Executive Summary
This report comprises of data regarding the oil prices in the United States and China. The primary focus is the variation pattern throughout the year. The research also sought the relationship between the changes in the oil prices and the actual cause. Both countries portrayed some similarities in their price patterns. The prices began as little as $29/bl in the first quarter of the year. The prices rose to as high as $57/bl towards the end of the year. The main reason for the fluctuation was unexpected production and demand levels and reserve storage in both countries.
Contents
Executive Summary. 2
Introduction. 4
Objectives. 4
Hypothesis. 4
Literature review.. 5
Pricing Strategies. 5
Volatile market of oil and gas. 6
Data analysis. 7
Qualitative Analysis. 8
Oil price trends in the United States. 8
Oil price trends in China. 9
Quantitative Analysis. 10
Volatility index. 10
Conclusion. 12
References. 13
Appendix. 14
Introduction
The purpose of the study was to identify that rationale behind the fluctuating prices of oil over the last five years. The shift in the critical drivers of global prices of oil motivated the research. In recent decades, the demand for oil in the US and the supply from OPEC countries has globally controlled the price of oil products. However, over the recent past, drastic economic growth in China and the rapid expansion of United States oil production have added input in determining oil prices (Cheng , et al., 2017, pp. 1821-1831).
Objectives
Establish the demand and supply behavior of oil in the US, China.
To determine and quantify the consistency of oil products in the above-stated countries
To identify factors that led to the behavior of oil prices at different times of the year
Hypothesis
Oil is a very sensitive commodity and portrays an exemplary high volatility in the market. Prices of oil are controlled more by global phenomenon and least by local market behavior. The United States petroleum market trends continually dictates the global oil prices. However, China has proved an exemplary ability to supersede the US and influence the world market behavior of oil.
There are many other factors in control of the global oil prices, a decision-maker in the oil business must have an inclusive approach.
Literature review
Pricing Strategies
According to (Jensen, 2013), Pricing decisions are paramount to any business entity and forms a significant segment of the marketing plan. Pricing is a preliminary step to sales, which is the only activity in the corporate structure that brings revenue. Any alteration on price causes consumers to demonstrate resistance especially when it rises. More so, pricing determines the positioning of any product by both the dealer and the customer (Schindler, 2011, p. 71).
There are different categories of pricing based on various variables. One significant variable that concerns the study is the consistency of prices. Sellers have a tendency to go after the “daily low pricing” strategy (Frenie, et al., 2015, p. 90). Few businesses apply the approach and can maintain a relatively stable price trend. Other sellers feature high rates when not discounted. However, they later reduce the price and maximize on periodic sales. The strategy is known as “high-low” approach. Both “high-low” and everyday low pricing” aims to take advantage of This different demand elasticity (Madaan, 2009, p. 19).
Another strategy in pricing is the price introductory. In this case, the producer introduces a product at a relatively high price (Lamb, et al., 2008, p. 500). It can apply to commodities such as computer chips. The strategy is opportunistic in the sense that some consumers are willing to pay more to obtain the product urgently. On the other hand, a company may choose to introduce a product in the market with a low price (Hiduke & Ryan, 2013, p. 211). The low price lures the customers to shift and adapt to the new commodity, but the price restores having created a consistent demand. The strategy is known as penetration, and it targets new service or product launches that gain value only when it has a large number of buyers (Jensen, 2013) .
The cost-plus plan is another pricing strategy. A trading company marks up the cost of production, inclusive of all the logistics and a fixed percentage profit. The approach has one strength: that a company can already estimate the expected profit with accuracy (Ferrel & Hartline, 2013). The disadvantage is that the pricing does not take into account the future demand, neither does it competitor’s action. In contrast, consumer perceived value keeps the trading entity in close range of market behavior (Lee & Denver, 2016, p. 193).
Volatile market of oil and gas
Volatility in business implies a statistical measure of dispersion in returns within a given market index. Unpredictable and dynamic changes in prices within the stock market characterize a volatile market (Hilyard, 2012, p. 6). Therefore the risk associated with oil and gas business is high, and investors must take this into consideration. To overcome this challenge, investors must aim for long-term investments and disregard the temporary market fluctuations. One of the principal causes of volatility is the high price abrupt and frequent changes and heavy trading (Sovacol, et al., 2013, p. 103). Volatility is also likely to happen upon a commercial release, either at the state level or globally. A launch of an initial public offering (IPO), news related to a trading entity, a recommendation from a prominent analyst or results due to unexpected earnings are more causes of volatility.
