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Producers’ Reaction to Raw Material Price Changes Essay

These days all over the world people use products of crude oil. Most of people cannot imagine their life without products such as diesel or gasoline. However, these are only the finished products, which go through specific stages of production. They are made out of crude oil, which sometimes is called „black gold“. Fuel; however is not the only production made out of crude oil. Lubricants, asphalt, paraffin wax, tar – all these are product made out of crude oil. As stated by US Energy Information Administration (EIA): estimated consumption of oil in the world in 2011 will be 87.421 million barrels of oil each day. Obviously, crude oil is an important material in the modern world. It has an important role in economy as well. The cost of crude oil affects economy both directly and indirectly. Nowadays, debates about rising prices of fuel or heating are almost an everyday topic. The price changes of fuel are always mentioned on financial news on TV. Naturally, it is interesting what influences the cost of crude oil. How the rise or fall of price affects the price of fuel, and how businesses deal with the fluctuating prices. 1. Crude Oil as a Raw Material

When talking about product price changes it is important to understand how the price of raw material is calculated and how it is affected. The perception of how the price is set for the raw materials gives an opportunity to better understand the price of the final product, and all the fluctuations related to the final products’ prices. Also, it helps to recognize how various political decisions or world-wide events, including disasters or new innovations, affect various markets. As for crude oil prices, the statistical and analytical agency within the U.S. Department of Energy called Energy Information Administration (EIA) has defined seven key factors which have an influence on and each contribute to the price of crude oil.

1. Production. The Organization of Petroleum Exporting Countries (OPEC) consortium provides about 60 percent of all the oil production traded on international markets and 40 percent of the world’s oil production. All actions and statements of this organization can and do affect world oil prices, because of the dominant crude supply market share. Changes of the amounts of crude oil production lead to changes in price. If OPEC cuts the production, it generally means a rise in price of oil.

2. Supply. The other oil suppliers still represent 60 percent of the world’s oil supply. Even though non-OPEC suppliers as a group are 50 percent larger than OPEC, they have almost no spare capacity. Non-OPEC suppliers are considered to be “Price Takers”, rather than “Price Setters”. They respond to market prices, not like OPEC, who manipulate them. Consequently, non-OPEC suppliers practically produce near to full or at full capacity. Any fault in production has the effect on increasing oil supplies. As well, it gives OPEC the capability to further manipulate world supplies.

3. Global oil inventories. The supply and demand is balanced by global oil inventories. For example, if more oil is produced than demanded, the excess supplies can be stored. This principle also works in reverse order. If consumption exceeds demand, inventories can be used to meet the growing demand. The bond between oil inventories and oil prices makes corrections possible in either direction. If oil futures rise in comparison with the current spot price for oil, the need and urge to store oil will increase. As well, spot oil prices will drop, if market makers notice an inventory build. That is the response to balance demand with supply.

4. Financial markets. Oil is not only sold by its physical form, but also there are trade contracts for future delivery. This type of sales is called “futures”. In order to avoid future oil price increases, some major customers, like airline companies, purchase futures. That is because oil price changes have a significant impact on their ability to operate profitably. Also, often oil futures contracts are sold to lock in a price for a specific period of time.

5. Demand. The Organization of Economic Cooperation and Development (OECD) is an international organization of U.S., Japan, most of European countries, and other advanced countries. The organization is responsible for 53 percent of the world’s demand for oil. Even though OECD countries consume more than non-OECD countries, the rate of growth in OECD countries is considerably slower. OECD demand went down during the period from the year 2000 to 2010. However, non-OECD countries’ demand went up by 40 percent during the same period of time.

6. Non-OECD demand. For the last decade China together with Saudi Arabia and India had the largest growth in crude consumption among non-OECD countries. There is a direct relationship between the rate at which oil consumption rises and the rate of economic growth. It is not surprising that for China and India, the use of crude oil is increasing at a very fast pace compared to the United States’. Besides that, developing countries also usually have more manufacturing-related industries, which have a tendency to consume higher amounts of crude oil.

7. Spot market. Crude oil is sold all over the world. There are many different “streams” of crude oil, however they are likely to move in lockstep with one another regarding the prices. All these streams are put in a certain process of production to make product which are used, such as: gasoline, diesel, jet fuel, lubricant and other various petroleum products. All of the financial channels on TV are talking about crude oil prices. However the essential point here is the price of the final products. Any events that have the power to disrupt the flow of crude oil and end products have a significant effect on the price of those goods. Geopolitical events, massive oil leaks, natural disasters like hurricanes or earthquakes, terrorist acts, etc. all are included to the list of event which can and do influence the price. Both supply and demand are rather inelastic, this means that any of the above events, or perceived risk of the happening, usually leads to higher prices, especially in the futures market.

All these factors clearly show how easily the system of oil trading can be shocked, leading to huge swings in the price of crude oil. Also, it has to be pointed out, that most of the world’s oil supply is located in countries or parts of the world that are politically instable. All this explains why the price we pay for oil product is so volatile.

