Oil prices are determined by demand and supply. Changes in oil prices are the result of shifts in demand and/or supply, with the size of the price change depending on the size of the shift and the price elasticity of demand and supply.
Some of the shifts are long term, with the price of oil varying from year to year or even moving in a particular direction for longer periods of time. Thus the opening up of new supplies, such as from fracking wells, can lead to a long-term fall in oil prices, while agreements by, say, OPEC to curb output can lead to a long-term rise in prices (see the blogs The oil see-saw, OPEC deal pushes up oil prices and An oil glut).
Medium and long-term price movements can also reflect medium and long-term changes in demand, such as a recession – oil prices fell dramatically as the world economy slid into recession in 2008/9 and then recovered as the global economy recovered.
Another long-term factor is the development of substitutes, such as renewable energy, which can reduce the demand for oil; another is developments that economise on power, such as more fuel-efficient vehicles and machines.
But oil prices do not just reflect these long-term movements in demand and supply. They also reflect daily and weekly movements as demand and supply respond to global and national events.
Two such events occurred at the end of August/beginning of September this year. The first was Hurricane Harvey. Even though it was downgraded to a tropical storm as it made landfall across the coast of the Gulf of Mexico, it dumped massive amounts of rain on southern Texas and Louisiana. This disrupted oil drilling and refining, shutting down a quarter of the entire US refining capacity. 
The initial effect was a surge in US oil prices in late August as oil production in much of Texas shut down and a rise in petrol prices as supplies from refineries fell.
Then prices fell back again in early September as production and refining resumed and as it became apparent that there had been less damage to oil infrastructure than initially feared. Also the USA tapped into some of its strategic oil reserves to make up for the shortfall in supply.
Then in early September, the North Koreans tested a hydrogen bomb – much larger than the previous atom bombs it had tested. This prompted fears of US retaliation and heightened tensions in the region. As the Reuters article states:
That put downward pressure on crude as traders moved money out of oil – seen as high-risk markets – into gold futures, traditionally viewed as a safe haven for investors. Spot gold prices rose for a third day, gaining 0.9 per cent on Monday
Quite large daily movements in oil prices are not uncommon as traders respond to such events. A major determinant of short-term demand is expectations, and nervousness about events can put substantial downward pressure on oil prices if it is felt that there could be a downward effect on the global economy – or substantial upward pressure if it is felt that supplies might be disrupted. Often markets over-correct, with prices moving back again as the situation becomes clearer and as nervousness subsides.
Articles
U.S. crude edges higher, gasoline tumbles after Harvey Reuters, Libby George (4/9/17)
Global oil prices fall after North Korea nuclear weapon test Independent, Henning Gloystein (4/9/17)
Brent crude oil falls after North Korea nuclear test The Indian Express (4/9/17)
Oil prices remain volatile AzerNews, Sara Israfilbayova (4/7/17)
Questions
- What are the determinants of the price elasticity of demand for oil?
- Search news articles to find some other examples of short-term movements in oil prices as markets responded to some political or natural event.
- Why do markets often over-correct?
- Explain the long-term oil price movements over the past 10 years.
- Why is gold seen as a ‘safe haven’?
- If refineries buy oil from oil producers, what would determine the net effect on oil prices of a decline in oil production and a decline in demand for oil by the refineries?
- What role does speculation play in determining oil prices? Explain how such speculation could (a) reduce price volatility; (b) increase price volatility. Under what circumstances is (b) more likely than (a)?
If you want a ticket for an event, such as a match or a concert, but the tickets are sold out, what do you do? Many will go to an agency operating in the ‘secondary market’. A secondary market is where items originally purchased new, such as tickets, company shares, cars or antiques, are put up for sale at a price that the market will bear.
The equilibrium price in a secondary market is where supply equals demand and the actual price will approximate to this equilibrium. In the case of tickets, this equilibrium price can be much higher than the original price sold by the venue or its agents. The reason is that the original price is below the equilibrium.
