and
simultaneously take steps towards building a new climate economy.
Recommendations:
Enhance the positive effects of oil prices in reducing inflation by
speeding up price pass through. Put in place instruments to smooth the
effects of price changes. Reduce oil price subsidies or increase taxes –
which is good in economic and environmental terms. Reduce fiscal
deficits. Introduce less monetary tightening than would have been the
case without the oil price decline. Reduce energy intensity or diversify
trade and production to reduce the economy’s dependence on volatile oil
prices.
 Conclusion
For long run development oil will remain an important source of energy.
What is required is to make rational choices about the development of
energy mix for the future. The government should chalk out strategies
for ensuring efficiency in use and development, adequacy and reliability
of supply, and measures to alleviate environmental impacts. For
Investor’s confidence in all energy sectors a predictable and transparent
framework is essential. Since better investor climate will in turn increase
supply and help stabilize prices. Within the framework of a national
energy policy, a number of specific measures to promote energy
efficiency and diversity will help in reducing vulnerability to high oil
prices (Asian Development Bank 2005). About 28% of total
commercial energy is imported in Pakistan and the dependence on
imported fuels is expected to increase even further in future given the
depleting gas resources. The continuously rising trend in the oil prices in
the international market will have a negative impact on Pakistan’s
foreign reserves.

Pakistan needs to explore the vast potential of its indigenous energy

resources, much of which has remained unexploited, especially that of
coal. The government must diversify the country’s energy supply mix to
reduce the risk of oil price fluctuations in the global energy market.
Energy conservation programs should be applied. There is a need to
seriously promote efficiency improvement or demand management. So
far this seems to be a lost opportunity for Pakistan. As discussed earlier,
some countries have successfully implemented this approach. At the
macro level, government policy cannot completely eliminate the adverse
impacts of high oil prices but appropriate policy response can minimize
it.

For the improvement of balance of payment, Pakistan

should made serious efforts to boost its exports to counter
high oil payments.