Oil prices have been rising in recent weeks. At the beginning of October 2010, the spot price of Brent Crude was $80 per barrel. By December it has passed $90 per barrel. There is some way to go before it gets to the levels of mid-2008, when it peaked at over $140 per barrel (only then to fall rapidly as the world slid into recession, bottoming out at around $34 per barrel at the end of 2008).
Higher oil prices are a worry for governments around the world as they threaten higher inflation and put recovery from recession in jeopardy. You will probably have noticed the higher petrol prices at the pumps. If you spend more on petrol, you will have less to spend on other things.
So why have oil prices risen and are they likely to continue rising? The following articles examine the causes of the recent surge and look ahead to the likely response from OPEC and the path of oil prices next year.
Articles
Saudi Arabia to Check Oil Rally in 2011, Merrill’s Blanch Says Bloomberg, Juan Pablo Spinetto (13/12/10)
OPEC Cheating Most Since 2004 as Options Signal Oil Hitting $100 Next Year Bloomberg, Grant Smith and Margot Habiby (13/12/10)
Oil higher after OPEC output rollover; eyes on China Reuters, Christopher Johnson (13/12/10)
Central heating oil price shoots up by 70pc The Telegraph, Harry Wallop (10/12/10)
Speculators driving up price of oil St. Louis Post-Dispatch, Kevin G. Hall (12/12/10)
UK petrol prices reach record high BBC News (10/12/10)
Data
Brent cude oil prices (daily) U.S. Energy Information Administration (use the bar at the top to switch between daily, weekly, monthly and annual prices)
Commodity Prices Index Mundi
OPEC Basket Price and other data OPEC
Questions
- Explain why oil prices have been rising. Use a diagram to illustrate your answer.
- How can the concepts of price elasticity of demand, income elasticity of demand and price elasticity of supply help to explain the magnitude of oil price movements?
- Examine what is likely to happen to oil prices over the coming months. What are likely to be the most important factors in determining the direction and size of the price movements? Distinguish between demand-side and supply-side effects in your answer.
- What are ‘crude futures’? Explain how actions in the futures market are likely affect spot prices.
- To what extent can OPEC control oil prices?
- If crude oil prices go up by x%, would you expect petrol station prices to go up by approximately x%, or by more than or less than x%? Explain.
- Why have central heating oil prices risen by around 70% of over the past three months? What are the implications of your answer for the type of market structure in which central heating oil companies are operating?
House prices are in the news again, but that should come as no surprise because they are such a favourite topic of the British! Three different organisations – the Halifax Bank, the Nationwide Building Society and Rightmove – have all reported that house prices fell in November. The Halifax reported a 0.1% fall, the Nationwide a 0.3% fall and Rightmove a 3.2% fall. The Halifax and Nationwide base their figures on house price information supplied by prospective mortgage applicants while Rightmove report the average asking price of those putting their property on to the market. We should not worry too much about the variations in the magnitude of the reported price falls because the downward trend in house prices is now pretty well established. The Halifax, for instance, has reported five monthly falls since April and they estimate that the average house price over the three months to November is 0.7% lower than a year ago. While the other two organisations are still reporting annual house price inflation rates in positive territory, these rates too are edging closer and closer to negative territory.
The recent falls in house prices come after a rebound in prices in the second half of 2009 which carried on into the early months of this year. The Nationwide had annual house price inflation rates peaking in the spring at around the 10% mark. This appears to have reflected an increase in housing demand and can be seen in the Bank of England mortgage approval numbers for house purchase which recovered from as low as 26,702 in November 2008 to 59,215 in November 2009. By April, Rightmove was reporting that property supply was beginning to outstrip demand and in their May report they noted that suppliers were coming on to the market more quickly than at any time since June 2008. It is argued that supply increased further through late May and into June when the new coalition government suspended house information packs (HIPs). HIPs were a set of documents, including a property information questionnaire, which a seller needed to provide before a property could be marketed.
Rightmove reported in their November press release that the number of new sellers coming to the market each week between 10 October and 6 November averaged 24,028. This was a fall of 9.1% on the previous 4-week period. But, we need to see this reduction in the context of housing demand and the mortgage approvals numbers again provide clues as to the strength of housing demand. The fall in approvals in October to just 47,185 approvals was the sixth consecutive monthly fall. This number of approvals, as Rightmove note, is about half the monthly number of additional properties coming on to the market. In other words, the flow of properties coming on to the market is contributing to a large stock of properties on the books of estate agents. While some existing suppliers have been taking their property off the market, Rightmove note that the current average number of unsold properties on estate agents’ books is only a little down on the historic high reported a couple of months back. This leaves sellers fighting over a limited number of prospective buyers.
