Document Sample
					Application of Demand & Supply
Crude Oil
Arvind S-01; Dhawal G-08; Rupesh S-26; Samay L-29

Introduction Crude oil is a naturally occurring substance (i.e., ―Fossil Fuel‖, formed from organic remains over a period of millions of years) found in certain rock formations in the earth. It is a dark, sticky liquid which, scientifically speaking, is classified as a hydrocarbon. This means, it is a compound containing carbon and hydrogen, with or without non-metallic elements such as oxygen and sulfur. Crude oil is highly flammable and can be burned to create energy. Derivatives from crude oil make an excellent fuel.

Uses Different types of oil that are obtained from crude oil are as mentioned below: 1. Ethane and other short-chain alkanes 2. Diesel fuel (petro diesel) 3. Fuel oils 4. Gasoline (Petrol) 5. Jet fuel 6. Kerosene 7. Liquefied petroleum gas (LPG) 8. Natural gas Certain types of resultant hydrocarbons when mixed with other nonhydrocarbons, create other products like: 1. Alkenes (olefins), which can be manufactured into plastics or other compounds. 2. Lubricants (produces light machine oils, motor oils, and greases, adding viscosity stabilizers as required). 3. Wax, used in the packaging of frozen foods, among others. 4. Sulfur or Sulfuric acid. These are useful industrial materials. Sulfuric acid is usually prepared as the acid precursor oleum, a byproduct of sulfur removal from fuels. 5. Bulk tar. 6. Asphalt 7. Petroleum coke, used in speciality carbon products or as solid fuel. 8. Paraffin wax 9. Aromatic petrochemicals to be used as precursors in other chemical production. Measuring Crude Oil Crude oil is measured in barrels. When crude oil first came into large-scale commercial use in the United States in the 19th century, it was stored in


wooden barrels. One barrel equals 42 US gallons, or 159 litres. In some cases crude oil is also measured in tons. The number of barrels contained in each ton varies depending on the type and specific gravity of each crude, however the average number considered would be around 7.33 barrels per each ton.


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The world population is the total number of living humans on Earth at a given time. As of November 2008, the world's population is estimated to be about 6.7 billion (6,700,000,000). In line with population projections, this figure continues to grow at rates that were unprecedented before the 20th century, although the rate of growth has almost halved since its peak of 2.2% per year, which was reached in 1963. The world's population, on its current growth trajectory, is expected to reach nearly 9 billion by the year 2042. The growth in population of the different regions from 2000 to 2005 was: 237.771 million in Asia 92.293 million in Africa 38.052 million in Latin America 16.241 million in Northern America TSM08-09/Managerial Economics/Demand-Supply Crude Oil/Arvind/Dhawal/Rupesh/Samay

1.955 million in Oceania -3.264 million in Europe 383.047 million in the

whole world

A significant factor on petroleum demand has been human population growth. Oil production per capita peaked in the 1970s. The world‘s population in 2030 is expected to be double that of 1980. There are speculation or predictions that oil production in 2030 will have declined back to 1980 levels as worldwide demand for oil significantly out-paces production. There are claims that the rate of oil production per capita is falling, and that the decline has gone undisguised because a politically incorrect form of population control may be implied by mitigation. Oil production per capita has declined from 5.26 barrels per year (0.836 m³/a) in 1980 to 4.44 barrels per year (0.706 m³/a) in 1993, but then increased to 4.79 barrels per year (0.762 m³/a) in 2005. In 2006, the world oil production took a downturn from 84.631 to 84.597 million barrels per day (13.4553×106 to 13.4498×106 m3/d) although population has continued to increase. This has caused the oil production per capita to drop again to 4.73 barrels per year (0.752 m³/a). One factor that has so far helped ameliorate the effect of population growth on demand is the decline of population growth rate since the 1970s, although this is offset to a degree by increasing average longevity in developed nations. In 1970, the population grew at 2.1%. By 2007, the growth rate had declined to 1.167%. However, oil production is still outpacing population growth to meet demand. World population grew by 6.2% from 6.07 billion in 2000 to 6.45 billion in 2005, whereas, global oil production during that same period increased from 74.9 to 81.1 million barrels (11.91×106 to 12.89×106 m3), or by 8.2%.

Agricultural effects of peak oil, Food vs. fuel and 2007–2008 world food price crisis


Because supplies of oil and gas are essential to modern agriculture techniques, a fall in global oil supplies could cause spiking food prices and unprecedented famine in the coming decades. Geologist Dale Allen Pfeiffer contends that current population levels are unsustainable, and that to achieve a sustainable economy and avert disaster the United States population would have to be reduced by at least one-third, and world population by two-thirds. The largest consumer of fossil fuels in modern agriculture is fertilizer production via the Haber process, which is essential to high perennial corn yields. If a sustainable non-petroleum source of electricity is developed, this process can be accomplished without fossil fuels using methods such as electrolysis.