Example how natural tragedies affect the price of crude oil: In 2010 April 20th in the Gulf of Mexico a huge oil spill took place. It was one of the biggest oil spills in history. Without a doubt it had a significant impact on the oil prices.

Figure 1. History of oil prices.

Clearly, the chart shows that the price of oil rose when the clearing begun. This proves, that certain events have influence on oil prices. 2. Gasoline usage

Gasoline is the most popular Transportation Fuel in the U. S. Gasoline is one of the most popular fuels consumed in the United States and the main product made from oil. Usage of petrol in 2010 was approximately 132 billion gallons, which means about 360 million gallons a day. Gasoline used as energy for transportation stands for more than 64%, 48% of all petrol consumption and more than 18 % of all consumed energy in U.S. Petrol is mostly used in cars and light trucks. It is also consumed by owners of boats, recreational vehicles ran by fuel and landscaping, farm, construction equipment. Benzine is made year-round, however, the highest demand and the biggest imported quantity is seen in the summer. The graph shows the amount of gasoline consumed in U.S. 1950-2010:

Over 260 million vehicles on the streets Nowadays, in the United States, gasoline is the fuel used by most passenger engines. There are more than 260 million vehicles that use gasoline, the amount of them increases each day and they manage to travel over 12,164 miles per year. There are around 170,000 fueling stations that ensure comfortable refueling for users. Above two-thirds of fuel consumed for moving is in the form of petrol. Each benzine station usually sells three types of petrol:

* Regular * Midgrade * Premium 3. Determining gasoline prices

The changes of gasoline prices affect all the countries and their economies. Each person that owns a vehicle run by petrol is affected individually. Every day the retail price of gasoline changes, but only few people know what exactly makes the prices fluctuate. There are several different factors that has sway on fuel prices. The first and also the biggest reason that influences the price of petrol is the cost of crude oil from which it is obtained. In 2000, average retail price of gasoline was only 2.37$ per gallon and the total price included only 55% of crude oil. After more than 10 years the costs of it grew and the percentage of crude oil now seeks over huge 66%. In the last few years the consumption of petrol fuel grew so rapidly that the producers of these had many difficulties succeeding to fulfill their cutomers needs.

The growth of demand of fuel is another huge factor that has affected the cost of petrol. The demand isntantly grew up and the supplies went down. This made a huge influence on petrol price. In addition, another great reason of gasoline price growth is refining costs and profits. In 2000, it made approximately 15% of total price of fuel. After 10 years, the percentage of those costs consisted over 12%. The percentage reduced, but it still remains high and definately makes a huge impact on retail fuel price.

Crude oil price change influence on producing gasoline

The price of crude oil is one of the main factors that influences the cost of retail gasoline. The cost of crude oil changes each day. The price depends on many different factors. The change of the crude oil price hugely affect the retail price of gasoline. When the price of crude oil grows, eventually the cost of petrol also rises. The growth of crude oils price reduces the production of gasoline, diesel, gas. Producers lowers the production of petrol and fuel and also increases the retail prices of them. When the price reach highest point, the demand of fuel, gas and gasoline reduces. After the price and demand stabilizes, price starts to reduce and demand begins to grow.

Conclusion

First of all we can say that prices of oil production generally are set by OPEC. They provide crude oil all over the world, so generally they can control prices of oil. Moreover, other suppliers still represent 60 percent of the world‘s oil supply, however they don‘t set prices, they are more like „price takers“. So OPEC certainly manipulates the power they have. Global oil inventories help to balance supply and demand; the excess supplies are more likely to be stored, when growth of the prices is forecasted. OECD is mainly responsible for the demand of oil. Even though OECD countries consume more than non-OECD countries, the rate of growth in OECD countries is considerably slower. Crude oil is the main material which is used to make gasoline, diesel, jet fuel, lubricants and other various petroleum products, but it doesn’t set the total price of fuel, the main thing is the final product.

Moreover, the price of crude oil can be affected if the system is disturbed, because of natural disasters like hurricanes or earthquakes, terrorist acts, etc. Talking about gasoline, it is the most popular fuel consumed in the U.S. and the main product made from oil. Petrol is used in almost all cars, light trucks and boats. Usage of petrol in 2010 was approximately 132 billion gallons, which means about 360 million gallons a day. Gasoline used as energy for transportation stands for more than 64%, over 48% of all petrol consumption and more than 18 % of all consumed energy in the United States.

Furthermore, there are around 260 million vehicles that use gasoline, the amount of them increases each day and they manage to travel over 12,164 miles per year. To sum up, the main things which fluctuate prices of fuel are: the fluency of crude oil supply system and the actions and statements made by OPEC. All in all, raw materials’ prices change and influence producers’ behavior. In the case of crude oil production, prices tend to go up, because of relatively inelastic supply and demand. Yet, more efficient technologies are created to minimize or replace use of crude oil products.


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