Can Crude Oil Price be a Barometer of Global Economy?

If one gets the impression that rise or fall in crude oil price shown in figure 1, has an impact on the economic growth or recession respectively, then it is most likely to be a misconception. On the contrary, fluctuations in Crude Oil Price represent the global economic pulse. The two fundamental principles for removing this misconception are:

a) The oil as a commodity and major source of energy is not outside the realm of economic principle of demand & supply and equilibrium price.

b) The economic factors which influence the demand side of the equation are the root causes for disrupting the supply side, thereby altering the price.

The speculators and traders (not real consumers) act as spoilers during the interim period, before demand & supply curves stabilizes, but then again some other economic factors (for example demand for steel, construction materials, infrastructure development etcetera) change, and disturb the delicate balance of oil demand & supply curve. Thus, it is not the Oil Price which acts as the primary change agent, but rather, it is the economic growth or recession which are the prime movers for fluctuations in daily oil price.

This principle is best illustrated by the recent reduction of nearly 500,000 bpd in daily production rate by OPEC countries and Russia, with the apparent objective of arresting the declining oil price. This decision, as per common belief should have raised the oil price per barrel. But due to lack of demand and economic slowdown being experienced across the globe, oil price has continued to move downwards.

So the decision to cut production rates is only to manage inventories and surplus capacity in the short term. If the money supply had been same, as it was in the year 2007 to first half of 2008, the traders and speculators would have managed to keep the price at a level, attractive for both traders and oil producers.

The energy consumers and producers can be well informed, during strategic planning and budgeting, by monitoring the PEN constituents of Oil Price (Supply & Demand).

What is PEN?

 Taking the analogy of “Atom and its structural constituents – Protons, Electrons, Neutrons”, we can organize various economic factors into three categories, while developing the Decision Support System (DSS). The resultant effect of the PEN factors illustrated in figure 2, will determine the net impact on the Oil Price.

Protons or Positive factors are the drivers which increase demand for energy and are likely to move the price upwards. For example GDP growth of BRIC (Brazil, Russia, India, China) countries, economic growth of developed countries, consumer demand, political stability & development in underdeveloped countries, etcetera.

Electrons or Negative forces, which drive the demand for energy (and price) downwards are economic slowdown, natural disasters and wars / aggression (in short term), new and alternative sources of energy, transportation efficiencies (Freight rate decline), financial constraints, etcetera.

Neutrons or neutral factors though by definition shall have no net effect on the supply & demand curve, but in the context of Oil as a commodity, the Neutrons (Speculators) are those factors which act as weights on either Protons or Electrons depending on the timings. These weights are like transient forces which should dissipate with time. Unfortunately, the world today is very dynamic and economic factors are varying at a fast pace, so leaving little time for such Neutrons to dissipate. Thus fast changing phenomenon provides strength to speculators, who intensify the price movements in either direction, before reaching the equilibrium state.

At “Tiberias Management Consultants Pte. Ltd.”, we are continuously monitoring global energy scenario as part of the Oil & Gas market research projects. The first DSS named as “EXPERT System” was developed in year 2005 for demand and supply forecasting, which is being updated continually. For latest updates and new developments, please visit the website www.tiberiasmc.com periodically.

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