cartoon

This cartoon is lampooning how oil price has increased over three generations. As we can see, the gasoline price was only 17 cents per gallon during the grandfather’s time, and then increases to 3 dollars per gallon (near 18 times)during the father’s generation. Within a year, the price further increases to 3.72 dollars per gallon: an increase of 24% (US gasoline price on 12/5/08 from http://tonto.eia.doe.gov/oog/info/gdu/gasdiesel.asp). Thus the son deduces from this trend that when he grows up, the gasoline will not be affordable as he says, “I’m doomed to ride a bike for the rest of my life”.

Now let's review the reasons accounting to the rise in oil price which was covered in tutorial 6. Firstly, we will look at the demand factors. The demand for oil is increasing dramatically partly due to the industrialisation of emerging markets like China and India. As oil is the main energy source which currently has no close substitutes, the global economic growth is inevitably accompanied with a rise in the oil consumption. Increase in demand is also caused by speculative buying as some people want to make a profit by selling at higher price later if the oil price continues to rise, or they want to save cost concerning price will climb up.

Now we will look at the supply side. Countries producing oil are usually politically unstable like Iraq. Turbulence in Middle East may cause the production of oil to be unstable. Moreover, as the oil reserves are depleting around the world, the drills have to go deeper into the ground. This requires better equipment which means higher cost of production. Despite all these, the supply of oil actually increases in the past years. Therefore, both demand and supply curves have shifted rightward. However, oil prices increases because increase in demand is the more significant driving force.

Furthermore, the oil industry is a near monopoly market. The high set up cost, high chance of failure and geographically limited oil reserves all act as the barrier to entry. The monopolist, OPEC, has control over the supply and hence the monopoly power to set price. OPEC can deliberately hold back supply and manipulate the price. As the market is highly price inelastic, OPEC can easily increase its total revenue by increasing the price. The consumers have to accept this price or walk away without the good as there are no alternatives that they can turn to.

Below is another cartoon which seems to talk about oil price at the first glance. However, it is also illustrating inflation as the actual barrel costs 100 dollars.