This is illustrated in the figure (click here for a PowerPoint). Assume that the total supply of tickets is Qs. Assume also that the official box office price is Pbo
and that demand is given by the demand curve D. At the box office price demand exceeds supply by Qd – Qs. There is thus a shortage, with many fans unable to obtain a ticket at the official price. Many of you will be familiar with having to be as quick as possible to get hold of tickets where demand considerably outstrips supply. Events such as Glastonbury sell out within seconds of coming on sale.
If you buy a ticket and then find out you cannot go to the event, you can sell the ticket on the secondary market through an online site or agency. Such agencies could be seen as providing a useful service as it means that otherwise empty seats will be filled. But if the equilibrium price is well above the original ticket price, there is the potential for huge gain by the agencies, who may pay the seller considerably less than the agency then sells the ticket to someone else.
What is more, the difference between the original price and the equilibrium price in the secondary market makes ticket touting, or ticket ‘scalping’, highly profitable. This is where people buy tickets with no intention of using them themselves but in order to sell them at much higher prices on the secondary market. Such ticket touting has been illegal for football matches since 1994 and was illegal for the 2012 London Olympics, but it is legal for plays, concerts, festivals and other events.
Ticket touts are often highly organised in obtaining tickets at official prices by buying early and using multiple credit cards and multiple identities to avoid systems that restrict the number of tickets issued to a card. They often use internet bots to mass purchase tickets the moment they go on sale.
Those in favour of ticket touting argue that the high price in the secondary market is just a reflection of demand and supply (see the IEA article below). Ticket touting allows tickets to be directed to people who value them most and will get the greatest benefit from it. What is more, banning ticket touting, so the argument goes, would simply drive it underground.
Those against argue on grounds of equity. Ticket prices set below the equilibrium are designed to give greater equality of access to fans. Rationing on a first-come first-served system, either on the internet or by a queue, is seen to be fairer than one by ability/willingness to pay. A poor person may be just as keen to go to an event as a rich person and gain just as much enjoyment from it, but cannot afford the high equilibrium price. What is more, non of the profit from the higher prices reaches the event organisers or the artists or players. Yet the mark-up and hence profit made by ticket touts can be massive, as the first Observer article below shows.
Various measures are being tried to prevent ticket touting. One is the use of paperless tickets, with the number of tickets limited per person and with people having to show their ticket on their phones along with ID at the door or gate. If a person cannot attend, then the solution is a system where they can give the ticket back to the box office (perhaps electronically) which will re-sell it for them at the official price.
A government-backed investigation, the Waterson review reported in May 2016 and recommended that touts should be licensed and that there should be harsher penalties for firms that flout consumer rights law as applying to ticket sales. Whether this would be sufficient to bring secondary market prices down significantly, remains to be seen. In the meantime, organisers do seem to be trying to find ways of beating the touts through smarter means of selling.
Articles
MP Nigel Adams calls for secondary ticket marketing to be reformed Music Week, James Hanley (14/9/16)
Iron Maiden go to war with ticket touts BBC News, Mark Savage (22/9/16)
The new age of the ticket tout BBC World Tonight, Andrew Hosken (25/5/16)
Government urged to help music industry tackle ticket touts The Guardian, Rob Davies (13/9/16)
Ticket touts face licensing threat The Guardian, Rupert Jones (26/5/16)
How the ticket touts get away with bleeding fans dry The Observer, Rob Davies and Rupert Jones (15/5/16)
What sorcery is this? A £140 ticket for new Harry Potter play now costs £8,327 The Observer, Rob Davies and Laurie Chen (14/8/16)
Ticket touts made $3m from the last Mumford & Sons tour. $0 went back to the music industry. Music Business Woldwide, Adam Tudhope (6/9/16)
This is tout of order – join the Daily Mirror campaign to beat rip-off ticket resales Daily Mirror, Nada Farhoud (19/9/16)
Ticket touts: A muggle’s game The Economist (20/8/16)
Can We Fight Back Against The Robot Touts Ruining Live Music? Huffington Post, Andy Webb (6/9/16)
In defence of ticket touts Institute of Economic Affairs, Steve Davies (25/2/15)
Report
Consumer protection measures applying to ticket resale: Waterson review Department for Business, Innovation & Skills and Department for Culture, Media & Sport 26/5/16)
Guide
#Toutsout MMF & FanFair Alliance September 2016
Questions
- Why can ticket touts sell tickets above the equilibrium price shown in the diagram?
