Explain the Key Demand Side Drivers of Price for Oil.
1(a) Explain the key demand side drivers of price for oil. In recent years, the fluctuations of oil prices have gotten the attention of the whole world. From $20s in 2003, it hit a mid-term peak of $148 in mid 2008, then fell to $30 during early 2009, and now back to $70-$80. Economic principles have demonstrated that the rise of oil price is a function of lack of supply and greater demand. We know that oil is lack of supply since there’s no major oil field found in the last 40 years and oil can’t be made within decades. However, the following conundrum has not been resolved: What are the key demand side drivers of price for oil?
The price of oil depends on a variety of factors which leads to the increase of price. In summary, there are five key demand side drivers, the rise of developing countries, especially China and India, the depreciation of US Dollar, the stimulation on world economy, the increase of global transport, and the rise of other raw material prices. First of all, the major key demand side driver of price for oil is the rise of developing countries1. The two largest ones are China and India. The population of China is 1. 3 billion and that of India is 1. 1 billion, combining the population of these two countries, it becomes 2. billions of population. It is more than one third of the whole world population. Combining all populations of United States, all developed countries in Europe, and Russia, there is only around 0. 7 billion population. The population of China and India is more than triple all developed countries combined. Can you imagine how much the use of oil will be increased by just China and India? Furthermore, these two developing countries have just started to develop for about two decades. The average age of China is 37 and the average age of India is 25 only.
That means, in the coming 20 to 40 years, the economy of these two countries will still be growing and developing. Thus, the demand of oil will keep increasing for the coming 20 to 40 years. Even though there maybe down turn cycles during this period of time, in long run, it must be rising greatly. However, the economy may not have to go up if the central banks make the wrong moves. That brings us to the second key demand side driver of price for oil, the depreciation of US Dollar. Since we’re currently using a flat monetary system, money can be unlimitedly printed.
The governments don’t have to pay anything but just turn on the money printers. Along with the election political system using by most developed countries, it makes an ultimate combo for depreciation of US Dollar in long run. 1 Knowing that the central banks want the economy to grow but not too fast, and not fall at all. Thus, whenever there’s economy recession, the central banks will do whatever they can to save the banking system and the economy. Since 1987, their actions have been printing money and keeping low interest rates in order to stimulate the economy.
This leads to the depreciation of US Dollar as well. Thus, it becomes a driver to the rise of oil price. 2 The expanding monetary policy of the central bank of the major countries have also stimulated the economy, as they wished. Stimulation of economy must lead to an increase in demand of oil because of more usage of electricity, more usage of transportation, more demand in most products and services. Almost everything in our economy needs oil to operate. As we named it few decades ago, the oil economy. 2. Therefore, the stimulation of economy must lead to an increase in oil demand.
Next, the increase of global transport. The globalization has led to a global manufacturing arbitrage which greatly increases the global transport. Almost 99% of all transport fuel is derived from crude oil, making the increase of global transport a key demand side driver of oil price. Even though the technology of electricity vehicles has been improving greatly and efficient enough to be in use, the market share of it is still very small, and its efficiency is not yet good enough to be popular and not yet able to compete with the fuel oil vehicles2.
Especially in China, there’s only 25 vehicles per a thousand residence while there’s over 800 vehicles per a thousand residence in United States. It won’t surprise us if the vehicle market of China grows double digits, or more, every year in the coming decade. Lastly, the rise of oil price has also led to the rise of other raw materials prices such as precious metal price and water price. Mutually, the rise of other raw materials prices have also led to the rise of oil price. It is into a mutual cycle affecting each other since it requires water and recious metal to produce oil, and it requires oil and precious metal to produce water, and the same for all commodities. This obviously will drive the oil price to sky-rocket if situation is worse enough, and very likely it’ll be. In conclusion, the rise of oil price depends not only on lack of supply but also the increase in demand by the five main demand side drivers. Since oil is still a must-use raw material right now and in the coming decade, we wish that it won’t bring us to war. Although it did in 2002, when US declared war on Iraq, we wish the leaders would learn and don’t make the same mistake again. ) Roger, James(2004) Hot Commodities: how anyone can invest profitably in the world’s best market 1 st ed . Beeland Interests Inc. 2) Leeb, Stephen and Lee Donna(2004)The Oil Factor: Protect Yourself and Profit from the Coming Energy Crisis The Warner Book Group 1(b) Evaluate how effective a price discount will be in raising revenues during a recession Pricing Strategy is critical to the success of a company, which can have huge influence on company profits. In some markets, consumers will be very sensitive to a change in price, while others may not react at all, elasticity usually used as a measurement for this4.
