The Current Oil Price Dilemma

Oil prices have been constantly escalating in the past few years. This has been associated with inflation and economic instability of various countries.  Changes in oil prices are often considered as a trigger for inflation and recession. This has largely affected major developments around the world economy. The recent increase in the prices of oil has raised a lot of concern among different countries.  The nature of oil price increase affects the state of a country’s economy and this may have an adverse macroeconomic effects.  The recent increase in prices of oil has differing short term and long term impacts on households and firms.

There are various factors that have contributed largely to the increase in the prices of oil. A long term factor that might have indirectly contributed to the increase of oil prices is the declining world reserve base of oil. However, there are a wide range of short term factors that have converged leading to increased demand of oil and consequently causing an upward pressure on oil prices.  Some factors that can be clearly identified as contributing to the high prices of oil include the OPEC policies, the declining value of the U.S. dollar, the change in structure of oil industries, low levels of crude oil and gasoline inventories and civil wars. In addition, oil has become more costly in extraction. This is because to increase the output, more expensive and technically complex extracting equipments must be used.

OPEC has contributed greatly to the recent escalation of oil prices. For instance, despite the increasing demand of oil, OPEC members have decided to keep their output unchanged. This has defied the market expectation of an increase in production, leading to a sudden increase of oil prices. Despite the meetings, held by OPEC members, to discuss the issue of increasing the quantity of oil produced, OPEC’s president has claimed that some members are hesitant to adopt this proposal.

The recent clashes in Libya have also contributed to the abrupt increase of oil prices. At the moment, there is no oil coming out of Libya. This has led to the reduction in the supply of oil resulting in an increase of oil prices.  

The increase in oil prices has resulted to countries taking various actions in attempt combat inflation.  For instance, in United States, Obama administration ordered 30 million barrels of oil from the U.S. emergency reserves to be sold to oil firms. This action was triggered by the reduced oil supply which was mainly caused by the increased turmoil in Middle East and the Northern part of Africa, particularly Libya. This move was the largest ever and was intended to increase the U.S. oil supply during the peak summer driving season.

For many developing countries, the increase in oil prices has led to a significant structural reform on domestic petroleum pricing system, which is a critical component in macroeconomic policies of these countries.  Exchange rate movements have partly offset the oil price increase in some of these developing countries. For example, the economic stability of China is already being threatened by the increase in international oil prices.  This is evident from the increased cost expenditures in industries that largely depend on oil such as China’s aviation industry, whose cost expenditure increased by 1.28 billion yuan in the year 2010

The governments of these developing countries have been reluctant to pass this oil price increase to the consumers. Passing the oil price increase to the consumers may lead to social resistance, especially from the disadvantaged group of the society. However, they may be forced to pass the higher prices to consumers because if they do not pass it, the country could experience a high fiscal burden. This would in turn oblige the government to cut its social spending.

In conclusion, it is important for the governments in developing countries to cushion the effects of high oil prices to the vulnerable group of the society. Rapid rise in oil prices can be mitigated by use of innovative oil inventory management strategies. Also, OPEC members should come to an agreement so that there is a continuous production of crude oil to avoid shortages, which trigger inflation.   

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