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Oil prices and economic effects
Increase in oil prices impact the economy
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Introduction Oil is one of the primary source of energy and strategic to the development of modern economy. Oil is an important resource which attracts interest by stakeholders in the management of the country’s economy. There is always hot issues whenever there is an oil price fluctuation and is discussed in the economic cycle and in the political landscape. Oil is a global commodity where its price fluctuation and uncertainty affects global economies of countries. This discussion will review the factors that determine the price of oil and its effect to a country’s economy. These price fluctuations pose risks and threats to governments and corporate organisations. The discussion will analyse the risks of oil price fluctuations and the threat to an organisation. The overall effect of the risks and threats can be minimised through the use of derivatives and enterprise risk management. The discussion will critically analyse the various tools and mechanisms to minimise the impact of the risks and threats posed by the fluctuating oil prices. The discussion will conclude with identification of some opportunities with oil price fluctuations. Factors Influencing Fuel Price Fluctuations • Crude oil hold major cost component of diesel fuel and gasoline prices. The international oil price is also influence by number factors. There are seven factors that influence and contribute to the crude oil prices according to the US Energy Information Administration. Production OPEC consortium contribute to about 40% of the world’s oil production and its export represents 60% of oil traded on the international market. Due to the size of OPEC, its actions on production and supply cuts lead to the world’s crude oil price fluctuations. When reviewing ... ... middle of paper ... ...s. In long paper contract, position makes money if the market rises and loses money when it falls whiles in short paper position loses money if market rises. Another hedging strategy available for the IOCs is the swap contracts where obligation is given to the parties to exchange on paper a fixed price in crude for a floating price. The swap providers makes the market so demanded and control the premium which is built into the fixed price offered and financial institutions act as brokers. Another hedging strategy available to IOCs to reduce risk against price fluctuation is put option where the IOC has the right but not obligation to sell over a given period of time or at a specific date in exchange for paying a premium. The key risks to be managed in dealing with derivatives for price risks are liquidity, credit, cashflow, basis, legal, tax and operational risks.
America is dependent on other nations for their ability to create energy. The United States is the world’s largest consumer of oil at 18.49 million barrels of oil per day. And it will continue to be that way for the foreseeable future considering the next largest customer of oil only consumes about 60% of what the U.S. does. This makes the U.S. vulnerable to any instability that may arise in the energy industry. In 2011, the world’s top three oil companies were Saudi Aramco (12%), National Iranian Oil Company (5%), and China National Petroleum Corp (4%). The risk associated with these countries being the top oil producers is twofold. One, they are located half way around the world making it an expensive to transport the product logistically to a desired destination. And two, the U.S. has weak, if not contentious,...
In 2004, crude oil producers around the world expected a 1.5% growth in the world’s demand for crude oil. The actual growth rate was more than double the projections at 3.3%. This growth was due to rapidly industrializing of foreign countries such as, China and India. Therefore the lack of crude oil affected the supply of gasoline to consumers at the pump.
Caterpillar Inc. also faces the risk of its cash flow and earnings being affected by fluctuations in the exchange rates of currency, commodity prices, and interest rates. To control for this, the company’s Risk Management Policy ensures prudent management of interest rates, commodity prices, and exchange rates of foreign currency by allowing the use of derivative financial instruments. According to the policy, the derivative financial instruments are not supposed to be used for the purpose of speculation. In its pricing strategy, Caterpillar Inc. faces the risk of difficult shipping of its products. This risk can be encountered by offering its products on instalments and lease to its loyal customers (Caterpillar, Inc. (CAT), 2011).
Currently, the most important factor in the rise of gas prices is the increasing cost of crude oil. Unfortunately, the United States has three percent of the world’s oil reserves. (Horsley) In 2009, the United States was third in crude oil production as well as the world’s largest petroleum consumer. (e. I. Administration) Such consumption required and still requires the United States to import petroleum/crude oil from other countries.
In 1970 oil reserves became more scarce, leading to a decrease in production, while consumption continued to grow rapidly (Wright, R. T., & Boorse, D. F. 2011). In order to fill the gap between rising demand and falling supply of oil, the United States became more and more dependent on imported oil, primarily from Arab countries in the Middle East. (Wright, R. T., & Boorse, D. F. 2011). As the U.S and many other countries became highly industrialized nations, they became even more dependent on oil imports. With demand being higher than the actual amount of supply, prices kept rising reaching a peak of $140 a barrel in 2008. (Wright, R. T., & Boorse, D. F. 2011).