In the short term, the extent of further downward pressure on house prices will depend on extent of the imbalance between demand and supply. If a large number of suppliers begin to remove their property from the market, perhaps on the hope that the market will improve later next year, this would help to address the imbalance. Equally, if first-time buyers were to return to the market in larger numbers then that too would help to alleviate downward pressure on prices. The latter, however, is unlikely given the tight credit conditions which are resulting in potential first-time buyers struggling to find the deposit needed to get on to the property ladder. It seems that while many wannabe buyers of property may have a willingness to purchase, their ability to purchase continues to be frustrated by their inability to find the necessary deposit.
Articles
House prices slip further in November Financial Times, Norma Cohen (9/12/10)
Bonus for first-time buyers as house prices plummet for the third month in a row Daily Mail (9/12/10)
House prices drop fort he third month, has the bubble burst? London Daily News (9/12/10)
House prices fall 0.1% but hopes rise Independent, Peter Cripps (9/12/10)
House prices drop amid mortgage ‘deep freeze’ Telegraph, Myra Butterworth (9/12/10)
Data
Mortgage approval numbers are available from the Bank of England’s statistics publication, Monetary and Financial Statistics (Bankstats) (See Table A5.4.)
Halifax House Price Index Halifax (part of the Lloyds Banking Group)
Nationwide House Price Index Nationwide Building Society
Rightmove House Price Index Rightmove
Live Tables on Housing Market and House Prices Department of Communities and Local Government
Questions
- Tracking house prices is like following a roller-coaster ride! See if you can re-tell the story of UK house prices over the past year using demand and supply diagrams.
- Why do you think UK house prices are so volatile? Can you point to any other market where prices are so volatile? If so, do they share any common features?
- How important are first-time buyers in affecting house prices? What factors do you think affect the number of prospective first-time buyers deciding to enter the housing market?
- Using a demand and supply diagram illustrate the effect on house prices of: (i) a tightening of financial institutions’ lending criteria; (ii) the expectation of forthcoming house price falls; and (iii) increasing economic confidence .
- Although UK house prices are volatile they do increase over the longer-term and by more than the average price of consumer goods and services. What might explain this?
- What do we mean by a demand-supply imbalance? Would you expect this imbalance to continue?
- The average house price is currently falling. But, different housing markets will have their own price patterns. What might explain any differences in house price patterns across different housing markets?
The owner-occupied housing market has seen widespread coverage. With house prices falling throughout the recession and problems accessing mortgages for many people, it is this sector of housing that has received most attention. However, it is rental homes that we’ll be considering here and a new strategy being adopted by landlords. As access to mortgages dried up, people instead turned to renting. Demand for rental properties began to increase, such that competition between potential tenants increased significantly. Not only has there been a substantial increase in rents – up by some 35%, but it has also led to a new ‘sealed bid’ strategy.
A strategy that is often used for purchasing houses is where potential buyers submit sealed bids and it is this approach which is now spreading to the rental sector, as demand and competition for properties increases. Potential tenants are required to submit a sealed bid, containing the amount that they are willing to pay to rent out the property and all this must be done within a deadline. Whoever submits the highest bid ‘wins’ the property and hence tenants are encouraged to submit a bid at or close to the maximum they are willing to pay. Landlords insist that they are not trying to force tenants to pay more, but that it is simply the most effective way of letting properties that are short in supply, but face significant demand. As the BBC News article states:
‘It seems that with the current state of the housing market, sealed bids will be here to stay – as long as many would-be renters are chasing a dwindling supply of good rental homes.’
Rental ‘gazumping on the up as demand rises Metro, Tariq Tahir (8/11/10)
’Bidding war’ for homes to rent BBC News, Nigel Cassidy (20/11/10)
Rental market’s now so hot tenants are having to make sealed bids Mail Online, Sebastien O Kelly (8/11/10)
Is the buy-to-let market on its way back? Seek4Media (20/11/10)
Gazumping on the rise as London rental soars Gulf Times, London Evening Standard (8/11/10)
Questions
- Using a supply and demand diagram, explain the trend we have seen in the rental market, thinking about the impact on demand, supply and hence on price. How does this explain why sealed bids have been used to combat the increased competition?
- Which factors have affected (a) the demand for rental properties and (b) the supply of rental properties? How is the elasticity of demand and supply relevant here in terms of the impact on price?