Companies trading in the oil and gas have interacted closely with volatile market, especially in the recent past. Over the last one year, a barrel of oil has declined to $27 and recovered to around $50 (Baumeister & Kilian, 2016, pp. 139-160). The fluctuation is so huge within such considering that other economic parameters are held constant. As a result, it is tough to generate a strategic approach to stabilizing margins and maintain profit growth. The unpredictable economic landscape amplifies the risks and the consequences of errors (Clauss, 2016). Therefore, companies must continue building upon existing confidence by compiling and interpreting appropriate data at the point of decision.
Data analysis
The primary source of the data in this report is world business news. As mentioned earlier, the study focused on two major economies that dictate the global prices of fuel. It recorded the figures of crude oil prices from January 2016 to December 2016. However, information regarding the prices of crude oil in China was not readily available. Therefore, the researcher obtained the retail prices of gasoline and diesel and correlated the data backward to get the price of crude oil. As a result, the research had to accommodate two assumptions: the first one is that the cost of production from crude oil to finished gasoline and diesel are constant throughout the year. The second one is that the cost of production contributes least to the price of the finished product.
The credibility of the above assumptions is that the two countries are stable economies. The cost of production is, therefore, constant and does not fluctuate. Other factors control the price of products like oil, which has universal consumption and constant demand.
The table below shows different prices of oil throughout the year, 2016.
FUEL PRICES IN USA AND CHINA IN 2016
Month
Jan
Feb
Mar
April
May
June
July
Aug
Sept
Oct
Nov
Dec
USA ($/brl)
30
29.64
37.2
35.89
46.2
47.98
45.24
45.74
43.91
50.29
45.57
51.9
China ($/brl)
32.40
36.21
44.17
40.57
48.60
47.77
42.57
45.66
45.33
50.59
45.89
57.29
US DISEL($/gl)
2.17
1.98
2.1
2.14
2.3
2.43
2.41
2.31
2.38
2.48
2.44
2.5
US DIESEL ($/l)
0.57
0.52
0.56
0.57
0.61
0.64
0.64
0.61
0.63
0.66
0.65
0.66
P.FACTOR
52.26
56.59
66.92
63.39
75.95
74.64
70.96
74.85
69.74
76.65
70.60
78.47
China dsl
0.62
0.64
0.66
0.64
0.64
0.64
0.6
0.61
0.65
0.66
0.65
0.73
Qualitative Analysis
Oil price trends in the United States
The oil price declined drastically towards the end of 2015 and the beginning of 2016 in the US because the local production had hit doubled (Krauss, 2016, pp. 1-3). The influx contributed to declining importation, and hence the Saudi, Nigeria and Algerian oils had to compete for Asian countries suddenly. As a result, the producers had to drop their exporting prices. However, the production was failing due to the little exploration investments. RBC capital markets projected that oil drilling schemes capable of producing an average of 500,000 barrels per day were either canceled or shelved by OPEC countries (Knoema, 2017). On the contrary, China took advantage of this opportunity and acquired more refined to finished products and exported to other nations (Baumeister & Kilian, 2016, pp. 131-158).
In the 2015 July Commodity Forecast report, World Bank anticipated that the average cost of oil would drop from $51/bbl to $43/bbl in 2016. The report was a review of an earlier prediction of $41 per barrel. It factored in the supply interference from Canada and Nigeria in the second quarter and the expected demand in China.
On June 2015, International Monetary Fund uncovered comparable projected decline from $51.6 per barrel to $43.6 per barrel in the mid-year report. The demand prediction, supply reduction as well as smooth recovery of rotary rigs in the United States influenced the statement.
Both Organization for Economic Cooperation and Development and the Economist Intelligence Unit provided a global crude oil price forecast. The OECD in indicated that oil prices would stagnate at $50 per barrel in 2017. On the other hand, EIU estimated that oil prices would escalate in 2017, as a result of consumption rising beyond production (World Bank, 2017).