Before the 70’s, oil from the Middle East was very cheap, and in North America, it was about $4 a barrel. But then, the leaders of the Middle East discovered that everyone needed their oil, so they formed OPEC (Organization of Petroleum Exporting Countries). Practically overnight, they jacked up the prices of oil by limiting the supply. This was the first oil crisis. It lasted for a while, but then they got greedy, and started supplying more oil, in hopes to make more money. But then there was more supply than demand, so t...
The expanding global market has created both staggering wealth for some and the promise of it for others. Business is more competitive than ever before, and every business, financial or product-based, regardless of size or international presence is obligated to operate as efficiently as possible. A major factor in that efficient operation is to take advantage of every opportunity to maximize profits. Many multinational organizations have used derivatives for years in financial risk management activities. These same actions that can protect multinational organizations against interest rate futures and currency fluctuations can be used to create profits for those same organizations.
In conclusion, hedging risk with financial derivatives can give firm range of benefits such as lower probability of having financial distress, lower value of debt ratio, and earn tax benefit. It can be concluded that firm should hedge risk using financial derivatives because lot evidence shows that firm using this strategy is more successful than those who are not. However, since different type of companies facing different risks, they should not necessarily use the same hedging strategy.
hedging risks and what instruments to use are really depend on whether the company is risk
In conclusion, the supply and demand of oil is a complex issue that depends on several factors. Geopolitical affairs are the major issues that affect supply and demand of oil. Geopolitical factors include wars, uprisings and political inconsistencies in the world. Other factors that influence the demand and supply of oil include market domains, availability of oil, recession and the world GDP. Since 1859, the price of oil has been inconsistent. Despite the fact that oil prices increased and fell, there has been a considerable rising trend in those prices. In most cases, the falling of the price reaches the previous price level. However, increase of prices goes beyond earlier prices. This trend has seen oil prices rise over the years. With this in mind, it is clear that by 2020 the real price of oil will be more than 200 dollars.
After the financial crisis of the late 1990s, the demands for risk management tools have increased. The investors have been effectively utilizing such products as KOSPI 200 futures and options, 3-Year KTB futures and USD futures to meet their hedging needs.
The Kingdom of Saudi Arabia is a petrostate. It is a petrostate in the sense that the oil sector dominates the national economy and international exports. (Colgan 226) This is due to Saudi Arabia’s one crop economy, oil. (Ali 100) Oil accounts for 70-80% of the state revenue as well as roughly 95% of export revenues. Before the discovery of oil in the 1930s, the economy rested on Islamic pilgrims. Containing the Grand Mosque, Al-Masjid al-Haram, Saudi Arabia gets a large influx of believers every year for the Hajj, one of the Five Pillars of Islam. During this time of year, income was made by food and shelter sold to the travelers. This was enough to support the state, but not enough to make it the monetary power it is today. What allowed for Saudi Arabia’s climb in the world economic ladder was oil. Oil has been a valuable industrial resource since the beginning of World War 1. Since then the demand for oil has progressively become higher and higher amongst industrial nations, allowing for oil rich states to receive large amounts of affluence. Among these oil rich states is Saudi Arabia, the region with the highest capacity for oil production out of the entire Middle East. From their remarkably high oil production, Saudi Arabia was able to gain considerable amounts of wealth and political significance. Oil in Saudi Arabia politically affected the Saudi government in both their foreign and domestic policy by providing economic power, the ability to fund wars, the ability to use economic diplomacy.
The oil & gas sector faces specific risks affecting its financial performances. The main variables affecting the industry are political, geological, price, fiscal, supply and demand as well as cost risks. Given the specific risks, the demand for energy is still gr...
...ting in hedging activities in the financial futures market companies are able to reduce the future risk of rising interest rates. By participating in the financial futures market companies are able to trade financial instruments now for a future date (Block & Hirt, 2005).
Oil and natural gas production has been exponentially multiplying since 2008, making the United States independent from foreign energy. This is important for the United States economy because in the last century a significant amount of GDP has gone to the importation of Oil and gas, doing so we have become victims of the rise and fall of the volatile prices set by OPEC, driving the United States to economic crisis, as it happened in the 1973 oil crisis where oil prices rose dramatically from $3.00 per barrel to $12.00 per barrel .