What determines the oil price? Part IV

By | October 20, 2021

5: Different perceptions of the market

Among market analysts and researchers, there is no agreement on how to understand the oil market, the behavior of oil producers, the demand for oil or the actual formation of the oil price.

  • On the supply side, views on the behavior of oil-producing countries can be roughly divided into two categories: welfare-maximizing theories (profits as a motive) and “others”, with many intermediate shades. Among other things, emphasis is placed on security and foreign policy issues, property rights and politically set income targets.
  • On the demand side, the analyzes address factors such as economic growth in different parts of the world, income and price elasticities for the demand for energy in general, and oil in particular, the price of alternative energy carriers and technological development. Political measures help to complicate the picture. The perception of what is the best market form varies between the extremes of free competition and monopoly . Price formation is seen as a result of either economic or political forces in the market, or as an interaction between the two.

Should oil be understood as a scarce resource in the economic sense? The answer is important for the perception of how the oil price will develop in the longer term. Oil is a non-renewable resource, and thus finally in the geological sense. Nevertheless, it is not obvious that it should be perceived as such in an economic sense. Recoverable reserves become larger and more valuable when either the price is higher, the exploration and extraction costs are lower or the technology is better. In all these cases, more oil can be extracted from a given reservoir.

The oil is perceived as final, also in economic terms. In this sense, prices are expected to increase in the future as it decreases again. If it is not perceived to be so, competition between producers, substitutes (alternative energy carriers) and economic development in the long term will bring the price of oil more in the direction of the way other goods are priced. Then it is the cost of producing it that is decisive for the price development. Today, most oil-producing countries make more money than is needed to cover costs (“ground rent”). In Norway, the state takes in most of this profit through taxation and direct ownership, and puts it into the Petroleum Fund. This means that lower prices in themselves will often not reduce production in many existing production areas, such as in Norway and the Middle East, but will be able to significantly reduce earnings for both companies and states.

According to TIMEDICTIONARY, political influence on the oil market has been particularly focused through The Seven Sisters, OPEC and countries in the Middle East where around 2/3 of the world’s conventional oil reserves are located (especially Saudi Arabia which is the world’s largest oil exporting country). For many oil-exporting countries, oil revenues are crucial to their export revenues (typically around 90 percent of total export revenues).

The demand side has also been more strongly influenced politically . For the past 15 years, the EU has pursued an active energy and environmental policy to serve the interests of consumers and the internal market. As early as 1974, the IEA was established by Western oil-importing countries led by the United States after the first oil shock. The member countries largely belong to the Western political sphere of interest (North America, the EU, Japan and some Asian emerging economies, Australia and New Zealand).

The purpose was to give OPEC a counterweight in the oil market through energy saving, development of alternative energy sources and research and development. The IEA also has its own emergency preparedness and plan for an oil crisis (production interruption and price shock). State-owned strategic petroleum reserves (SPR) can then be sent to the market if a crisis situation arises. Based on our dual role as a Western and as an oil-producing country, Norway is only an associate member of the IEA and occasionally acts as an observer in the OPEC context.


Conventional and unconventional petroleum resources

Conventional and unconventional petroleum resources are often distinguished . Conventional resources are mostly in liquid substance – as in Norway, the Middle East, Russia, etc. Unconventional resources are less available ; where the oil and gas are often mixed with (are part of) sand, rock or coal. It then gets an extra (most often) underground processing link that makes it more expensive to extract, involves greater risk and makes it less relevant to extract.

Oil from oil sands has long been produced in Canada, partly through surface production, while the United States in recent years has had strong growth in shale oil and gas production further underground. Slate production requires that the stone is crushed (“fracking”) so that the oil or gas can then be pumped up. US energy authorities believe that unconventional resources are far greater than conventional ones, and distributed in a number of places in the world. The boundary between conventional and unconventional resources changes according to the technological changes and border shifts that take place in the petroleum sector. The term “proven reserves” is often used for conventional resources.

What determines the oil price 4