- In what ways could ticket touts be said to be distorting the market?
- How do ticket touts reduce consumer surplus? Could they reduce it to zero?
- Why may allowing ticket touting to take place result in empty seats at concerts or other events?
- Would it be a good idea for event organisers to charge higher prices for popular events than they do at present, but still below the equilibrium
- How does the price elasticity of demand influence the mark-up that ticket touts can make? Illustrate this on a diagram similar to the one above.
- Is it in ticket touts’ interests to adjust prices as an event draws closer, just as budget airlines adjust seat prices as the plane fills up? Could organisers sell tickets in the primary market in this way with prices rising as the event fills up?
- Discuss the various ways in which the secondary ticket market could be reformed? To what extent do these involve reforms in the primary ticket market?
Your Americano, Latte or Cappuccino may soon be more expensive. This is because coffee bean prices are rising. A combination of continuing growth in demand and poor coffee harvests in various parts of the world have led to a rise in both Arabica and Robusta prices, with the International Coffee Organization’s Composite Indicator price (in US dollars) having risen by over 30% since mid-January this year (see chart below: click here for a PowerPoint)
Supply has been affected by droughts in Brazil and Vietnam, two of the world’s biggest coffee producers, and by pests (the Coffee Berry Borer) in the Kilimanjaro region of Tanzania and in other East African countries. Global exports of coffee in July 2016 were 22% down on the same month in 2015.
The growing shortage and rising current (spot) prices is reflected in future prices. 
These are prices determined in the market now for trading at a specified future date (e.g. in three months’ time). Future prices depend on predictions of the balance of demand and supply in the future. According to the MarketWatch article below, “Analysts at Société Générale in a note predicted that prices could climb about 30% further by the end of next year”. The current (mid-September) spot price of robusta coffee beans is around $0.96 per lb. The December 2016 future price is around $1.48.
So what effect will this have on the prices in Starbucks, Costa or Caffè Nero? And what effect will it have on ground or instant coffee in supermarkets? To quote the MarketWatch article again:
A research report from the US Department of Agriculture found that, on average, a 10% increase in green-coffee-bean prices per pound would yield a 2% increase in both manufacturer prices and at the register in places like Starbucks Corp.
This is because the cost of coffee beans is just one element in the costs of coffee roasters and coffee shops. Also these companies use futures markets to smooth out the prices they pay. They hold stockpiles of coffee, which they build up when prices are low and draw on when prices are high. This helps to reduce fluctuations in retail prices.
So don’t worry too much about the price of your morning coffee – at least, not yet.
Articles
Why a surge in coffee-bean prices may not hit the Starbucks set—yet MarketWatch, Rachel Koning Beals (9/9/16)
Wired coffee prices may not slip far News Markets, David Cottle (9/9/16)
Late-harvest woes prompt Brazil coffee harvest downgrade Agrimoney (7/9/16)
Look Out, Latte Lovers: Brazil Drought Hurts Espresso Beans Bloomberg, Fabiana Batista and Marvin G. Perez (13/9/16)
Why Your Morning Coffee Is About to Become Even More Expensive Fortune (28/7/16)
Climate change brews a storm for East Africa coffee farmers Business Daily (East Africa), Paul Redfern (4/9/16)
Coffee Market Report ICO (August 2016)
Data
Commodity Prices Index Mundi
Historical Data on the Global Coffee Trade ICO
ICO’s Coffee Trade Statistics Infographic for July 2016 ICO blog (31/8/16)
Questions
- What determines coffee futures prices?
- How are the price fluctuations of coffee in coffee shops related to the price elasticities of demand and supply? What determines these elasticities?
- Why does a strengthening (an appreciation) of the currency of a coffee exporter affect (a) the price of coffee to producers in the country; (b) international coffee prices in dollars?
- Are poor coffee harvests on balance good or bad for coffee producers? How does this depend on the market price elasticity of demand? Does the answer vary from producer to producer?
