How Oil Prices Affect AD And AS Of An Economy

Determinates of oil price

How oil prices affect AD and AS of an Economy?

Oil is a very important resource for any country. It forms the backbone for any economy to survive. Petroleum is made from crude oil, an important fossil fuel. If the supply of petroleum stops then the world would come to a standstill. Without oil, there would not be any vehicle on the road (Abiri, Emiri and Deinduomo, 2009). This would lead to basically no production of goods as raw materials cannot be taken from one place to another. Going to the work place or school that is located in far off places would not be possible without the use of petroleum. Petroleum has the potential to make the world go round. Petroleum is also used for life-saving purpose. In case of medical emergencies, people have relied on helicopter and ambulance services to reach the hospital on time. In this research paper, we see how an oil exporting economy Nigeria has been affected by the oil price fluctuations in the global scenario. The nation is seen to be over dependent upon the crude oil export that has made the country vulnerable to oil price shocks.

Oil is considered to be a high demand commodity so any fluctuation in its price will have a significant impact on the economy. The oil prices are affected by 1) Supply and demand 2) Sentiments in the market. It is seen that as demand raises, prices also increases and vice versa. In case of oil market, the scenario may be different as oil future market determines the prices of oil. A person can purchase at a definite price and date as per the contract with the future oil market (Abraham, 2006). On the selected date, buyers and sellers they obligate to fulfil their transaction. There are two types of future traders they are speculators and hedgers. Hedgers are the airline owners who buy future oils to guard against any oil price rise. Speculators are those who study on the future oil prices.

There is both positive and negative impact associated with low prices. An economy that is exporting oil will not prefer in the exploration of new oil field when they see global oil prices are falling. The importing countries are in an advantageous position as they can import in large amount. This will, as a result, lower the overall price situation in the economy. The economy also faces a lower future inflation (Cossé, 2006). Exporting countries are the ones who are in a disadvantageous position. A large sector of the population is employed in this sector for their source of income. With shut down of oil companies, a country’s unemployment situation is seen to rise. For the United States economy, it was seen that consumers benefited from the falling oil price. The trend showed a boom in the States, but it is likely to jeopardize with continued pressure on oil prices (Falola and Genova, 2005). This might lead to energy companies to cut down on development and production. Investment in oil and energy services would also become moderate.

Effects of low oil prices in an economy

Effect on the Nigerian Economy:

Nigeria Delta region is located at the top of Gulf of Guinea, on the west coast of Africa. This region consists of nine dominant oil producing states, and local government area has about 185. This region consists of 800 oil producing communities and almost over 900 oil producing wells. Nigerian delta region is the largest tertiary delta system and is the extreme prolific hydrocarbon zone (Haerens, 2010). The Nigerian Basin has huge deposition of petroleum, and current oil generation is also done from this region. The main source of oil and gas belongs to the deltaic tertiary system. This region is also covered with dense mangrove forests. The past five decades have shown that a total of 1182 wells has been drilled in the Nigerian Basin, and about 400 oil and gas locations has been documented.

There was not much fluctuation in the oil prices between September 2014 and March 2015. The trend was comparatively stable in the last year.