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The world increased its daily oil consumption from 63 million barrels in 1980 to 85 million barrels in 2006 The demand side of Peak oil is concerned with the consumption over time, and the growth of this demand. World crude oil demand grew an average of 1.76% per year from 1994 to 2006, with a high of 3.4% in 2003-2004. World demand for oil is projected to increase 37% over 2006 levels by 2030 (118 million barrels per day (18.8×106 m3/d) from 86 million barrels (13.7×106 m3), due in large part to increases in demand from the transportation sector. Energy demand is distributed amongst four broad sectors: transportation, residential, commercial, and industrial. In terms of oil use, transportation is the TSM08-09/Managerial Economics/Demand-Supply Crude Oil/Arvind/Dhawal/Rupesh/Samay

largest sector and the one that has seen the largest growth in demand in recent decades. This growth has largely come from new demand for personaluse vehicles powered by internal combustion engines. This sector also has the highest consumption rates, accounting for approximately 68.9% of the oil used in the United States in 2006, and 55% of oil use worldwide. Transportation is therefore of particular interest to those seeking to mitigate the effects of Peak oil. Although demand growth is highest in the developing world, the United States is the world's largest consumer of petroleum. Between 1995 and 2005, US consumption grew from 17.7 million barrels a day to 20.7 million barrels a day, a 3 million barrel a day increase. China, by comparison, increased consumption from 3.4 million barrels a day to 7 million barrels a day, an increase of 3.6 million barrels a day, in the same time frame. As countries develop, industry, rapid urbanization and higher living standards drive up energy use, most often of oil. Thriving economies such as China and India are quickly becoming large oil consumers. China has seen oil consumption grow by 8% yearly since 2002, doubling from 1996-2006. In 2008, auto sales in China were expected to grow by as much as 15-20 percent, resulting in part from economic growth rates of over 10 percent for 5 years in a row. Although swift continued growth in China is often predicted, it is predicted that China's export dominated economy will not continue such growth trends due to wage and price inflation and reduced demand from the US. India's oil imports are expected to be more than triple from 2005 consumption levels by 2020, rising to 5 million barrels per day (790×103 m3/d).

Production The most common method of obtaining petroleum is extracting it from oil wells found in oil fields. With improved technologies and higher demand for hydrocarbons various methods are applied in petroleum exploration and development to optimize the recovery of oil and gas (Enhanced Oil Recovery, EOR). Primary recovery methods are used to extract oil that is brought to the surface by underground pressure, and can generally recover about 20% of the oil present. The natural pressure can come from several different sources; where it is provided by an underlying water layer it is called a water drive reservoir and where it is from the gas cap above it is called gas drive. During the oil price increases since 2003, alternative methods of producing oil gained importance. The most widely known alternatives involve extracting oil from sources such as oil shale or tar sands. These resources exist in large quantities; however, extracting the oil at low cost without excessively harming the environment remains a challenge. Chemically transforming methane or coal into the various hydrocarbons found in oil. The best-known such method is the Fischer-Tropsch process.


As crude oil prices increase, the cost of coal to oil conversion becomes comparatively cheaper. The method involves converting high ash coal into synthetic oil in a multi-stage process. Currently, two companies have commercialised their Fischer-Tropsch technology. Shell Oil in Bintulu, Malaysia, uses natural gas as a feedstock, and produces primarily low-sulfur diesel fuels. Sasol in South Africa uses coal as a feedstock, and produces a variety of synthetic petroleum products. The process is today used in South Africa to produce most of the country's diesel fuel from coal by the company Sasol. The process was used in South Africa to meet its energy needs during its isolation under Apartheid. This process produces low sulfur diesel fuel but also produces large amounts of greenhouse gases. An alternative method of converting coal into petroleum is the Karrick process, which was pioneered in the 1930s in the United States. It uses low temperatures in the absence of ambient air, to distill the short-chain hydrocarbons out of coal instead of petroleum. Oil shale can also be used to produce oil, either through mining and processing, or in more modern methods, with in-situ thermal conversion. Conventional crude can be extracted from unconventional reservoirs, such as the Bakken Formation. The formation is about two miles (3 km) underground but only a few meters thick, stretching across hundreds of thousands of square miles. It further has very poor extraction characteristics. Recovery at Elm Coulee has involved extensive use of horizontal drilling, solvents, and proppants. More recently explored is thermal depolymerization (TDP), a process for the reduction of complex organic materials into light crude oil. Using pressure and heat, long chain polymers of hydrogen, oxygen, and carbon decompose into short-chain hydrocarbons. This mimics the natural geological processes thought to be involved in the production of fossil fuels. In theory, thermal depolymerization can convert any organic waste into petroleum substitutes.