- To what extent is a sealed bid format fair on potential tenants? Who does such a strategy favour?
- How could this sealed bid strategy be an example of price discrimination?
- What is likely to happen to your consumer surplus if you have to submit a sealed bid?
Governments and businesses across the world have been trying to become more environmentally friendly, as everyone becomes more concerned with climate change and emissions. In the UK, incentives had been put in place to encourage large-scale organisations to reduce their consumption of gas and electricity. The Carbon Reduction Commitment Scheme began in April 2010, with companies and public-sector orgainisations required to record their energy consumption. Then in April 2011 it was planned that those consuming over 6000 MWh of electricity per year (about £500,000 worth) would be required to purchase ‘allowances’ of £12 for each tonne of carbon dioxide that is emitted by their use of fuel: electricity, gas, coal and other fuels. This would require the organisations working out their ‘carbon footprint’, using guidance from the Department of Energy and Climate Change. In the case of coal and gas, the emissions would be largely from burning the fuel. In the case of electricity it would be largely from generating it.
The government had intended to use the revenue received from the sale of allowances to pay subsidies to those firms which were the most successful in cutting their emissions.
By raising money from the largest emitters via a levy and giving it back as a ‘refund’ to those who cut their usage the most, the government would not have been able to raise any revenue, but it did tackle the core of the problem – reducing emissions. However, following the Spending Review, this scheme will now actually generate revenue for the government. Paragraph 2.108 on page 62 of the Spending Review states the following:
The CRC Energy Efficiency scheme will be simplified to reduce the burden on businesses,
with the first allowance sales for 2011-12 emissions now taking place in 2012 rather than 2011. Revenues from allowance sales totalling £1 billion a year by 2014-15 will be used to support the public finances, including spending on the environment, rather than recycled to participants. Further decisions on allowance sales are a matter for the Budget process.
Over 5000 firms and other organisations will now find that their hard work in cutting usage and being more environmentally friendly will give them much less reward, as the revenue raised from the levy will remain in the Treasury. All that firms will now gain from cutting emissions is a reduction their levy bill. The extra £1bn or more raised each year from the scheme will undoubtedly be beneficial for tackling the budget deficit, but it will no longer provide subsidies to firms which reduce their emissions. Furthermore, PriceWaterhouseCooper estimates that it will cost businesses with an average gas and electricity bill of £1 million an extra £76,000 in the first year and this may increase to an additional cost of £114,000 per year by 2015.
It’s hardly surprising that businesses are angry, especially when this withdrawal of subsidy, which some have dubbed a ‘stealth tax’, was not mentioned in the Chancellor’s speech, but was left to the small print of the Spending Review announcement. The following articles look at this highly controversial plan.
Articles
Spending Review: Large firms ‘face green stealth tax’ BBC News (21/910/10)
Business lose out via £1bn-a-year green ‘stealth tax’ Management Today, Emma Haslett (21/10/10)
Fury over £1bn green stealth tax in spending review Telegraph, Rowena Mason (20/10/10)
Is ‘stealth’ tax a threat to UK economy going green? BBC News, Roger Harrabin (20/10/10)
Green spending review – it could have been a whole lot worse Business Green, James Murray (20/10/10)
Coalition hits big business with stealth carbon tax Business Green, James Murray (20/10/10)
UK government hits big businesses with stealth carbon tax Reuters, James Murray (20/10/10)
UK’s carbon tax bombshell takes business by surprise Reuters, Will Nichols and James Murray (21/10/10)
CRC allowances sting in UK Spending Review The Engineer, M&C Energy Group (22/10/10)
The CRC scheme
CRC Energy Efficiency Scheme Department of Energy and Climate Change
Questions
- How does a tax affect the supply curve and what would be the impact on the equilibrium price and quantity?
- To what extent might this “stealth tax” (i.e. withdrawal of subsidy) adversely affect (a) businesses in the UK; (b) the economy more generally?
- Why will firms have to re-look at their cash flow, costs and revenue following this change? How might this affect business strategy?
- By taxing firms using more gas and electricity, what problem is the government trying to solve? (Think about market failure.)
Some numbers are a newspaper editor’s dream! One such number this week was -3.6%. This was the fall in house prices in September reported by the Halifax (part of the Lloyds Banking Group). This certainly helped to alert a large audience to the downward momentum in house price growth that has been underway since about the start of the summer. While the Nationwide Building Society reported a 0.1% rise in September it is significant that both Halifax and Nationwide estimate that across the three months to September house prices actually fell by around 0.9%. In other words, the average UK house price fell by 0.9% in the third quarter of the year.
