Question

. Since the enactment of the Petroleum Revenue Management Act, the benchmark price has never been accurately estimated. Indeed, IEA, World Bank, IMF etc often find it difficult to correctly predict international oil prices. Explain why this is so.

Answer 1

The petroleum industry, also known as the oil industry or the oil patch, includes the global processes of exploration, extraction, refining, transporting (often by oil tankers and pipelines), and marketing of petroleum products. The largest volume products of the industry are fuel oil and gasoline (petrol). Petroleum (oil) is also the raw material for many chemical products, including pharmaceuticals, solvents, fertilizers, pesticides, synthetic fragrances, and plastics. The extreme monetary value of oil and its products has led to it being known as "black gold". The industry is usually divided into three major components: upstream, midstream, and downstream. Upstream deals with Drilling and Production mainly.

Petroleum is vital to many industries, and is necessary for the maintenance of industrial civilization in its current configuration, making it a critical concern for many nations. Oil accounts for a large percentage of the world’s energy consumption, ranging from a low of 32% for Europe and Asia, to a high of 53% for the Middle East.

Other geographic regions' consumption patterns are as follows: South and Central America (44%), Africa (41%), and North America (40%). The world consumes 30 billion barrels (4.8 km³) of oil per year with developed nations being the largest consumers. The United States consumed 25% of the oil produced in 2007.The production, distribution, refining, and retailing of petroleum taken as a whole represents the world's largest industry in terms of dollar value.

Governments such as the United States government provide a heavy public subsidy to petroleum companies, with major tax breaks at virtually every stage of oil exploration and extraction, including the costs of oil field leases and drilling equipment.

In recent years, enhanced oil recovery techniques most notably multi-stage drilling and hydraulic fracturing have moved to the forefront of the industry as this new technology plays a crucial and controversial role in new methods of oil extraction.

Petroleum is a naturally occurring liquid found in rock formations. It consists of a complex mixture of hydrocarbons of various molecular weights, plus other organic compounds. It is generally accepted that oil is formed mostly from the carbon rich remains of ancient plankton after exposure to heat and pressure in Earth's crust over hundreds of millions of years. Over time, the decayed residue was covered by layers of mud and silt, sinking further down into Earth’s crust and preserved there between hot and pressured layers, gradually transforming into oil reservoirs.

Petroleum in an unrefined state has been utilized by humans for over 5000 years. Oil in general has been used since early human history to keep fires ablaze and in warfare.

Its importance to the world economy however, evolved slowly, with whale oil being used for lighting in the 19th century and wood and coal used for heating and cooking well into the 20th century. Even though the Industrial Revolution generated an increasing need for energy, this was initially met mainly by coal, and from other sources including whale oil. However, when it was discovered that kerosene could be extracted from crude oil and used as a lighting and heating fuel, the demand for petroleum increased greatly, and by the early twentieth century had become the most valuable commodity traded on world markets.

?? ?? = ?? − ?1??? + ?2(??) ? + ?3 1 3 ∑(??−?) ? 6 ?=4 + ?? ?

The definitions of the variables are: ?? for annual oil production; ?? for cumulative production; ?? for the real price of oil; and ?? ? for temporary oil supply disturbances. The supply of oil is influenced by two fundamental factors. First, as cumulative oil production increases, it becomes harder and harder to extract an additional barrel of oil given existing geological and technological constraints. The extent to which such constraints become binding depends on the magnitude of ?1? . ?1? is time-varying because a breakthrough in extraction technology, or a discovery of new oil fields, will cause ?1? to drift down, resulting in a more persistent increase in oil supply compared to a positive but transient supply shock driven by ?? ? . Second, the parameters ?2 and ?3 try to capture the traditional supply-curve effect where a rise in oil prices increases the quantity supplied. ?2 is the principal determinant of the short-run elasticity of supply, reflecting the ability of oil producers to expand supply based on existing capacity. The long-run elasticity of supply is determined mainly by the sum of ?2 and ?3. For example, a permanent increase in the price of oil would make the use of higher-cost extraction technologies profitable and encourage greater exploration effort. Such effect occurs with a lag though, mainly because it takes time to implement new extraction technologies and put newly-discovered oil fields into production.

Oil Demand

log ( ?? ??−1 ) = ?? + ?1(?? − ??−1) − ?2 log ( ?? ??−1 ) − ?3 log ( 1 9 ??−1 ??−10 ) + ?? ? The oil demand equation captures three determinants of demand. First, the demand for oil grows with world GDP growth. The parameter ?1 represents the elasticity of oil demand growth with respect to world GDP growth. The parameter ?2 represents the short-run price elasticity of demand, while the sum of ?2 and ?3 is the long-run elasticity of demand. The latter includes a ten-year lag, reflecting the time it takes to improve the fleet efficiency of the stock of automobiles in response to a sustained increase of oil prices.

World GDP

World GDP is equal to trend world GDP plus the world output gap. 0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.2 2000 2004 2008 2012 2016 2020 2024 Short-run Long-run 16 Y? = Y̅? + ?? The definitions of the variables are: Y? and Y̅? for the logarithms of actual and trend output, respectively, and ?? for the world output gap. Trend output is affected by the trend growth rate ?? as well as a stochastic shock ?? ?̅ that captures level shocks to trend output. Y̅? − Y̅?−1 = ?? + ?? ?̅ The trend growth rate ?? varies over time, capturing varying rates of capital accumulation, world labor force growth, and total factor productivity growth. It is negatively affected by rising oil prices. ? represents the long-run autonomous source of growth. ? represents the trend growth rate of the real oil price, which is approximately 7 percent over the historical sample used in the estimation (1983-2014). It reflects the threshold of the real oil price growth rate after which the negative effects on world trend growth start to kick in. ?? = ?1 ??−1 + (1 − ?1 )? − ?2 (log ?? ??−1 − ?) − ?3 (log ??−1 ??−2 − ?) + ?? ? The world output gap measures the position of the world business cycle. ?? = ?1 ??−1 + ?2(??−1 − ??−2) − ?3 (log ?? ??−1 − ?) − ?4 (log ??−1 ??−2 − ?) + ?? ? According to this equation, oil prices are potentially important factors affecting world economic upturns and downturns. Lower oil prices increase world cyclical output, in part because of the higher marginal propensity to consume out of income in oil-importing countries than in oil-exporting countries. Similar to the equation for world potential growth ?? , the parameter ? reflects the rate of growth of the trend real oil price after which the negative effects from higher oil prices start to kick in.