Production Challenges Oil extraction is costly and sometimes environmentally damaging Offshore exploration and extraction of oil disturbs the surrounding marine environment. To avoid oil spills Global warming on account of carbon-di-oxide emission resulting from burning oil Identification of correct oil well TSM08-09/Managerial Economics/Demand-Supply Crude Oil/Arvind/Dhawal/Rupesh/Samay

Infrastructure setup for extracting oil Government policies & approvals


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OPEC The Organization of the Petroleum Exporting Countries (OPEC) is a permanent, intergovernmental Organization (cartel), created at the Baghdad Conference on September 10–14, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. The five Founding Members were later joined by nine other


Members: Qatar (1961); Indonesia (1962); Socialist Peoples Libyan Arab Jamahiriya (1962); United Arab Emirates (1967); Algeria (1969); Nigeria (1971); Ecuador (1973) – suspended its membership from December 1992October 2007; Angola (2007) and Gabon (1975–1994). OPEC had its headquarters in Geneva, Switzerland, in the first five years of its existence. This was moved to Vienna, Austria, on September 1, 1965.

OPEC's objective is to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry. They have quotas for each member of OPEC and in relation to this the price of oil is set. Price setting is such that it effects the entire industry prices. Cost & Investment

Oil exploration can cost tens or hundreds of billions of dollars. The actual costs depend on such factors as the location of possible oil reserves (i.e. on land or in deep water), how large the oil field is expected to be, how detailed the exploration information must be, and the type and structure of the rock below the ground. Exploration requires careful mapping of the surface in order to locate suitable sites (ie, types of geological structures), deep formation surveys (eg, with two and three-dimensional seismic techniques), and test-drilling. It is not easy to determine a typical cost of such activities. OPEC has the lowest average production costs in the oil industry. This is partly because some OPEC Member Countries have large amounts of oil in reasonably accessible locations. Yet OPEC Members will still need to spend tens of billions of dollars in future to meet the growing need for oil.

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Oil price

Medium-Term Oil Prices, 1994-2008 (not adjusted for inflation). In terms of 2007 inflation adjusted dollars, the price of oil peaked on 30 June 2008 at over $143 a barrel. Before this period, the maximum inflation adjusted price was the equivalent of $95-100, in 1980. Crude oil prices in the last several years have steadily risen from about $25 a barrel in August 2003 to over $130 a barrel in May 2008, with the most significant increases happening within the last year. These prices are well above those which caused the 1973 and 1979 energy crises. This has contributed to fears of an economic recession similar to that of the early 1980s. One important indicator which supported the possibility that the price of oil had begun to have an effect on economies was that in the United States, gasoline consumption dropped by .5% in the first two months of 2008, compared to a drop of .4% total in 2007. However some claim the decline in the US dollar against other significant currencies from 2007 to 2008 is a significant part of oil's price increases from $66 to $130. The dollar lost approximately 14% of its value against the Euro from May 2007 to May 2008, and the price of oil rose 96% in the same time period. Helping to fuel these price increases were reports that petroleum production is at or near full capacity. In June 2005, OPEC admitted that they would 'struggle' to pump enough oil to meet pricing pressures for the fourth quarter of that year.

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Demand pressures on oil have been strong. Global consumption of oil rose from 30 billion barrels (4.8×109 m3) in 2004 to 31 billion in 2005. These consumption rates are far above new discoveries for the period, which had fallen to only eight billion barrels of new oil reserves in new accumulations in 2004. In 2005, consumption was within 2 million barrels per day (320×103 m3/d) of production, and at any one time there are about 54 days of stock in the OECD system plus 37 days in emergency stockpiles.

Long-term oil prices, 1861-2007 (top line adjusted for inflation) Besides supply and demand pressures, at times security related factors may have contributed to increases in prices, including the "War on Terror," missile launches in North Korea, the Crisis between Israel and Lebanon. nuclear brinkmanship between the US and Iran, and reports from the U.S. Department of Energy and others showing a decline in petroleum reserves. Another factor in oil price is the cost of extracting crude. As the extraction of oil has become more difficult, oil's historically high ratio of Energy Returned on Energy Invested has seen a significant decline. The increased price of oil makes non-conventional sources of oil retrieval more attractive. For example, the so-called "tar sands" are actually a reserve of bitumen, heavier, lower value oil compared to conventional crude. It only became attractive to production companies when oil prices exceeded about $25/bbl, high enough to cover the costs of production and upgrading to synthetic crude.


Effects of rising oil prices

World consumption of primary energy by energy type in terawatts (TW), 1965-2005.

