Oil prices fall as oil output increases

Oil prices have slumped to $64 a barrel on Monday due to a rising supply from OPEC+ as well as higher output from Iran in response to speculative demand from America.

The hopes of a coming demand surge is attributed to the optimism surrounding America’s economic recovery.

The $1.9tn economic stimulus which the Biden administration announced combined with the new goal of vaccinating 200 million Americans has likely increased confidence within the American economy.

This is because the vaccination efforts, as well as the stimulus, has bettered the public health of the American economy as well as the economic well-being of the most disadvantaged members of American society, hence, due to life seeming to be on the up-side for more and more people, confidence has increased.

With an increase in confidence, the American economy is likely to recover as consumer spending will increase, and this increase may lead to a positive multiplier effect.

If consumer spending increases, aggregate demand within the economy will also rise, yielding an increase in Real GDP. But, at the same time, businesses will get busier, leading to an additional smaller shift in aggregate demand as some of the spending leaks out of the economy.

This leakage may be in the form of imports as busier shops and stores have to import goods, services or raw materials.

Then, there is a final, even smaller shift in aggregate demand as due to increased buying and selling of goods, the American government will see an increase in VAT revenue which they too will likely spend.

So, oil producers have taken these factors into account and are thus preparing to meet the coming surge in aggregate demand from the American economy by ramping up oil production.

Consequently, this decision increases the supply of oil, which is why Brent Crude fell by 1.5% to $63.90 a barrel.

However, due to the coming demand surge, this decrease in the price of oil is temporary due to oil prices frequently fluctuating.

Despite this, due to oil being used by pretty much every business, as it is used for fuel in transporting and logistics etc. when the price of oil falls, businesses do temporarily benefit from it as their operating costs will decrease.

This means these businesses will be able to increase the supply of the goods and services which they produce temporarily, however, this only applies if we assume perfect factor mobility, meaning there are no lag-times between factor inputs.

However, in reality, this decrease in costs may not have as big of an impact as expected as factor inputs are relatively immobile, for example, labour is somewhat of an immobile factor as people do not just up and leave their family and home for opportunities due to loss aversion.

This means certain firms will be unable to upscale production in time to reap the benefits of the decreased oil prices.

Nevertheless, the oil companies will still likely make a profit, this is because due to the vaccination efforts in both America as well as Europe, there will be a global surge in demand for oil, and this will pocket some very nice profits for the oil giants.

And what will they do with those profits? Some will likely reinvest them into greener energy as in the long-term, oil demand will decrease as renewable alternatives become increasingly favoured by global economies.


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