- How does speculation affect coffee prices (both spot and future)? Is such speculation of benefit to (a) the coffee consumer; (b) the coffee grower?
The demand for oil is growing and yet the price of oil, at around $46 per barrel over the past few weeks, remains at less than half that of the period from 2011 to mid 2014. The reason is that supply has been much larger than demand. The result has been a large production surplus and a growth in oil stocks. Supply did fall somewhat in October, which reduced the surplus in 2015 Q3 below than of the record level in Q2 – but the surplus was still the second highest on record.
What is more, the modest growth in demand is forecast to slow in 2016. Supply, however, is expected to decrease through the first three quarters of 2016, before rising again at the end of 2016. The result will be a modest rise in price into 2016, to around $56 per barrel, compared with an average of just over $54 per barrel so far for 2015 (click here for a PowerPoint of the chart below).
But why does supply remain so high, given such low prices? As we saw in the post The oil industry and low oil prices, it is partly the result of increases in supply from large-scale investment in new sources of oil over the past few years, such as the fracking of shale deposits, and partly the increased output by OPEC designed to keep prices low and make new investment in shale oil unprofitable.
So why then doesn’t supply drop off rapidly? As we saw in the post, A crude indicator of the economy (Part 2), even though shale oil producers in the USA need a price of around $70 or more to make investment in new sources profitable, the marginal cost of extracting oil from existing sources is only around $10 to £20 per barrel. 
This means that shale oil production will continue until the end of the life of the wells. Given that wells typically have a life of at least three years, it could take some time for the low prices to have a significant effect on supply. According to the US Energy Information Administration’s forecasts, US crude oil production will drop next year by only just over 5%, from an average of 9.3 million barrels per day in 2015 to 8.8 million barrels per day in 2016.
In the meantime, we can expect low oil prices to continue for some time. Whilst this is bad news for oil exporters, it is good news for oil importing countries, as the lower costs will help aid recovery.
Webcasts
IEA says oil glut could worsen through 2016 Euronews (13/11/15)
IEA Says Record 3 Billion-Barrel Oil Stocks May Deepen Rout BloombergBusiness, Grant Smith (13/11/15)
Articles
IEA Offers No Hope For An Oil-Price Recovery Forbes, Art Berman (13/11/15)
Oil glut to swamp demand until 2020 Financial Times, Anjli Raval (10/11/15)
Record oil glut stands at 3bn barrels BBC News (13/11/15)
Global oil glut highest in a decade as inventories soar The Telegraph, Mehreen Khan (12/11/15)
The Oil Glut Was Created In Q1 2015; Q3 OECD Inventory Movements Are Actually Quite Normal Seeking Alpha (13/11/15)
Record oil glut stands at 3 billion barrels Arab News (14/11/15)
OPEC Update 2015: No End To Oil Glut, Low Prices, As Members Prepare For Tense Meeting International Business Times, Jess McHugh (12/11/15)
Surviving The Oil Glut Investing.com, Phil Flynn (11/11/15)
Reports and data
Oil Market Report International Energy Agency (IEA) (13/11/15)
Short-term Energy Outlook US Energy Information Administration (EIA) (10/11/15)
Brent Crude Prices US Energy Information Administration (EIA)
Questions
- Using demand and supply diagrams, demonstrate (a) what has been happening to oil prices in 2015 and (b) what is likely to happen to them in 2016.
- How are the price elasticities of demand and supply relevant in explaining the magnitude of oil price movements?
- What are oil prices likely to be in five years’ time?
- Using aggregate demand and supply analysis, demonstrate the effect of lower oil prices on a national economy.
- Why might the downward effect on inflation from lower oil prices act as a stimulus to the economy? Is this consistent with deflation being seen as requiring a stimulus from central banks, such as lower interest rates or quantitative easing?
- Do you agree with the statement that “Saudi Arabia is acting directly against the interests of half the cartel and is running OPEC over a cliff”?
- If the oil price is around $70 per barrel in a couple of years’ time, would it be worth oil companies investing in shale oil wells at that point? Explain why or why not.
