Oil on the Boil

After the Space race in the post world war era, one race that’s still on is the race for crude, dude. Crude oil is one of the most important raw material to meet energy requirements of mankind. Crude oil is drilled out of various locations across the planet earth. So what exactly did I want to say? Let’s have a look at the possible reasons for soaring oil prices. In the process we take a look back at the history, jump right back and look at the present factors,  in the process we’ll try growing wiser by some useful analysis.


A century and a half ago when the industrial revolution really picked up in the present western economic power-houses, most of these countries met their requirements either through their own oil fields or got it done through their colonies and some other countries  willing to open up their oil fields to these rapidly increasing economies. Post world war as the economic scenario changed, and the world was freed from the clutches of the imperialism, more and more countries were vying for sustainable economy. At the same time rapid industrialization had begun in most of the world. This required large energy requirements. The countries which had huge oil reserves were mostly the third world countries which had anything but oil. These countries were looking to achieve economic independence and growth through this essential commodity.

This resulted in formation of what we know as the OPEC (Oil Producing and Exporting Countries) OPEC was formed in 1960 with five founding members Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.  Two of the representatives at the initial meetings had studied the Texas Railroad Commission’s methods of influencing price through limitations on production. By the end of 1971 six other nations had joined the group: Qatar, Indonesia, Libya, United Arab Emirates, Algeria and Nigeria.  

            Throughout the post world war era OPEC was not such a key player in controlling the oil prices until in 1971 the Texas Railroad commission set proration at 100%. This meant that Texas producers (Texas, Oklahoma and Louisiana) were not limited to the amount of oil produced. More importantly it meant the ability to control the oil prices shifted from the US to OPEC. In 1973 Yom-Kippur war started by Egypt and Syria attacking Israel. Most of the western countries supported Israel, this led to the Arab countries imposing an oil embargo on these western countries, leading to uncertainty and sent the oil prices sky high. The Iran-Iraq war led to further spiraling of the prices due to reduction of production by almost 2-2.5 million barrels per day in that year. Further the price controlling of the US in the mid 1970’s led to the condition where US consumers were paying 50 percent more for the imported oil than the domestic production. In effect the domestic petroleum industry was subsidizing the US consumer.

Did the policy achieve its goal? In the short term, the recession induced by the 1973-1974 crude oil price rise was less because U.S. consumers faced lower prices than the rest of the world.  However, it had other effects as well. 

In the absence of price controls U.S. exploration and production would certainly have been significantly greater. Higher petroleum prices faced by consumers would have resulted in lower rates of consumption: automobiles would have had higher miles per gallon sooner, homes and commercial buildings would have been better insulated and improvements in industrial energy efficiency would have been greater than they were during this period. As a consequence, the United States would have been less dependent on imports in 1979-1980 and the price increase in response to Iranian and Iraqi supply interruptions would have been significantly less.

OPEC has seldom been effective at controlling prices, while often referred to as a cartel; OPEC does not satisfy the definition. One of the primary requirements is to enforce member quotas. The only enforcement mechanism that ever existed in OPEC was the Saudi Spare capacity. With enough spare capacity to be able to increase production to sufficiently offset impact of low prices on its own revenues, Saudi could enforce discipline by threatening to increase production to crash prices.

During the 1979-1980 period of rapidly increasing prices, Saudi Arabia’s oil minister Ahmed Yamani repeatedly warned other members of OPEC that high prices would lead to a reduction in demand. His warnings fell on deaf ears. 

Surging prices caused several reactions among consumers: better insulation in new homes, increased insulation in many older homes, more energy efficiency in industrial processes, and automobiles with higher efficiency. These factors along with a global recession caused a reduction in demand which led to falling crude prices.  Unfortunately for OPEC only the global recession was temporary. Nobody rushed to remove insulation from their homes or to replace energy efficient plants and equipment , much of the reaction to the oil price increase of the end of the decade was permanent and would never respond to lower prices with increased consumption of oil. 

