This paper reviews the article by Mark Shenk on crude oil prices reported in Bloomberg.com on May 7, 2009 (Shenk, 2009). In this article Shenk, states that in anticipation of the revival of the economy in the near future, the oil demand will increase based on increased consumption, the oil prices rose to a new high since November 2009. The author quotes the report of the Treasury Secretary, showing a reassuring position of the US banking system, as the reason for the gain in the prices.
Changes in Demand for Oil
After reading this article, I do not think that there will be a drastic change in the demand for oil in the immediately following months. Although the statement of the Treasury Secretary talks about a better position of the US banking system, the inventory levels of US crude oil rose by 2.8% above the five-year average for the period at 375.3 million barrels during the week ended May 1(Shenk, 2009). The oil demand would increase only when there is an increase in the consumption of oil on the revival. The oil demand is affected by several factors including the oil reserve position and production levels.
The consumption of oil causes a great change in demand for oil, which again depends on the increase in the per capita income of the people. Changes in the exchange rates and changes in stock indices also affect the oil demand largely. Speculation in oil as a commodity would cause a serious change in demand.
Changes in Supply of Oil
The law of supply implies that when the oil prices increase the supply position would automatically increase since the price rises increase the revenue. Excess production and lack of spare capacity with the OPEC countries will affect the supply of oil. This would lead to piling up of inventories and a resultant change in supply. A change in consumption would also result in a corresponding change in the supply of oil to the market. Constraints in the refining capacity would affect the supply position of oil. Changes in demand also affect the supply position, with higher demand for oil increases the supply and vice versa.
Government Intervention on Oil Price
When the government interventions and fix the maximum price that could be charged for oil would vitiate the supply position seriously, as the quantity the producers would be willing to supply would be much lower than the quantity the consumer is willing to buy. This would lead to a shortage of oil. Gas stations would frequently run out of oil and the quantity would be rationed based on the ability of the people to wait in long queues. The price control by the government would thus lead to shortages or surpluses of oil depending on the revenue that the producers can earn from the price fixed by the government.
Producers would be worse off when the price is fixed arbitrarily at a lower level than the cost of producing oil. Most economists are of the view that when the prices are set by the government arbitrarily, without regard to the market equilibrium based on the actual and demand-supply position of oil, the society would be worse off (Eldredege). However, under circumstances when there is a monopolistic tendency or there is a cartel of producers fixing the price by controlling the demand, it would do well for the people, if the government intervenes and fixes the price in those situations.
References
Eldredege, B. (n.d.). Econ 101: Supply, Demand and Price. Web.
Shenk, M. (2009). Crude Oil Rises on Speeculation Worst of Recession is Past. Web.