SCENARIO OF CRUDE OIL PRICES
I. Background
Australia has seven major oil refineries only capable of light crude oil requirements ( 2007). The trend in the oil refinery industry in the country is to minimize the capabilities of plants to produce heavier crude oils (e.g. from light to getting lighter). In addition, importation is more lucrative as heavy crude oil is abundant while cheaper prices are offered compared to domestic produced. Crude oil is prominent in future markets where the common motivation is not to assure crude volume rather for risk distribution. These markets would then take part in supplying the necessary information about future prices. Believing that economic theories are in maximum usage in the country, this is not so because of lack of exchange intermediary and high trading relationship with Asia.
It becomes a practice for regions to acquire “marker crude” (e.g. Brent, Dubai and Oman) to maintain market availability and determine competition among global players. The existence of derivative market limits the capabilities of economic theories applicable in the behavior of crude oil prices. For example, the fourth relevant issue in oil price watch is the stock level ( 2006). However, the data that will operate the theory (e.g. small or large stocks) is observable in the volume of future contracts being traded where no physical production or distribution really happened. In contrast, Asia and Australia do not have future exchange of crude oil that limits the capability of economic theory particularly supply and demand to recognize price. Tapis, their crude maker, implements independent panel approach to producers, refiners and traders to settle crude prices.
II. Short-run, Medium-run and Long-run Prices
II. A. Determinants of Supply
III. A. 1. Price of Crude Oil
When the price of a good rises, the quantity supplied will also rise. In the short-run, the theory may not be applicable to pure producers due to the presence of retailer’s bargaining. Alternatively, a vertically-integrated producer will also be haggled by end-users as reduction in operational cost (e.g. logistics) due to the absence of retailers would be justified. According to & (1998), bargaining is an adaptive behavior used by human interactions to satisfy their needs (). In the long-run, however, increasing the price of crude oil may not exist and not exercised by buyers and sellers because of the eminent familiarity and customer satisfaction that may defer any price increases. In effect, incentive to produce more does not essentially precedes increase in price.
II. A. 2. Price of Other Commodities
When its price increases, the supply for a good will decrease, if not, become obsolete as producers would tend to shift to the former. However, this will depend on whether producers have enough inputs like machineries, technology, and entrepreneurship to shift business. But when a product life cycle is studied closely ( & 2001), it is hard to determine when the producers will be ready for the lucrative shift. In case they will shift, they will become too vulnerable in the introduction phase, may not maximize the growth phase and too embedded in the mature stage. Perhaps, the shift may be possible in the decline stage where profits fall or the industry becomes saturated by competitors. The paradox of the shift, however, is that at the time of decline phase, producers may not engage the price incentive of business shift as the market for other commodities is already saturated by the early birds. Market saturation may deter increasing prices and halt any shift incentives for the remaining spirants.
II. A. 3. Cost of Production
The general rule is that when this will rise, producers will cut back on product leading to decrease in supply. However, the evidence of the price-sensitive oil and exporting industries continuing their businesses is a primary exemption to the rule. The existence of learning curve, oligopolistic market structures and risk diversification of large international firms has the ability to absorb price shocks to the cost of inputs, technology, organizational changes and government polices (e.g. taxes). As observed, there is an eminent presence of rationality exemplified by these producers. Since they have the financial, structural and strategic depth, they enter an industry which has dynamic and unpredictable cost of production. In this way, they may have financial loss from time-to-time, but long-term gains will be pervasive due to the opportunity to dominate the market.
II. A. 4. State of production technology
When production technology is high, production will become more efficient that can lead to increase in supply. However, technology is not the only factor of production existing in the producer’s plant. There exist more complex interrelationships between these factors to be able to exploit the improved efficiency of one. The most crucial of all is governing human resources. Without proper guidance from the leaders of a firm, production efficiency will not hold because of resistance, de-motivation or just a plain technological ignorance. Technology is not 100% automated and human intervention as well as errors is inevitable. In addition, technology may also be intended for a specific segment of the industry, say, large corporations. As such, aggregate supply may not necessarily increase because small entrepreneurs who cannot afford to buy the technology cannot contribute in increasing supply.
II. B. Determinants of Demand
II. B. 1. Price of Commodity
When the price of a good rises, the quantity demanded will decrease. However, this is proved not true by another economic model that distinguishes normal to inferior good (, & 2002 ). In addition, this may not hold for buyers who resell the product to profit from market pegged to end-users. Retailers are known as the primary cause of substantial increase in pricing especially in Japan where buyer-manufacturer links are so diverse with several middlemen. In effect, the tendency of demand to follow this assumption will continuously be flawed as long as there is incomplete information from end-users regarding transportation costs, mark-up and warehouse price of such goods in which retailers tend to exploit.
II. B. 2. Price of Other Commodities
When the price of other commodities increases, the demand for a product will also increase. This is existent in substitute goods but absent on complimentary ones (. 2002 ). However, even this classification is disputable. Take for example substitute products to crude oil. In the perspective of manufacturer producing a hybrid of the two in one product, they are complimentary goods. In effect, the assumption does not hold for business customers who have the ability to transform inputs into outputs. However, for end-users who have no other things to do with the product, the assumption redeem its significance because end-users will not spend their time and money to act as hybrid manufacturers. They will just consume the product and follow the original assumption.
II. B .3. Income of consumers
As income rises, the demand for the good also increases. This is true for normal goods but inconsistent to inferior goods (. 2002 ). However, there are cases that this may not hold for both kinds of goods. Rich as well as working and poor people have variety of investments and savings is also their priority. In effect, even though their income or wealth may increase, their consumption for wither normal or inferior goods will not necessarily happen due to being conservative on spending. In the long-run, the deferred demand due to increase in income would now be unpredictable. This is because investments and savings are pegged to risks, economic uncertainties and individual people strategy. As a result, there is a possibility that any wage increase pose by the government will not significantly affect an economy under recession.
II. B. 4. Consumer Tastes
This may be the psychological side of economics which gave it a very challenging position as a determinant of demand. Partially, this can only be the determinant that can directly affect economic behavior; however, the result is also ambiguous and embedded on the “brains” of individuals. Consumer tastes can determine the level of demand through advertising and market research ( 2002 ). As long as producers focus their resources towards informing consumers, providing quality and protecting its reputation, desirability of its products will pull more demand. However, competitors also have their own strategies to counter any industry actions. In effect, this makes a heavily competitive industry under uncertainty.
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