In the past, the price of oil has led to economic recessions, such as the 1973 and 1979 energy crises. The effect the price of oil has on an economy is known as a price shock. In many European countries, which have high taxes on fuels, such price shocks could potentially be mitigated somewhat by temporarily or permanently suspending the taxes as fuel costs rise. This method of softening price shocks is less in countries with much lower gas taxes, such as the United States. Some economists predict that a substitution effect will spur demand for alternate energy sources, such as coal or liquefied natural gas. This substitution can only be temporary, as coal and natural gas are finite resources as well. Prior to the run-up in fuel prices, many motorists opted for larger, less fuelefficient sport utility vehicles and full-sized pickups in the United States, Canada and other countries. This trend has been reversing due to sustained high prices of fuel. The September 2005 sales data for all vehicle vendors indicated SUV sales dropped while small cars sales increased. Hybrid and diesel vehicles are also gaining in popularity.

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Possible Causes For Rising Price of oil Demand World crude oil demand grew an average of 1.76% per year from 1994 to 2006, with a high of 3.4% in 2003-2004. World demand for oil is projected to increase 37% over 2006 levels by 2030, according to the 2007 U.S. Energy Information Administration's (EIA) annual report. Demand is projected to reach 118 million barrels per day (18.8×106 m3/d) from 2006's 86 million barrels (13.7×106 m3), driven in large part by the transportation sector. A 2008 report from the International Energy Agency (IEA) predicted that although drops in petroleum demand due to high prices have been observed in developed countries and are expected to continue, a 3.7 percent rise in demand by 2013 is predicted in developing countries. This is projected to cause a net rise in global petroleum demand during that period. The transportation sector is the largest energy sector, and the one that has seen the largest growth in demand in recent decades. This growth has largely come from new demand for personal-use vehicles powered by internal combustion engines. This sector also has the highest consumption rates, accounting for approximately 68.9% of the oil used in the United States in 2006 and 55% of oil use worldwide as documented in the Hirsch report. Cars and trucks are predicted to cause almost 75% of the increase in oil consumption by India and China between 2001 and 2025. In 2008, auto sales in China have been expected to grow by as much as 15-20 percent, resulting in part from economic growth rates of over 10 percent for 5 years in a row. Demand growth is highest in the developing world, but the United States is the world's largest consumer of petroleum. Between 1995 and 2005, US consumption grew from 17.7 million barrels a day to 20.7 million barrels a day, a 3 million barrel a day increase. China, by comparison, increased consumption from 3.4 million barrels a day to 7 million barrels a day, an increase of 3.6 million barrels a day, in the same time frame. Per capita, annual consumption by people in the US is 24.85 barrels, 1.79 barrels in China, and .79 barrels in India. As countries develop, industry, rapid urbanization and higher living standards drive up energy use, most often of oil. Thriving economies such as China and India are quickly becoming large oil consumers.[China has seen oil consumption grow by 8% yearly since 2002, doubling from 1996-2006. In 2008, auto sales in China were expected to grow by as much as 15-20 percent, resulting in part from economic growth rates of over 10 percent for 5 years in a row. Although swift continued growth in China is often predicted, others predict that China's export dominated economy will not continue such growth trends due to wage and price inflation and reduced demand from the


US.India's oil imports are expected to more than triple from 2005 levels by 2020, rising to 5 million barrels per day (790×103 m3/d). Another large factor on petroleum demand has been human population growth. Because world population grew faster than oil production, production per capita peaked in 1979 (preceded by a plateau during the period of 19731979). The world‘s population in 2030 is expected to be double that of 1980. The role of fuel subsidies State fuel subsidies have shielded consumers in many nations from the price rises, but many of these subsidies are being reduced or removed as the cost to governments of subsidization increases. In June 2008, AFP reported that "China became the latest Asian nation to curb energy subsidies last week after hiking retail petrol and diesel prices as much as 18 percent... Elsewhere in Asia, Malaysia has hiked fuel prices by 41 percent and Indonesia by around 29 percent, while Taiwan and India have also raised their energy costs.‖ In the same month, Reuters reported that Countries like China and India, along with Gulf nations whose retail oil prices are kept below global prices, contributed 61 percent of the increase in global consumption of crude oil from 2000 to 2006, according to JPMorgan. Other than Japan, Hong Kong, Singapore and South Korea, most Asian nations subsidize domestic fuel prices. The more countries subsidize them, the less likely high oil prices will have any affect in reducing overall demand, forcing governments in weaker financial situations to surrender first and stop their subsidies. That is what happened over the past two weeks. Indonesia, Taiwan, Sri Lanka, Bangladesh, India, and Malaysia have either raised regulated fuel prices or pledged that they will. The Economist reported: "Half of the world's population enjoys fuel subsidies. This estimate, from Morgan Stanley, implies that almost a quarter of the world's petrol is sold at less than the market price."U.S. Secretary of Energy Samuel Bodman stated that around 30 million barrels per day (4,800,000 m³/d) of oil consumption (over a third of the global total) is subsidized But energy analyst Jeff Vail warned that cutting subsidies would do little to reduce global prices.