The annual rate of house price inflation, as the name suggests, compares house prices with the same point in time a year ago. The impact of the house price falls in the third quarter has been to reduce the annual rate of house price inflation to around the 3% mark. While the annual rate is still in positive territory, an obvious concern is how long this will be the case. Well, we can expect the annual rate to fall further because the UK saw strong house price growth in the final quarter of 2009 – the Nationwide estimates this to have been 2.2%. If I (Dean) was to throw my hat in the ring and hazard a guess as to the annual rate of house price inflation in the final quarter of 2010, I’d be inclined to say that it would be around the zero mark. If my crystal ball is found to be right, it would mean that house prices will end 2010 no higher than they finished 2009.
Now this is going to surprise you, but there has been considerable agreement amongst economists as to the reasons behind the recent house price falls. In short, it has been shifts in housing demand and supply. The evidence, such as that from estate agents, points to increases in houses prices during the second half of 2009 and the early part of this year as having induced additional housing supply. This means that estate agents saw instructions to sell increase strongly. People felt a little more confident about putting their property on the market and there was also a recovery in the volumes of new homes constructed.
So far, so good, you might think. But, as this year has moved on growing uncertainty about the economic environment and the on-going difficulties facing many potential buyers, especially first-time buyers, in obtaining mortgage credit, has contributed to a weakening of demand. The impact on the number of potential first-time buyers has been particularly acute because, by being increasingly credit-constrained, they have in effect become increasingly deposit-constrained too. The point is that buyers, especially first-time buyers, are being asked to find relatively large deposits to compensate for limited mortgage credit and both their limited ability and willingness to find these deposits is impacting on housing demand. So with a weakening demand we have been left with what Rightmove describes as a ‘supply hangover’. The effect has been for prices to fall.
It is a feature of housing markets that demand–supply imbalances induce considerable volatility in house prices. Going forward, it will continue to be the relative magnitudes of instructions to buy (housing demand) and of instructions to sell (housing supply) that will determine the path of house prices. Just how imbalanced will those estate agents books remain? How long will the supply hangover persist? Could supply increase further as people rush to sell and thereby further destabilising the market? Or will sellers begin taking property off the market, deciding that now is not the time to sell? Questions like these help to show just how real and how exciting the concepts of demand and supply are. Demand and supply are not concepts confined to the pages of textbooks they are alive and at work. The UK housing market demonstrates just how alive they are!
Articles
House prices record worst monthly fall ever Independent, Alistair Dawber (8/10/10)
Regions slip behind in bleak housing market Financial Times, Norma Cohen (8/10/10)
What next for house prices? Telegraph, Kara Gammell (8/10/10)
Fears grow for new market crash as house prices plummet Daily Record, Holly Williams (8/10/10)
Property price plunge blamed on need to sell The Herald, Helen McArdle (8/10/10)
Housing market crash feared after average house prices take record plunge Guardian, Jill Treanor (7/10/10)
UK house prices fell 3.6% in September, Halifax says BBC News (7/10/10)
Data
Halifax House Price Index Halifax (part of the Lloyds Banking Group)
Nationwide House Price Index Nationwide Building Society
Rightmove House Price Index Rightmove
Live Tables on Housing Market and House Prices Department of Communities and Local Government
Questions
- 2010 has been a year of contrasting fortunes for house prices. See if by using a demand and supply diagram you can illustrate the impact of demand and supply shifts on house prices in the first half of the year and then do the same again for more recent months.
- What do Rightmove mean by a ‘supply hangover’? What factors do you think will determine whether this effect persists?
- You become an estate agent. You buy 2 big books. One is to be used to record instructions to buy and the other instructions to sell. You have a meeting with your staff where you discuss those factors that you think will determine how full these two books will be from period to period. What factors do you think you are likely to identify? What impact would one book being fuller than the other have on house prices?
- Explain what we mean by a potential house buyer being credit-constrained. What is meant by a potential buyer being deposit-constrained? Why might first-time buyers be more deposit-constrained than other types of buyers?
- You often hear people talk about the housing market. But, what do we mean by a market? And what do we mean by a housing market? Do prices in all housing markets behave in the same way?
- We’ve seen that there are several institutions that publish an average house price figure. How do you think the likes of Halifax and Nationwide do this? What of Rightmove? Are there any other ways of estimating the average house price? Can you think of any problems that might arise with these estimates?
- It’s now your time for you to dust-off your crystal ball. Imagine that you are employed to write a monthly commentary on UK house prices. What would you expect to be reporting in the coming months?