Thursday, June 26, 2008

Will Oil Price Go Down One Day?

This is a question asked by one of my student in our MSN conversation

Student’s question: Sir, I have a question. Do you think oil price will go down again?

Thanks for asking or else I will be drained of topic so soon in my newly-started blog. Ok, as you can see in Economics there are always two sides of argument with one weighing more than the other. Before I jump into my personal conclusion, here are what I’m going to say


1. If there is a swing in the mood of speculators. The whole world including Arab Saudi itself is now blaming speculation activities that take place in the oil market. Expectation that the oil price will increase even more in the near future to USD $ 200 per barrel, has caused more investors to jump to buy oil futures hoping to make quick bucks, causing demand to increase abnormally relative to supply. Once these investors feel that the oil price has peaked, then they will sell heavily causing the price to surge dramatically

2. If the rate of increase in the supply of oil outstrip demand, which I feel that it is very unlikely to happen.

3. Global recession. There is other demand-driven reason to explain the oil price phenomenon. Other than speculative demand, the US effort to build up its own oil reserve is also one of the main causal. Bear in mind, that US has the largest oil reserves in the world. Next, the strong industrialisation by China & India also mean an increase in fuel consumption. In a nutshell, for prices to fall US, China & India economy must fall at the same time

4. Discovery of substitutes for oil. There was once the talk on bio-fuel & bio-diesel. If the research conducted a great success, people will switch away from petrol to the more economical bio-fuel. Both have positive cross elasticity of demand. Increase in price of oil will cause the demand for bio-fuel to increase as well. Also if hydrogen cars are cheaper than petrol cars, the price of oil will go down as more people substitute towards the usage of hydrogen car


1. Bear in mind, oil is still somehow a form of scarce economic resource. As such, over the time its price will definitely rise due to shortages or its demand outstrip supply. The only thing which is still possible is that, we can figure out a way to slow down its rate of increase (Just like drugs to slow down the spread of cancer cells)

2. Arab Saudi & other OPEC (Organisation of Petroleum Exporting Countries) members will not attempt to increase the supply of oil more than the rate of increase in demand (short run effort) to cool down the price. This is because the demand for oil is inelastic & as such a fall in the price means fall in total revenue for these main oil exporting countries

3. Even if there were global recession, soon after the cycle has gone & global economy is on their way recovery, prices of oil may return to its original level & perhaps hit another new high. History has proven this to us!

4. The development of bio-fuel is still in the infant stage. Meanwhile the economic effect from the usage of hydrogen cars is not widely known. If it is really effective in helping an average household to save more, why hasn’t all car companies or consumers itself install that kind of tank?

In a nutshell, I would conclude that the oil price will definitely increase & there is no way that its price will go down. The only thing I can say, is that its rate of increase may slow down depending on economic cycle

1 comment:

-shann- said...

I have my own opinion as to why the oil prices are increasing. All the reasons mention in the post have always been a case. Oil price are in actual fact not increasing. It is because the value of US currency has decreased. Authority should really look at pricing world oil at a different currency other than in USD as a measure to bring down the oil prices.