Supply ― All the easy oil and gas in the world has pretty much been found. Now comes the harder work in finding and producing oil from more challenging environments and work areas. — William J. Cummings, Exxon-Mobil company spokesman, December TSM08-09/Managerial Economics/Demand-Supply Crude Oil/Arvind/Dhawal/Rupesh/Samay


2005 , In order to pump oil, it first needs to be discovered. The peak of world oilfield discoveries occurred in 1965 at around 55 billion barrels (GB)/year. The rate of oil barrels of oil discovered has been falling steadily since. Less than 10 Gb/yr of oil were discovered every year between 2002-2007. Reserves Conventional crude oil reserves include all crude oil that is technically possible to produce from reservoirs through a well bore, using primary, secondary, improved, enhanced, or tertiary methods. This does not include liquids extracted from mined solids or gasses (tar sands, oil shales, gas-toliquid processes, or coal-to-liquid processes). Oil reserves are classified as proven, probable and possible. Proven reserves are generally intended to have at least 90% or 95% certainty of containing the amount specified. Probable Reserves have an intended probability of 50%, and the Possible Reserves an intended probability of 5% or 10%.Current technology is capable of extracting about 40% of the oil from most wells. Some speculate that future technology will make further extraction possible,but to some, this future technology is already considered in Proven and Probable reserve numbers. In many major producing countries, the majority of reserves claims have not been subject to outside audit or examination. Most of the easy-to-extract oil has been found.Recent price increases have led to oil exploration in areas where extraction is much more expensive, such as in extremely deep wells, extreme down whole temperatures, and environmentally sensitive areas or where high technology will be required to extract the oil. A lower rate of discoveries per explorations has led to a shortage of drilling rigs, increases in steel prices, and overall increases in costs due to complexity. Concerns over stated reserves ― World reserves are confused and in fact inflated. Many of the socalled reserves are in fact resources. They‘re not delineated, they‘re not accessible, they‘re not available for production — Sadad I. Al Husseini, former VP of Aramco, October 2007. By Al-Husseini's estimate, 300 billion (64×109 m3) of the world‘s 1,200 billion barrels (190×109 m3) of proved reserves should be recategorized as speculative resources. One difficulty in forecasting the date of peak oil is the opacity surrounding the oil reserves classified as 'proven'. Many worrying signs concerning the



depletion of 'proven reserves' have emerged in recent years. This was best exemplified by the 2004 scandal surrounding the 'evaporation' of 20% of Shell's reserves. For the most part, 'proven reserves' are stated by the oil companies, the producer states and the consumer states. All three have reasons to overstate their proven reserves:    Oil companies may look to increase their potential worth. Producer countries are bestowed a stronger international stature Governments of consumer countries may seek a means to foster sentiments of security and stability within their economies and among consumers.

The Energy Watch Group (EWG) 2007 report shows total world Proved (P95) plus Probable (P50) reserves to be between 854 and 1,255 Gb (30 to 40 years of supply if demand growth were to stop immediately). Major discrepancies arise from accuracy issues with OPEC's self-reported numbers. Besides the possibility that these nations have overstated their reserves for political reasons (during periods of no substantial discoveries), over 70 nations also follow a practice of not reducing their reserves to account for yearly production. 1,255 Gb is therefore a best-case scenario. Analysts have suggested that OPEC member nations have economic incentives to exaggerate their reserves, as the OPEC quota system allows greater output for countries with greater reserves.

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The following graph shows refutable jumps in stated reserves without associated discoveries, as well as the lack of depletion despite yearly


Graph of OPEC reported reserves Kuwait was reported to have only 48 Gb in reserve, of which only 24 were "fully proven." This report was based on "leaks of confidential documents" from Kuwait, and has not been formally denied by the Kuwaiti authorities. This leaked document dates back from 2001, so the figure includes oil that have been produced since 2001, roughly 5-6 billion barrels, but excludes revisions or discoveries made since then. Additionally, the reported 1.5 Gb of oil burned off by Iraqi soldiers in the first Gulf War are conspicuously missing from Kuwait's figures. On the other hand investigative journalist Greg Palast has argued that oil companies have an interest in making oil look more rare than it is in order to justify higher prices. Other analysts in 2003 argued that oil producing countries understated the extent of their reserves in order to drive up the price of oil.

Unconventional sources Noncrude oil, Tar conventional oil, Heavy sands, and Oil shale


Raw bitumen is separated from the sand in giant separation cells. Unconventional sources, such as heavy crude oil, tar sands, and oil shale are not counted as part of oil reserves. However, oil companies can book them as proven reserves after opening a strip mine or thermal facility for extraction. Oil industry sources such as Rigzone have stated that these unconventional sources are not as efficient to produce, however, requiring extra energy to refine, resulting in higher production costs and up to three times more greenhouse gas emissions per barrel (or barrel equivalent). While the energy used, resources needed, and environmental effects of extracting unconventional sources has traditionally been prohibitively high, the three major unconventional oil sources being considered for large scale production are the extra heavy oil in the Orinoco Belt of Venezuela the Athabasca oil sands in the Western Canadian Sedimentary Basin, and the oil shales of the Green River Formation in Colorado, Utah and Wyoming in the United States. Chuck Masters of the USGS estimates that, "Taken together, these resource occurrences, in the Western Hemisphere, are approximately equal to the Identified Reserves of conventional crude oil accredited to the Middle East." Authorities familiar with the resources believe that the world's ultimate reserves of non-conventional oil are several times as large as those of conventional oil and will be highly profitable for companies as a result of higher prices in the 21st century.

