Economic environment: Oil and Petrol Prices

An earlier blog in this short economic environment series looked at inflation - the general tendency of the price level to drift upwards through time. A large part of recent inflationary pressure has come from higher energy costs. There’s also been discussion of the economic importance of confidence which is also influenced by the (highly visible) price of petrol. In fact, the price of oil (and petrol ... and energy in general) is one of the most significant issues firms face from the economic environment.

Data from Timetric.

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RPI: Percentage change over 12 months - Petrol and oil : yearly from Timetric

The graph I’ve chosen looks not at oil or petrol prices directly, but the rate of change in the price. As with many economic variables (like exchange rates), part of the problem is uncertainty brought on by changes that are very hard to predict. Firms find it hard to plan, budget and invest when such a crucial price is constantly fluctuating.

The price of oil (and therefore petrol, and most sources of energy which are derived from oil or gas) is ultimately driven by the forces of supply and demand. If you want to practice using supply and demand graphs, the oil market is an excellent example to work with.

Demand mainly comes from the transport sector, the chemical and plastics industry and the energy business. It is closely connected to the level of economic activity – and even the weather. Demand is forecast to rise in the long term as citizens of the ‘emerging markets’ (Brazil, India, China etc) achieve living standards closer to the ones we enjoy.
Supply meanwhile is constrained by numerous ‘bottlenecks’. Firstly, most of the world’s conventional oil stocks are in the Middle East, which is often troubled by uncertainty and volatility. Supply lines can be disrupted. Although stocks of oil are still relatively abundant, they are ever more difficult to extract (from the Arctic, or Greenland), inaccessible (deep sea drilling that lead to the BP oil disaster) or controversial (Canadian tar sands, or biofuels). You hear a lot from politicians about “breaking our addiction” to oil because it presents all kinds of problems: political, social, environmental .... and economic.

Effects of higher oil prices on firms
- See how the price of oil spiked upwards in 2008 (possibly giving the world economy the shove it needed to head into a deep recession) and again in 2010 (raising worries about a ‘double dip’ recession). It’s not an exaggeration to say that big oil price increases can have this effect.
- If a firm’s customers are spending more money on energy and fuel, they have less to spend on your products or services.
- Most firms will experience an increase in their costs (Easyjet losses widen as fuel prices rise). Suppliers may want to pass these increases on to customers.
- Oil prices are ‘embedded’ in most products (consider the fact that almost anything that has been transported contains oil as an ingredient).
- The price of oil and energy influences the general level of confidence (see above).
- Firms increasingly seek to distance themselves from the risks of higher energy prices and negative public relations by pursuing environmental and ‘green’ initiatives.