- Distinguish between short-run and long-run shut down points. Why is the short-run shut down price likely to be lower than the long-run one?
Over the past three months oil prices have been falling. From the beginning of September to the end of November Brent Crude has fallen by 30.8%: from $101.2 to a four-year low of $70.0 per barrel (see chart below: click here for a PowerPoint). The fall in price has been the result of changes in demand and supply.
As the eurozone, Japan, South America and other parts of the world have struggled to recover, so the demand for oil has been depressed. But supply has continued to expand as the USA and Canada have increased shale oil production through fracking. 
As far as OPEC is concerned, rather than cutting production, it decided at a meeting on 27 November to maintain the current target of 30 million barrels a day.
The videos and articles linked below look at these demand and supply factors and what is likely to happen to oil prices over the coming months.
They also look at the winners and losers. Although falling prices are likely in general to benefit oil importing countries and harm oil exporting ones, it is not as simple as that. The lower prices could help boost recovery and that could help to halt the oil price fall and be of benefit to the oil exporting countries. But if prices stay low for long enough, this could lower inflation and even cause deflation (in the sense of falling prices) in many countries. This, in turn, could dampen demand (see the blog post, Deflation danger). This is a particular problem in Japan and the eurozone.
Major oil importing developing countries, such as China and India, however, should see a boost to growth from the lower oil prices.
Some oil exporting countries will be harder hit than others. Russia, in particular, has been badly affected, especially as it is also suffering from the economic sanctions imposed by Western governments in response to the situation in Ukraine. The rouble has fallen by some 32% this year against the US dollar and nearly 23% in the past three months alone.
Then there are the environmental effects. Cheaper oil puts less pressure on companies and governments to invest in renewable sources of energy. And then there are the direct effects on the environment of fracking itself – something increasingly being debated in the UK as well as in the USA and Canada.
Videos
Oil price at four-year low as Opec meets BBC News, Mark Lobel (27/11/14)
Opec losing control of oil prices due to US fracking BBC News, Nigel Cassidy (4/12/13)
How the price of oil is set – video explainer The Telegraph, Oliver Duggan (28/11/14)
How Oil’s Price Plunge Impacts Wall Street Bloomberg TV, Richard Mallinson (28/11/14)
Oil Prices Plummet: The Impact on Russia’s Economy Bloomberg TV, Martin Lindstrom (28/11/14)
Articles
Oil prices plunge after Opec meeting BBC News (28/11/14)
Crude oil prices extend losses Financial Times, Dave Shellock (28/11/14)
Oil price plunges after Opec split keeps output steady The Guardian, Terry Macalister and Graeme Wearden (27/11/14)
Falling oil prices: Who are the winners and losers? BBC News, Tim Bowler (17/10/14)Hooray for cheap oil BBC News, Robert Peston (1/12/14)
Russian Recession Risk at Record as Oil Price Saps Economy Bloomberg, Andre Tartar and Anna Andrianova (28/11/14)
Rouble falls as oil price hits five-year low BBC News (1/12/14)
Data
Brent Spot Price US Energy Information Administration (select daily, weekly, monthly or annual: can be downloaded to Excel)
Spot exchange rate of Russian rouble against the dollar Bank of England
Questions
- Use a diagram to illustrate the effects of changes in the demand and supply of oil on oil prices.
- How does the price elasticity of demand and supply of oil affect the magnitude of these price changes?
- Explain whether (a) the demand for and (b) the supply of oil are likely to be relatively elastic or relatively inelastic? How are these elasticities likely to change over time?
- Distinguish between the spot price and forward prices of oil? If the three-month forward price is below the spot price, what are the implications of this?
- Analyse who gains and who loses from the recent price falls.
- What are the effects of a falling rouble on the Russian economy?
- What are likely to be the effects of further falls in oil prices on the eurozone economy?
Oil prices are determined by demand and supply. Changes in oil prices are the result of shifts in demand and/or supply, with the size of the price change depending on the size of the shift and the price elasticity of demand and supply. 
The initial effect was a surge in US oil prices in late August as oil production in much of Texas shut down and a rise in petrol prices as supplies from refineries fell.