Control over supply Entities such as governments or cartels can artificially reduce supply to the world market by limiting access to the supply through nationalizing oil, cutting back on production, limiting drilling rights, imposing taxes, etc. International sanctions, corruption, and military conflicts can also reduce supply. Nationalization of oil supplies‎ Factor affecting global oil supply is the nationalization of oil reserves by producing nations. The nationalization of oil occurs as countries begin to deprivatize oil production and withhold exports. The point is while estimates of oil reserves may vary, politics have now entered the equation of oil supply. "Some countries are becoming off limits. Major oil companies operating in Venezuela find themselves in a difficult position because of the growing TSM08-09/Managerial Economics/Demand-Supply Crude Oil/Arvind/Dhawal/Rupesh/Samay

nationalization of that resource. These countries are now reluctant to share their reserves."

Only 7% of the world's estimated oil and gas reserves are in countries that allow companies like ExxonMobil free rein. Fully 65% are in the hands of state-owned companies such as Saudi Aramco, with the rest in countries such as Russia and Venezuela, where access by Western companies is difficult. The PFC study implies political factors are limiting capacity increases in Mexico, Venezuela, Iran, Iraq, Kuwait and Russia. Saudi Arabia is also limiting capacity expansion, but because of a self-imposed cap, unlike the other countries. As a result of not having access to countries amenable to oil exploration, ExxonMobil is not making nearly the investment in finding new oil that it did in 1981. Monopoly/Cartel influence on supply OPEC is an alliance between 12 diverse oil producing countries (Iran, Iraq, Venezuela, Kuwait, Saudi Arabia, Algeria, Gabon, Indonesia, Libya, Nigeria, Qatar, and the United Arab Emirates) to control the supply of oil. OPEC's power was consolidated as various countries nationalized their oil holdings, and wrested decision-making away from the "Seven Sisters," (Anglo-Iranian, Socony-Vacuum, Royal Dutch Shell, Gulf, Esso, Texaco, and Calso.) and created their own oil companies to control the oil. OPEC tries to influence prices by restricting production. It does this by allocating each member country a quota for production. All 12 members agree to keep prices high by producing at lower levels than they otherwise would. There is no way to verify adherence to the quota, so every member faces the same incentive to ‗cheat‘ the cartel. Washington kept the oil flowing and gained favorable OPEC policies mainly by arming, and propping up Saudi regimes. According to some, the purpose for the second Iraq war is to break the back of OPEC and return control of the oil fields to western oil companies. OPEC being a cartel has a significant market compared to non-OPEC players. Due to this, decisions taken by OPEC closely affects oil pricing & every industry across the globe. It is a form of monopoly which exercises its power through its sheer size. By simply holding supply it increases its price along side increasing demand for crude oil. Due to the above there are significantly less players in the market. The equilibrium between demand & supply keeps shifting its origin. An important contributor to price increases has been the slow down in oil supply growth, which has continued since oil production surpassed new discoveries in 1980. The fact that global oil production will decline at some point, leading to lower supply is the main long-term prices. This is because there is a limited amount of fossil fuel, and the remaining accessible supply is consumed more rapidly each year. Increasingly, remaining reserves become more technically difficult to extract and therefore more expensive. Eventually,