The crude oil prices spiked during the Iraq’s invasion of Kuwait, both important oil producers. Then in the 1990’s the prices rose due to increase in economy of the US and energy demands of developing countries. Declining Russian production also led to increase in global oil prices.

During the start of the 21st century the prices soared higher due to Iraq war and the reduction in global oil production and also the US inventories (future stock) reaching a 20 year low. This lead to large scale speculations and global rise of crude oil prices.


How is oil traded? Basically it’s traded in the US dollars. The NYMEX (New York Mercantile Exchange ) allows trading of all consumer commodities. Here the prices are basically driven by speculations as in a stock market. So if I get to know that US is going to invade Iraq and say the union in Venezuela’s oil production companies are off to a strike, I know the supply will decrease, the demand is always increasing so I buy oil now hoping prices will increase and when the war is just nearing I will sell it and make profit. So that’s how global oil prices are driven on speculations. Moreover the decision by OPEC to cut the production and drive global oil prices to meet their revenues and other decisions drive the oil prices.


So now we know how everything got into place. Let us just figure out what factors are employed to drive the oil prices low or high.

As we know OPEC countries try to limit production to attain a stable oil price. If they increase production then supply exceeds demand and the prices go down. So we keep this in mind.

Next we move to appreciation of dollar with respect to other countries’ currency. This leads to decrease in purchasing power of the OPEC countries as they make all their transactions of oil in dollars. So the crude oil prices go up. Or they start trading in Euro or Yen as was seen in recent years by Iraq and now recently by Iran due to US recession and global appreciation of currencies’ against the dollar.

The oil prices are basically driven by speculation and which are very much based on future demand and supply. If there are scenarios which may disrupt future oil supplies like the war on Iraq by US in 2003. This led to total closing down of production in Iraq and this lead to decrease in global crude oil supply by almost 1.5-2 million barrels per day. This led to increase in global crude oil prices.

Then a terrorist attack like the recent one on Pakistan’s ex-Prime Minister Benazir Bhutto led to the global crude oil price increase as it was thought to have caused instability in the middle East which is the global leader in oil production.

The current rice in global oil prices can be attributed to the increased demand from the developed countries like India and China whose energy consumption has increased over years due to rapid Industrialization and Urbanization. The demand has gone up but not the supply.

Moreover as demand increases more the crude oil level in the ground goes down. This leads to decrease in production. Also new technological advances have to be made to achieve the same production capacity.

Then there are varied levels of thickness of the crude oil present across the globe. Not all crude is suitable for producing the various petrochemicals. Then the global refineries are also structured in a different way as to be able to handle a particular kind of Crude oil level.

Currently in countries like India, the government is trying to contain the oil prices at the cost of Oil marketing companies. This is leading to losses for these companies. In an election year to appease the public government is trying to reduce the effect of increase in global crude oil prices. And the oil companies are made to subsidize for the public leading to losses. Moreover these companies are running out of funds to explore new oil fields, improve process to produce cheaper petrochemicals and to have process models to achieve the environmental norms which come expensive.


All this factors lead to increase of global oil prices in their own ways. So what comes out of this?? Well one thing that mankind has surely got to think is to move towards non-conventional sources of energy. Moreover conservation of energy should be done. Use of public transport should be encouraged, as it makes dutiful use of energy. Each one can contribute to decrease in consumption of energy in small ways.


Say when I was typing all this stuff trying to consume a lot of energy from my body, I put my computer into a power saver mode with lower performance and lower energy consumption because I know I do not require high processing capabilities when I’m using a word processing applications. So somewhere down the line I reduced the global power consumption in a small way. Moreover, the funny side of all this is that I actually designed a low power multiplier unit for my final year project , so I’m contributing to reduction in global warming,  and power consumption and in some way I reduce the global oil requirements in a very small way. When I mean small I MEAN very  small but if everyone does that IN THEIR OWN WAY I guess IT WILL BE BIG TIME






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