On 24th
of February, Russia launched a military invasion in Ukraine. It not only had a
direct impact on the people of Ukraine and Russia, but it would also have lasting
ripple effects to the rest of the world. One of such impacts can be seen in Oil
price which in turn affects the cost of whole range of things thus affecting
economic stability. So, let’s talk about that today.
To start
with, we need to understand the fundamentals for any product pricing. The price
of any product basically depends upon two things- Demand and Supply.
Very simply
put, if the demand and supply is comparable (irrespective of both increasing or
decreasing), then you typically get the product at the right price.
However, when
the demand is comparatively higher than the supply- the price goes up.
Similarly,
when the opposite happens, that is, the supply is comparatively much higher
than the demand, then the price goes down.
This simple
equation holds true for almost all the products you can think of- from
vegetables to chemicals to food items- everything.
Now, coming
back to oil, the main raw material here is known as Crude Oil, which is refined
to various degrees to get many valuable end products, like – Petrol, Diesel,
Gasoline, Jet fuel, Lubricating oil, waxes, Asphalt and many more. So, it is
very easily understood how valuable all the end items of crude oil are- specifically
in today’s modern lifestyle.
If you
think about the production side, there are 2 main phases- First, extraction of
crude oil from the depths of the earth and the second is then refining the
extracted crude oil. The second phase is more of an Engineering problem and can
be easily mitigated. However, the distribution of crude oil under the earth’s
crust is not homogeneous at all and thus extraction of it poses more challenges
and geopolitical tensions.
If we go
back in time a little bit, people started to understand the impact and
importance of crude oil mainly in the beginning of the twentieth century. Efforts
were made to locate plausible places where crude oil can be extracted from. It
was observed that a very large proportion… more than almost 70 percent of the
proven oil reserves are under the authority of a handful of countries. So,
while the demand of crude oil and its’ end products keep rising globally, the
supply of it can be controlled by a few countries. This is where OPEC came to
the scene.
Like any
other product, crude oil price was also dependent on the demand and the supply.
With technological revolution, the demand kept rising whereas supply was
controlled by a few countries. Most of the countries with no or small oil
reserves have to rely on importing it. Countries holding oil reserves started
outbidding each other in a fierce competition for selling.
OPEC stands
for Organizations of the Petroleum Exporting Countries. The exact reason for
its creation is controversial, but it can be opined that it might be to preserve
their own interests. OPEC was basically formed by countries like- Saudi Arabia,
UAE, Iran, Iraq, Kuwait, Libya, Nigeria, Venezuela etc. who hold almost 70
percent of the total oil reserves. All these countries basically created a
united front to control the oil market. Their main agenda being- controlling
and modifying total oil production and export of its’ member countries and thus
affecting the global supply chain. The end result- the oil price is more or
less dictated by these OPEC countries.
Now, all
these that I talked about, they are pretty much what happens in the oil market
all the time. But special events can affect this whole supply chain in
surprising ways. When Covid-19 pandemic started, many nations went into
complete lockdown with commercial transportation coming to a halt. So, the
demand for most of the petroleum products went down sharply. There were a lot
of surplus production in spite of OPEC’s effort to cut down the production. Thus,
the oil price decreased.
Similarly,
Russia’s invasion of Ukraine has some severe effects. Russia is one of the few
non-OPEC member countries who has a sizeable crude oil export amount. Due to the
invasion, many European and non-European countries have put different sanctions
on Russia. Transport and thus supply will take a hit as well, which would then
put a pressure on the price. An open war also creates fluctuation in energy
demands and thus affecting the supply-chain logistics. Rising diplomatic and
political tensions would also affect the price. Most of these would likely
result in a price hike for crude oil- as we are observing for the last few
weeks.
What is in
store for the future?
It’s hard
to predict exactly what would happen here on as there are multiple factors in
play. Increasing environmental awareness and Govt backing have pushed the
search and implementation of alternate energy sources. EV or electronics
vehicles have gained much popularity in the Automobile industry. Solar energy
has taken its market share. Technological advancements have helped in
extracting crude oil from shells and thus spreading the oil reserve distribution.
Most of these though are for long term. In the short term, unless we see a
quick resolution of conflict between Russia and Ukraine, it seems like the only
way for Oil price, is to go up.
References:
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