Importance of Crude Oil In World Economy : Why Oil Price Changes ?

Crude Oil

Crude Oil is a very major natural resource. It’s available in various colors from yellow to dark black and in forms of viscous liquid as well as tar like substance. Crude is used in energy production and its refined form is used as petroleum product. Also the waste from refining is used for producing various important materials required in daily life. Due to such importance crude is traded physically as well as a derivative. Crude oil is traded as a commodity and its price is decided per barrel.

Crude is available under the crust of Earth. The extractions and refining process is very long and the world has already consumed almost one third of available crude oil. Also crude forming takes thousands of years. Hence this resource is limited. Oil industry is a trillions of dollar industry. Crude is used for fuel in the transport industry, preparing raw material for the packaging industry, production of energy, tar used in building roads, etc. Hence it is used for multiple purposes. This is the reason why crude price affects the prices of many commodities available in the world.

How Is Crude Oil Price Determined ?

  • Type of crude
  • Sulphur
  • Place of extraction and transport cost

Types of crude

Crude is two types in nature. One is light crude and another is heavy crude. Light crude is easy to refine and it produces more quantity of gasoline and petroleum. Heavy crude has more density of oil. Hence it takes more time to get refined and more working as well. Hence the process of refining becomes costly in case of heavy crude. So the price of crude is determined on the basis of light or heavy crude.

Sulphur

Sulphur determines the quality of crude. Sulphur is removed during the refining process as well. High presence of sulphur affects the pricing. The reason is more refining time and cost and another is transport cost (more weight). That’s why sour oil is cheaper than sweet crude.

Place of Extraction and Transport costs 

If the place is near ocean or water then it becomes easy and quick to export or transport oil through waterways. If the place is inland then the costs rises for transport and more time is consumed in transportation.

Why does the Price Rises ?

  • Demand and Supply
  • Development of economies

Demand and Supply

Lately there has been a lot of rise in demand for oil due to expansion of various industries and economies. Due to growing population there is an increase in demand for oil and its sub products. This is the reason why the demand for crude has spiked. On the other hand the supply of crude has not increased in accordance to demand. Also it takes thousands of years for production of crude oil inside the Earth’s crust. Hence due to low supply and high demand the price has boosted for crude oil.

Recently during the COVID pandemic and lockdown situation the demand of crude decreased significantly. On the other hand the production in crude cannot take halt. Hence there was an excess supply of crude than demanded. Crude is used majorly in the transport industry and hence lockdown affected it directly. At one point of time the price of crude even went negative. The reason was additional supply and lack of storage facility and no demand.

Hence demand and supply of crude play a key role in pricing crude oil and maintaining a balance in the world economy.

Development of Economies

Recently due to the rapid development of developing economies crude demand has increased. Major economies like China and India have created  excess demand of crude. Countries like Venezuela, Vietnam are also in the similar list. Due to more demand and not significant increase in supply of crude the prices have gone up more in the past decade.

How High Crude Prices Affect Economies on Micro Levels ?

When there is a spike in crude prices the simple thought is the price of petrol, diesel and gasoline will also grow. This will hamper the budget of small households. It will also increase prices of public transport, airlines, transport industry etc.

Due to increase in prices of the transport industry the prices of majorly all the goods will increase subsequently. Also crude’s by-products are used as raw materials in various industries like packaging. Hence the prices of such industrial goods will also rise which will indirectly affect the consumers.

Also crude oil is used as an energy generator. This will increase the energy cost of business units and production facilities and hence increase the prices of normal goods. So increase in crude affects many industries directly and consumers indirectly.

How High Crude Prices Affect Economies on Macro Levels ?

Increase in oil prices increase the inflation and decrease the economic growth of the economy. The reason being the association of crude oil with majorly all the industries and production units. The escalation in crude rates leads to higher cost of goods. Due to this some industries would not be able to produce more units due to high costs and less profits. This will also affect the countries importing crude oil. Such countries now have to pay more for crude as well as have to pay more tax to the government. This will lead to a direct effect on the production cycle as the extra money spent on tax cannot be used for consuming other goods.

Also crude is the base for petroleum, chemicals, plastic and fuel. Hence more the price of crude, more the cost. This leads to lesser purchasing capacity of an individual in the end which is the sign of inflation.

Importance of Crude

Crude is the major component for various products and industries. It is crucial for producing transportation fuels. Crude is used for producing gasoline, petrol, diesel etc. It is also used for producing petroleum products. Crude is also used in creating granules which are used in plastic roll manufacturing. It also forms a major part in raw material composition of many chemicals.

As per records in 2019 U.S. consumed more than 7 billion barrels of crude out of which 3.5 billion barrels went for gasoline, 1.5 billion barrels were used for diesel and heating procedures and the remaining was used as jet fuel and other purposes.

Oil is used for fertilizers, pesticides, soap, pvc pipes, cosmetics, tar etc. It is also utilized in the textile industry. Hence Crude oil is a prime natural resource. The reason is scarcity in availability and more demand for production of goods.

OPEC

OPEC is the central organisation which manages a major portion of crude oil extraction from the Earth. It is a group by Arab countries who have many sites for crude oil extraction. The organisation tries to create an equilibrium between demand and supply by maintaining the extraction quantity so that prices of crude remain stable over time. Other large producers of crude are Russia and the U.S.A.. The balanced price structure in crude maintains the balance in the economy and stock market.

 

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