reserves will only be economically feasible to extract at extremely high prices. It is thought by many, including energy economists such as Matthew Simmons, that prices could continue to rise indefinitely until a new market equilibrium is reached at which point supply satisfies worldwide demand. Although there is contention about the exact timing and form of peak oil, there are now very few parties who do not acknowledge that the concept of a production peak is valid – though before oil prices increased in 2008 to energy crisis levels, some commentators argued that global warming awareness and new energy sources means that demand may fall before supply, making reserve depletion a non-issue. In addition, turbulence in the Middle East (the world's largest oil-producing region) has led to decreased exports, especially civil unrest in Iraq after the 2003 U.S. invasion. Outside the Middle East, Venezuela has experienced strikes and political turbulence, and there is growing instability in West Africa. Alternatively, lower production rates may be due to the fact that oil's historically high ratio of Energy Returned on Energy Invested continues a significant decline. The increased price of oil also makes other, nonconventional sources of oil attractive to businesses. The most prominent example of this is the massive reserves of the Canadian tar sands. They are a far less cost-efficient source of heavy, low-grade oil than conventional crude, but with oil trading above $60/bbl, the tar sands have become very attractive to exploration and production companies. Recent months have seen billions of dollars invested in the tar (bitumen) sands. In view of tighter supplies worldwide, terrorist and insurgent groups have increasingly targeted oil and gas installations to maximize both mayhem and political gains. Sometimes, such attacks are perpetrated by militias in regions where oil wealth has produced few tangible benefits for the local citizenry, as is the case in the Niger Delta. The terror factor adds an additional premium, including insurance costs, to the price of oil. Even if total oil supply does not decline, increasing numbers of experts believe the easily accessible sources of light sweet crude are almost exhausted and in the future the world will depend on more expensive sources of heavy oil and renewable energy sources. Until the rises of 2008, CERA (a consulting company wholly owned by energy consultants IHS Energy) did not believe this would be such an immediate problem. However, in an interview with The Wall Street Journal, Daniel Yergin, best known for his quotes that the price of oil would soon return down to "normal", publicly amended the company's position on May 7, 2008, and now expects oil to reach $150 during 2008, due to tightness of supply This reversal of opinion is significant, as CERA, among other consultancies, provide price projections that are used by many official bodies to plan long term strategy in respect of energy mix and price, so the impact of a misprediction is far wider than might otherwise be expected. In contrast, some other organisations, such as the International TSM08-09/Managerial Economics/Demand-Supply Crude Oil/Arvind/Dhawal/Rupesh/Samay

Energy Agency (IEA), had already been much less optimistic in their assessments for some time. While efforts are underway to increase supply, for example through a number of new mines in Canada's tar sands region which is estimated to contain as much "heavy" oil as all the world's reserves of "conventional" oil, such efforts lag behind the increasing demand of recent years. Regulation and environmental efforts have also increased the shortage and price of oil. Other possible causes Besides supply concerns, many other issues have also had some effect on oil prices. Labor strikes, hurricane threats to oil platforms, fires and terrorist threats at refineries, and other short-lived problems are not solely responsible for the higher prices. Such problems do push prices higher temporarily, but have not historically been fundamental to long-term price increases. Possible financial causes Financial speculation Financial speculation occurs when investors purchase futures contracts to buy a commodity at a set price for future delivery. "Speculators are not buying any actual crude. ... When [the] contracts mature, they either settle them with a cash payment or sell them on to genuine consumers." Many prominent economists have argued that financial speculation is not a cause of rising oil prices, however several claims have been made implicating financial speculation as a major cause of the price increases. In May 2008 the transport chief for Germany's Social Democrats estimated that 25 percent of the rise to $135 a barrel had nothing to do with underlying supply and demand. Testimony was given to a U.S. Senate committee in May indicating that "demand shock" from "Institutional Investors" had increased by 848 million barrels (134,800,000 m3) over the last five years, similar to increases in demand from China (920 million barrels). The influence of Institutional Investors, such as sovereign-wealth funds, was also discussed in June 2008, when Lehman Brothers suggested that price increases were related to increases in exposure to commodities by such investors. It claimed that "for every $100 million in new inflows, the price of West Texas Intermediate, the U.S. benchmark, increased by 1.6%." Also in May 2008, an article in The Economist pointed out that oil futures transactions on the New York Mercantile Exchange (NYMEX), nearly mirrored the price of oil increases for a several year period, however the article conceded that the increased investment might be following rising prices, rather than causing them, and that the nickel commodity market had halved in value between May 2007 and May 2008 despite significant speculative interest. It also reminds readers "Investment can flood into the oil market without driving up prices because speculators are not buying any actual crude... no oil is hoarded or somehow kept off the market," and that prices of some commodities which are not openly traded have actually risen faster than oil prices.In June 2008, OPEC's


