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The Price of Petroleum Products

Crude oil prices have been on the declining trend since the middle of 2014, where there was a recorded drop of more than 50%. Prior to that, oil prices were moving in a band of between US$100 to US$120 per barrel since 2009. Oil price movement has both positive and negative implications to different countries. What are the factors contributing the current drop in the world oil prices? Is this episode of oil price drop good or bad for the world economy?

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Prices of liquid petroleum products are determined mainly by the behavior of crude oil. Crude oil is a world commodity and its price depends upon supply and demand. The price of crude oil has been on a declining trend since the second half of last year. During that period, the price dropped for more than 50% after recorded the highest price of about USD120 per barrel in the middle of last year. From then until now, it has fell to a below USD50 per barrel mark. This was the second big price drop in a decade. The last big drop was in 2009.
What are the factors contributing to the current episode of declining prices? What are the implications to the world economy? These two questions are very relevant in addressing the issue of declining oil prices. Knowing the factors responsible for oil price movement will help us anticipate necessary precautionary measures on a timely manner. Whereas, understanding its implication to the economy is crucial for policy decision.

The movement of crude oil prices is influenced by both the supply and demand and the interaction between the two. The demand for crude oil is derived from world economic situation. High economic growth is associated with strong demand for crude oil and will put an upward pressure on prices. Supply behavior is determined by the behavior of oil-producing countries. There are three distinct groups of producing countries with conflicting interest influencing the supply side. The first group is the non-OPEC big oil producers, such as the United States, Russia and Canada. The other two groups are within OPEC itself, which may not always be in agreement among them. This is the main challenge of a cartel, which is to get all members to comply with quota allocation. Within the industry, these two groups are known as the "hawks" and the "doves" of the OPEC.

The hawks are those oil-producing countries with smaller reserves relative to population, such as Iran and Iraq. The price hawks are pressing for lower output and higher prices. The doves are the OPEC member nations with larger reserves relative to population, such as Saudi Arabia, Kuwait, and the United Arab Emirates. They are in favor for higher output and lower prices, so as to preserve their market share over the longer term in order to increase the economic value of their oil resources. With relatively higher oil prices, consumers will find ways to reduce consumption below levels that otherwise would have prevailed.

Saudi Arabia sits on the largest oil reserve, and is also one of the biggest producers in the world. Therefore, it is only natural for the Saudi's to endeavor to maintain their market share. It is not in the best interest for the Saudis to take any short-term advantage of oil price movements ...

Solution Summary

The price of petroleum products is positively related to the price of crude oil. Crude oil prices, in turn, are determined by the supply and demand condition in the world. The supply behavior is influenced by interactions among oil producing countries, particularly within OPEC (that produces about half of the world crude oil). On the demand side, world economic condition determines global oil demand. Strong economic growth is associated with strong oil demand and vice versa.