Nigeria had been the beneficiary of an oil boom in the year 1999 when the military rule came to an end. In the year 2008, the prices of a barrel rose from $10 t0 $100. In the late June 2014, it has remained above $100. Since June 2014, the prices were seen to fall over by more than 30 percentages. The OPEC has ordered to cut down production. A major production cut in Saudi Arabia would help the oil prices to recover to $100 per barrel. This has caused alarm in many oil-dependent states such as Nigeria. Nigeria is considered as prostate despite the increase in the non-petro sectors. The profit as much as 90 percentages from the petroleum industry goes to Nigerian government. The government accrues revenue of about 80 percentages from petroleum and 90 percentages and more from the exports. This is leading to a serious issue for the country’s political class (Yeomans, 2004). The expenditures of the government were pertaining to the petroleum industry play a major role to sustain patronage networks that help run Nigeria (Idemudia, 2007). The countries worsening the political situation is likely to get worsen with election approaching. Nigeria is considered the largest economy in the African continent. Boko Haram Insurgency displaced Nigerian refugees moving to Cameroon, and Ebola outbreak are some of the challenging economic and political issues. The Nigerian economy is seen to face tremors of instability, and this has affected the entire Africa. The federal budget of Nigeria follows a conservative approach to estimating the world oil price (Krichene, 2008). By using a certain formula, the federal government distributes oil revenue among the states and government authorities. The government authorities only can gain in this way rather than local tax collection (Li and Molina, 2014). The oil production is also seen to be falling. The production of Nigerian oil was expected to be 2.5 million barrels of oil per day, but the actual production was about 1.9 million barrels reflecting that there was fall in the investment in the industry. The relationship between oil companies could not be established as there are still some flows that exist. Due to major political and security concerns, the international oil companies are shutting down operation in the area. In the last decade, we see that almost half of the production of Nigerian oil was exported to the United States. Imports of United States were also limited as they had their own hydraulic fracturing and availability of oil near their place (Nakaya, 2006). The president of Nigeria suggested that Nigeria should start marketing in the Asian market. This might require some new customers to meet the emerging requirements. With fall in the revenue for the Government of Nigeria, the president calculated the budget twice from the estimate of $78 per barrel to $65.  The national currency has also depreciated with the fall in oil prices. As a result, foreign reserves have eroded (Steinberg, Swaray and Moyo, 2008). The currency Naira was devaluated by 8% in 2014. The government is trying to keep targeted Naira between 160 to 175 US dollars.  If the oil prices continue to fall, it could pose an obstacle in conducting a free and fair election in the economy. To capture and control a wealth of oil a fierce struggle has been demonstrated. The central governor has shocked the country last year when he claimed $20bn state oil by the state oil company’s of Nigeria.

Effect on the Nigerian Economy

Oil extraction has ruined the deltas of Nigeria as a result has hampered fishing and farming.

The overall prices are affected by the prices of oil. The effect of reduced oil prices on the Nigerian Economy is explained through aggregate demand and aggregate supply curves. By Aggregate demand we mean the total goods and services demanded in an economy at a given time period. Aggregate supply is the supply of total services and goods in an economy at a certain time period (Ross, 2012). Aggregate demand is downward sloping and aggregate supply is upward rising in the short run.  

The economy is at equilibrium at point A initially where the curves of AD1 and AS1 curve intersects.  Due to some assumption, the aggregate demand shifts to the left and aggregate supply shifts to the right. The result of shifting leads the economy to equilibrium B. This situation leads to price level to increase from P1 to P2. Output level also increases from Y1 to Y2. The falling oil prices have no positive impact on the economy.

Conclusion:

PwC has predicted that the recent fall in oil prices will help Nigerian business to move from their reliance over oil to other issues. This will help the economy to be stronger. Nigeria is an attractive place for investors. Nigeria has huge source of commercial energy untapped. This commercial energy must be tapped to gather more economic stability. A tough decision is to be taken by the government and different enterprise to see how the fiscal discipline and strategic plan operates.

References

Abiri, K., Emiri, F. and Deinduomo, G. (2009). Law and petroleum industry in Nigeria. Lagos: Malthouse Press.

Abraham, M. (2006). The Gulf oil and gas sector. Abu Dhabi, United Arab Emirates: Emirates Center for Strategic Studies and Research.

Cossé, S. (2006). Strengthening transparency in the oil sector in Cameroon. [Washington, D.C.]: International Monetary Fund, African and Policy Development and Review Depts.

Falola, T. and Genova, A. (2005). The politics of the global oil industry. Westport, Conn.: Praeger.

Haerens, M. (2010). Oil. Farmington Hills, Mich.: Greenhaven Press/Gale, Cengage Learning.

Idemudia, U. (2007). Corporate partnerships and community development in the Nigerian oil industry. Geneva: UN Research Institute for Social Development.

Krichene, N. (2008). Crude oil prices. [Washington, D.C.?]: International Monetary Fund.

Li, X. and Molina, M. (2014). Oil. Santa Barbara: ABC-CLIO.

Nakaya, A. (2006). Oil. Detroit .: Greenhaven Press.

Ross, M. (2012). The oil curse. Princeton, N.J.: Princeton University Press.

Steinberg, C., Swaray, S. and Moyo, J. (2008). Nigeria. [Washington, D.C.]: International Monetary Fund.

Yeomans, M. (2004). Oil. New York: New Press.