An Analysis Of The Global Energy Price Spike

An Analysis Of The Global Energy Price Spike The costs of oil and its associated secondary products are rising in the US. These products include food, plastic goods, heat (especially during the winter), and vehicle fuel.

Oil companies and OPEC are reluctant to increase oil production to meet rising oil demand gradually returning to pre-pandemic levels, which would reduce oil prices. Rising oil prices cause financial stress on many, especially lower-income, American households, who are vulnerable to oil price changes. Rising oil prices thus pose a political concern for President Biden.

Why are oil prices rising?

The US oil market is an extremely competitive market.

In March 2020, Covid-19 pandemic lockdown measures halted most commercial and domestic transportation, among other activities. 71% of US oil powers transport (EIA.gov, 2021); therefore, the transport reduction caused an unexpected, abrupt drop in oil demand.

Lockdowns caused an unprecedented drop in oil demand.

The lack of traffic associated with Covid-19 pandemic lockdown measures converted many bustling streets to be deserted of vehicles.

Figure 1: Short run effects of the demand shift (March 2020) on the US oil market

Figure 1 represents the drop in oil demand caused by the lockdown as a leftward/inward shift in demand, from demand(pre-pandemic) to demand(pandemic).

Demand(pandemic) meets the supply curve at a lower equilibrium price and equilibrium quantity. Thus, the oil price (per barrel) and oil quantity sold (per barrel) decreases.

Figure 2 shows the effect of the demand shift on individual oil suppliers. Total revenue = Price x Quantity (barrels of oil) sold, both of which decreased. Thus, the price crash caused oil suppliers to lose revenue. ATC is average total cost-the total cost (the sum of fixed and variable costs) divided by the total quantity of oil (barrels) produced. Equilibrium price dropped below ATC, and some oil suppliers became unprofitable. The financial loss drove some oil suppliers to leave the US oil market.

Figure 2: short-run effects of the demand shift (March 2020) on individual oil suppliers. The oil industry laid off tens of thousands of workers (Krauss and Eavis, 2021). Dozens of companies went bankrupt or accrued debt (Krauss and Eavis, 2021).

These graphs model the US oil market to be a competitive market – a theoretical market structure with several requirements such as the absence of monopolies. In a competitive market, equilibrium price = marginal revenue (MR). A company’s profit-maximizing level is where MR = marginal cost (MC).

Since January 2021, US states have been generally lifting pandemic-related restrictions and transport use (among other oil-intensive activities) has been increasing. This causes an ongoing oil demand shift: demand is gradually approaching the level it was prior to the pandemic.

After oil firms reduced their supply during the pandemic, some firms were forced to exit the US oil market; this shifted oil supply left/inward. Now oil demand is rising due to relaxing lockdown measures, oil supply must also increase to meet the rising demand and trade oil at the equilibrium price and quantity.

However, supply is yet to increase.

Shared Energy : Why Not?

There is currently an oil supply shortage because demand is higher than supply. As a result, the current oil price is higher, and the oil quantity sold is lower.

One reason oil supply is yet to increase to meet rising demand is because oil suppliers must hit governmental and self-set climate objectives. Oil suppliers are incentivized to reduce their carbon emissions by extracting and producing less oil. Oil suppliers may also be “vilified by public investors” (Krauss and Eavis, 2021) if they increased oil exploration.

Futhermore, if oil suppliers increased oil production, they would be more susceptible to another rapid inward oil demand shift caused by another nationwide lockdown. The substitute of renewable energy also increases hesitancy in increasing oil supply as firms look to invest in renewables rather than oil.

US oil supply relies on imports from the global oil market, which is not a competitive market but an oligopoly. In the global oil market, OPEC (the Organization of the Petroleum Exporting Countries), a 13-nation intergovernmental organization, constitutes 30% of world oil supply, and owns an estimated 79.4% of the world’s proven oil reserves (Lawler, 2019). OPEC is therefore able to consensually decide on current oil production and supply levels, which directly influences the price of oil. OPEC’s current hesitancy to increase oil supply increases the world price of oil, which increases the cost of US oil imports.

In conclusion, if oil supply ceases to increase and oil demand continues to increase towards pre-pandemic levels, oil prices will continue to rise.

Written by Edred Opie

An Analysis Of The Global Energy Price Spike
REFERENCES:

Eia.gov. (2017). Home – Energy Explained, Your Guide To Understanding Energy – Energy Information Administration. [online] Available at: https://www.eia.gov/energyexplained/.

Krauss, C. and Eavis, P. (2021). Energy Prices Spike as Producers Worry Over Pandemic and Climate. The New York Times. [online] 4 Oct. Available at:

Lawler, A. (2019). OPEC’s market share sinks – and no sign of wavering on supply cuts. Reuters. [online] 22 Aug. Available at: https://www.reuters.com/article/us-oil-opec-graphic/opecs market-share-sinks-and-no-sign-of-wavering-on-supply-cuts-idUSKCN1VC0U4.