Oil prices have increased sharply over the past few years. Despite this rise in oil prices, growth of the global economy in all regions of the world is still strong and is expected to remain so for the next few years. The impact of oil price fluctuations on global economic growth has reduced as compared to previous decades. The global output lowered by approximately 1.5% when the oil prices shot up between 2003 and 2005 (EIA, 2008).
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The impact that oil has on growth is quite striking. Many companies are forced to take up new oil prices, change the mode of using their factors of production and also do away with unprofitable sectors. This reduces the profitability of industries. It can also cause world wide recession due to reduction of real wealth as governments increase their protectionism on imports and exports. Major Price shifts may also occur especially in economies that have many monopolies. Various policies all over the world are unsuitable and fail to address the effects of oil prices. Governments from some developing countries have set up systems of control which protect consumers and businesses from the price increases. However, these controls only protect growth in the short-term; in the long run, it affects financial stability and leads a government into debt (Selim, 2008, 300). The governments should focus on both short-term and long-term oil market volatility.
There is a tendency of the players in the oil industry over investing or under investing in oil extraction projects and this leads to mixed cycles. The current high prices are as a result of the underinvestment during the 1990s when the prices were low. For instance, 1997-1999 was characterized by low oil prices which contributed to lowered expenditure in oil exploration. These low prices, however, led to the high prices in 1999 to 2000 (Wright, 2008, 750). .
In the near future, however, the oil prices may collapse again due to growth in emerging markets such as China and India among others. Most oil consuming countries have developed mechanisms to deal with the volatility of oil prices. However, poor global financial systems and rigidity in the economies and policies of oil producing countries has increased the concentration of risks in these producing countries. The producing countries should be assisted in managing oil price volatility and diversification of economic risks. This is the greatest problem that the global economy is expected to address in regards to oil. However, the task may be quite difficult because the oil producers prefer to maintain control over oil production. Non-oil production in the producing countries should be prevented from shocks by diversifying their economies. This could be achieved through improved risk sharing mechanisms in both production and financial markets. Increasing the flexibility of exchange rates could also assist in protecting non-oil production (Mabro, 2006).
Oil price shocks can make existing capital stock obsolete thus pausing production. This may lead to delays of both workers and capital especially in energy intensive industries. Poorer countries suffered considerably in the recent oil price shock. However, most oil consuming countries have become less vulnerable to these oil shocks than they were before. The reasons behind this lessened vulnerability include: Labor markets are more flexible, financial markets have become deeper, monetary policies have become better anchored, final demand in oil consumption has become greater and energy efficiency has also increased. As a matter of fact, the effects of oil supply shocks on global growth have reduced by almost half of what they previously were.
The volatility of oil prices greatly influences the movement of exchange rates. Oil price volatility, both long term and short term, remains a great problem to the oil producing countries despite its effects on the global economy. Buffer stock supplies in oil can be used to alleviate the short term volatility while the long term volatility can be reduced by increased industry transparency.
With the world population rapidly growing, we expect oil production to be on the rise otherwise some countries will loose in terms of per capita consumption. This will be so because countries will increase protectionism in a bid to keep oil demand more level. More oil will be required to maintain the lifestyles of the countryâ€™s workers. Countries with financial difficulties may also be kept out of the oil market and this will lead to a reduced aggregate world demand for oil (Morehouse, 1997).
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It is possible that at some price, countries will bow down to recessionary pressures leading to a drop in demand for oil. A countryâ€™s debt situation will determine its oil price to a level which will enable it to sustain its economyâ€™s growth. Countries that use hydro and coal energy are more likely to over exploit these natural resources.
Oil prices are likely to remain on the rise because of the rising extraction costs and the frequent unrest in the Middle East countries which are the major oil producers. With the growing global economy, demand will be high and this will make the oil prices to shoot upward as countries complete for a barely growing supply of oil (Maugeri, 2006).
Countries differ in their ability to pay for high oil prices. Poor countries and more so third world countries will be pushed away from buying oil or they may be shunned by exporters either because of debts or due to recession. The worldâ€™s oil production is likely to decline in the near future with the decline of countries that can afford the high prices of oil. Oil consumption will then drop to very low levels because most countries will be unable to purchase the highly priced fuel and the oil producers will be unable to maintain their infrastructure for a limited oil supply. The leading oil exporters in the world are Saudi Arabia, Russia and the United States.
Oil price volatility will remain a major issue for consumers, policymakers and business people.