Changes in Supply of and Demand for Crude Oil: Implications for Oil Price

Abstract

The rise in oil prices since the end of the 2007-09 recession has surprised many analysts given the sluggish rate of economic growth in advanced economies. This highlights the changes occurring in the global oil market. This study examines trends in the supply of and demand for crude oil and how they can influence the future price of oil. On the supply side, the main issue is of peak oil or the point at which oil production begins to decline. Analysis of global oil reserve data predicts a peak occurring anywhere from 2014 to 2040. The peaking of production will place upward pressure on oil prices as production capacity declines as oil fields mature, production shifts toward lower quality oil costing more to produce and geopolitical risk rises as global production moves increasingly to OPEC and the former Soviet Union. A major change is also occurring in the global composition of oil demand. Virtually, all future growth in oil consumption will come from developing countries, especially China. Rising demand from them will put upward pressure on prices even if growth remains sluggish in developed countries.

JEL: Q40, Q41, Q47, Q49


Introduction

Over the past decade, oil has become a global commodity. In this global marketplace, there have been fundamental changes which will have a large impact on the future price of oil. This study examines these changes focusing on factors determining global supply and demand. On the supply side, the primary issue is peak oil. This refers to the concern that the world is running out of oil and that oil production will soon peak. Numerous doomsday predictions have been made by oil professionals at various times over the past two decades and have failed to come to fruition. Yet, the evidence is growing that these pessimistic forecasts may be right this time and that the era of cheap energy may be over. What is surprising is that despite the critical importance of the issue of peak oil, the topic has not been more widely discussed.

On the demand side, global composition of demand is shifting away from the advanced economies in Europe, Japan and North America towards developing economies, especially those in Asia. This means the impact of the US in determining oil price is becoming less and less of a factor. This study is organized as follows: Section 2 provides a historic review of oil prices, Sections 3 and 4 discuss issues surrounding peak oil, Section 5 examines the changing composition of global demand for oil, Section 6 examines production trends, Section 7 looks at the role of price elasticity. The paper ends with conclusions and implications for oil prices in Section 8.

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