Industrial Revolutions and Global Oil Prices
The market for oil is relatively unusual due to inadequacy of readily-available substitutes. Currently, oils prices have remained unsustainably low due to increased production of oil in the US and other oil producers around the globe. A plan proposed by Thomas Boone Pickens to establish wind farms that would produce electricity in the US would affect oil prices further because the plan is likely to reduce the quantity of natural gas that the country uses to produce electricity. However, Pickens’ plan is likely to be affected by other countries, such as China and India, who are encountering their own industrial revolutions.
The demand for oil is normally inelastic as cars cannot change from using petrol to electricity when the price of petrol increases. In the short-run, demand and supply are inelastic, as shown in Figure 1.
Figure 1: Supply and Demand for Oil and Equilibrium Price
The US is currently using about 25% of the total oil produced in the globe. However, Pickens’ plan is expected to reduce the US imports by one-third, as wind energy would create a substitute for electricity from natural gas. If the proposed plan would materialize, the demand for oil would decrease, leading to a decrease in oil prices globally. Figure 2 illustrates change in price from P to P1 when the demand decreases from Q to Q1.
Figure 2: Decrease in Demand for Oil after Pickens’ plan
However, increase in demand for oil in countries such as China and India has created an increase in supply of oil, and would replace the quantity of oil that Pickens’ plan would have slashed. A decline in quantity demanded due to wind power would lead to a decline in supply, but a high demand in China would result to increase in supply, thus, moving the price towards the equilibrium. In the long-run, decreased demand of oil will make oil prices stabilize at the equilibrium price P3 as indicated in Figure 2.
Figure 2: Equilibrium Price attained at P3
China is second after the US in terms of consumption of oil while India takes the third position. The constant rise in demand for oil in China and India is due to rapid rise in economic wealth. The demand graphs of oil consumption for India, China, and the US from 2010 to 2016 appear as shown in Figure 3 below.
Figure 3: Demand for consumption of oil (in ‘00,000 bbl/day)
In the long-run, the prices of oil are expected to be less unpredictable since a slight increase would compel people to turn to cheaper substitutes, such as buying electric cars and using renewable energy instead of generating electricity from natural gas. Solar energy can also offer a substitute to electricity generated from natural gas. Solar energy is also clean and cheap, hence, a better option to crude oil.
As a government’s energy policy advisor, I would recommend an energy policy that considers advanced use of renewable energy, which is capable of maintaining global oil prices at a certain maximum level, as well as reducing air pollution. The US government should fund Pickens plan because renewable energies, such as wind power and solar power, would promote energy access, enhanced supply security, as well as minimize cost of production. Renewable energies would encourage opening of new industries, as well as expansion of the existing industries; hence, creating more employment opportunities.