Secretary General Abdullah al-Badri stated that current world consumption of oil at 87 million bpd was far exceeded by the "paper market" for oil, which equals about 1.36 billion bpd, or more than 15 times the actual market demand. In response to the possibility that financial speculators artificially inflated the oil market, the U.S. Congress began hearings in June 2008 to discover if actions to "tighten restrictions on pension funds, investment banks and other investors that they say are driving up fuel prices" were necessary. An interagency task force on commodities markets was formed in the U.S. government to investigate the claims of speculators influence on the petroleum market concluded in July 2008 that "market fundamentals" such as supply and demand provide the best explanations for oil price increases, and that increased speculation was not statistically correlated with the increases. The report also noted that increased prices with an elastic supply would cause increases in petroleum inventories. As inventories have actually declined, the task force concluded market pressures are most likely to blame. Similarly, other commodities which are not subject to market speculation (such as coal, steel, and onions) have seen similar price increases over the same time period. In June 2008 U.S. energy secretary Samuel Bodman had said that insufficient oil production, not financial speculation, was driving rising crude prices. He said that oil production has not kept pace with growing demand. "In the absence of any additional crude supply, for every 1% of crude demand, we will expect a 20% increase in price in order to balance the market," Bodman said. This contradicts earlier statements by Iranian OPEC governor Mohammad-Ali Khatibi indicating that the oil market is saturated and that an increase in production announced by Saudi Arabia was "wrong". OPEC itself had also previously stated that the oil market was well supplied and that high prices were a result of speculation and a weak U.S. dollar. Futures speculators related to major oil producers, such as Sultan Hassanal Bolkiah Muizzaddin of Brunei Shell Petroleum, Saudi Prince Alwaleed Bin Talal Alsaud and Russian Vagit Alekperov of LUKoil, may have artificially boosted prices by speculating in the oil futures market. In September 2008, a study of the oil market by Masters Capital Management was released which claimed that speculation did significantly impact the market. The study stated that over $60 Billion was invested in oil during the first 6 months of 2008, helping drive the price per barrel from $95 to $147 per barrel, and that by the beginning of September, $39 Billion had been withdrawn by speculators, causing prices to fall.

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Monetary inflation The Austrian School of economics holds that price inflation derives from monetary inflation, and its advocates, such as the Ludwig von Mises Institute and congressman Ron Paul, argue that loose monetary policy from the Federal Reserve and other central banks is a major contributor to the increase in oil prices, and the cause of both commodity speculation and dollar devaluation. The price of oil is closely tied to the value of the U.S. dollar because oil is traded in dollars. This has led to concern among some economists that the principal earned from the sale of oil may lose value in the long run if the U.S. dollar loses real value. In discussing the effect of the changing value of the U.S. dollar on the real price of oil, however, it is important to include a calculation of effective exchange rates of the currencies in question, to separate the real and nominal values of those currencies. This method accounts for the amount that a dollar can buy (of electronics or food for example) compared to the amount another currency, such as a Euro or pound sterling, can purchase. While the U.S. dollar has lost nominal value to other major currencies from 2001 to 2007, its change in real value has not differed significantly from other currencies. In addition, by comparing the price of oil in various currencies to the fluctuations in the exchange rates of those currencies it is clear that oil price is no more significantly correlated to the value of the dollar than to any other currency. This also holds true in a comparison of oil price to gold price. Similarly, since the early 1970s, the price of oil has been negatively correlated to the value of the dollar, suggesting that the price of oil has more of an effect on the value of the dollar than vice versa. As developed economies depend heavily on oil for transportation, petrochemical feedstock, and industrial agriculture, this correlation would affect most currency values. Some analysts believe that as much as $25 of the June 2008 prices around $140 are due to dollar devaluation.

Forecasted prices and trends According to informed observers, OPEC, meeting in early December, 2007, seemed to desire a high but stable price that would deliver substantial needed income to the oil producing states, but avoid prices so high that they would negatively impact the economies of the oil consuming nations. A range of 70– 80 dollars a barrel was suggested by some analysts to be OPEC's goal. Some analysts point out that major oil exporting countries are rapidly developing; and because they are using more oil domestically, less oil may be available on the international market. This effect, outlined in the export land economic model, could significantly reduce the oil available for trade and


cause prices to continue to rise. Particularly significant are Indonesia (which is now a net importer of oil), Mexico and Iran (where demand is projected to exceed production in about 5 years), and Russia (whose domestic petroleum demand is growing rapidly). In May 2008, T. Boone Pickens, the influential oil investor who believes the world‘s oil output is about to peak, warned oil prices would hit $150 a barrel by the end of the year. ―Eighty-five million barrels of oil a day is all the world can produce, and the demand is 87 m,‖ Mr Pickens said in an interview with CNBC. ―It‘s just that simple.‖ In June 2008, Alexei Miller, head of Russian energy giant Gazprom, warned that the price of oil is likely to hit $250 a barrel sometime in 2009. Miller said that while speculation had played a role in oil prices, "this influence was not decisive.‖Bloomberg reported that, as of mid-June, "At least 3,008 options contracts have been purchased giving holders the right to buy oil at $250 a barrel in December". Also in June 2008, Shukri Ghanem, head of Libya's National Oil Corporation, said: "I think it [the oil price] will go higher. That is a trend that will continue for some time. The easy, cheap oil is over, peak oil is looming." On June 26, 2008, OPEC President Chakib Khelil said in an interview: "I forecast prices probably between $150-170 during this summer. That will perhaps ease towards the end of the year."Iran's OPEC governor Mohammad-Ali Khatibi predicts that the price of oil would reach $150 a barrel by the end of this summer. Near-term peak oil proponent Matthew Simmons predicts a rise to $300 a barrel or higher by 2013 as sweet crude petroleum becomes more scarce and major producers begin failing to meet demand.

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