The best price is determined by the firm’s objective, like maximizing the amount of profit made by the firm, maximizing the market share for the focus on the interaction between pricing and consumers’ willinginess to purchase3. The current economics situation is also a key factors on price strategy. A economic recession can lead to a price discount of companies in order to reduce the loss from stock/ running cost, a high sales rates can usually minimizing the negative effects of the economic crisis, especially on the product or service which are highly elasticity to price The buying power of customers can be highly related to the economics.
During a recession, customers cannot afford paying more for luxury or high quality goods, especially for products which are not vitally important for them, they may switch to inferiors goods and saves the money for essential product like food or daily goods. Therefore, the economic recession begins and buying power of customers decreases, sales rate will also be decreased. Economic recession may not be a short term issue, substantial decline in customers’ spending may persist, if economic keeps going down, customers’ spending and their buying power are likely to decrease even more.
Therefore, company usually reduce the price to attractive customer to purchase their product faster in order to avoid larger losses from decline in sales or existing stock which made at a high cost before recession, especially when there is no money for advertising or other promotions. The discount price strategy can also reduce the chance that customer switching to inferior goods or cheaper brands, on the other hands, it provides the opportunity to strengthen relationships with customers thereby improving customer loyalty5.
During recession, consumer sentiment is nearly at an all-time low, use this time to get closer to your customers, understand them on a deeper level, and show them what’s possible – what the futurewill hold, rather than reduce customer service4. A price discount important for any company since it improves its market share , position , and increases the number of its customers during and after the recession. 3. Begg, David and ard,Damian (2006) Economics for business 2nd ed. Mcgraw-Hill 4. Churchill, G. A. , and Peter, J. P. (1998). Marketing: Creating Value for Customers, 2d ed.
Boston: Irwin/Mcgraw-Hill1) 5 ) “How to Think About Pricing Strategies in a Downturn,” Harvard Management Update, Vol. 7, No. 3, March 2002 As long as the companies can maintain their revenues relatively stable due to the growth of sales rates or maintenance of a stable level of sales rates from boost selling out its products at an affordable price of customer, the discount sales can provide a financial resources in return, which is crucial in the time of economic crisis. It also silences customer complaints, helps cover fixed costs, and buys time until the economy rebound. Thus, the price discount can be an effective measure to maintain sales rate and revenues of companies. However, a price discount should not be viewed as the only reaction to recession. When recession comes, your production level should also be trimmed, postpone expansion plans that aren’t absolutely vital to your future growth, and cut nonessential costs wherever you can. As it is important to maintain your cash flow without drastically reducing your production capacity. In addition, it also depends on your brands position. Are you the product or service that’s all about being cheap?
Are you ready to live with that new brand position far beyond the recession? A low price strategy can easily turn on, but incredibly difficult to shrug off. Once the economy recovers, customer will complain about going back to paying full price. If your brand is not about price , a low price strategy is probably going to damage the brand image you’ve built, and it doesn’t only apply to luxury or high end brands. Getting into a price war with your competitors–without adjusting the value of the product or service will only lead to a downward pricing death spiral where no one wins5.
During a recession, a better strategy is to keep high-value products priced appropriately, but focus on selling more low-value products and services. In additions, Pprofitability of a company not only depends on pricing, the volume, impact on customer relationships and industry are also important. Funnel funds into R so you have new products and services that give you negotiating flexibility with customers and sales growth. Innovation can also gives you an edge when customers are seeking something new to lift up their own financial prospects during an recession . References: ) Roger, James(2004) Hot Commodities: how anyone can invest profitably in the world’s best market 1 st ed. Beeland Interests Inc. 2) Leeb, Stephen and Lee Donna(2004)The Oil Factor: Protect Yourself and Profit from the Coming Energy Crisis The Warner Book Group 3) Begg, David and Ward,Damian (2007) Economics for business 2nd ed. Mcgraw-Hill 4 ) Churchill, G. A. , and Peter, J. P. (1998). Marketing: Creating Value for Customers, 2d ed. Boston: Irwin/Mcgraw-Hill1) 5 ) “How to Think About Pricing Strategies in a Downturn,” Harvard Management Update, Vol. 7, No. 3, March 2002