Oil price trends in China
Unlike the United States, information about the general performance of the economy is not readily available in the public domain. In fact, the information available concerning China’s economy and commodity pricing is contradicting. The Chinese government does not report regularly the capacity or storage levels of state reserves. Therefore, financial analysts and experts calculate the surplus by the difference between the oils refined from the combined volume of domestic crude mined and the total imports.
The most reliable sources have proven that China has storage reserves with a capacity of 24.6 billion barrels. It is the highest figure in Asia-Pacific region. China’s oil demand started to decline in December 2015, with an average of 2.7 percent (China Oil Analytics, 2016, p. 1). In the first six months, the demand was higher than the mean whereas the GDP grew by 6.7 percent.
On July 12, oil and gas Journal reported that China’s oil demand declined by 2.7 percent to 10.88 Mb/d. Surprisingly oil imports decreased with 41percent, compared to the value of the same month in 2015. More so, the refiners in China have started to inject significantly significant figures of gasoline and diesel into the market (Wan, et al., 2016). The production rose to about 11 million barrels per day, an increase of 3.2 percent from June 2015. As indicated earlier, China’s local market cannot consume that much, so China has grown exports of refined fuels with 38 percent from June the previous year (MOTILAL OSWAL INVESTMENT SERVICES, 2016).
There were other factors that OPEC involved to encourage these large consumers to acquire at lower levels. However, the high demand from China helped in covering up the excess production. At whatever point their imports drops, the world will resume to the regular supply and oil prices may get as small as $30/b as it was at the beginning of the year (OPEC, 2016, pp. 7-18).
Quantitative Analysis
The information in the table above lead to a graphical representation shown in the figure below. It is important to note that the study focused on the cost of crude oil in dollars per barrel. The price appears on the Y axis whereas the time of the year is on the X axis.
Volatility index
The research used the formula of volatility as the standard deviation of the monthly log returns.
The table below shows the computation of volatility indices in both countries as computed in an excel sheet.
MONTH
China $/bl
monthly log return µ
µ-ū
MONTH
USA $/bl
monthly log return µ
µ-ū
Jan
32.4
0.111
0.004
Jan
30
-0.013
0.004
Feb
36.21
0.199
0.022
Feb
29.6
0.229
0.031
March
44.17
-0.085
0.019
March
37.2
-0.036
0.008
April
40.57
0.181
0.017
April
35.9
0.252
0.040
May
48.6
-0.017
0.005
May
46.2
0.038
0.000
June
47.77
-0.115
0.028
June
47.98
-0.059
0.012
July
42.57
0.070
0.000
July
45.24
0.011
0.002
Aug
45.66
-0.007
0.004
Aug
45.74
-0.041
0.009
Sept
45.33
0.110
0.003
Sept
43.91
0.136
0.007
Oct
50.59
-0.098
0.022
Oct
50.3
-0.098
0.023
Nov
45.89
0.222
0.029
Nov
45.6
0.129
0.006
Dec
57.29
Dec
51.9
AV. Log Returns
0.052
0.014
AV. Log Returns
0.050
0.013
The United States recorded a volatility Index of 0.13 while China recorded a volatility index of 0.014.
The data in the above computation has the following limitations. First, the study focused on the annual volatility. The prices oil far much volatile than to the extent that prices would fluctuate with even a margin of $10 within ten days (Griffin & Teece, 2016, p. 4). The research, therefore, averaged the prices within one month and obtained a figure that represents the whole month. Therefore the data has a broad perspective and long-term significance. The fluctuations within a month need a more accurate approach and daily monitoring.
Secondly, since the scope is broad, the reasons that the conclusions shall attach to the observations concerns only the large-scale state corporations. For small-scale oil and gas companies, there are more reasons behind volatility in prices such as local taxations, stock markets, local storage and reserve capacity.
Conclusion
There is a very close relationship between oil prices in the United States and China. A parallel rise and fall pattern is evident from the graphical representation of the price trends in 2016. Though different reasons were behind the increase and fall, they still exhibit some relationship. The growth in the first quarter in the US was due unsustainable exploration mechanism whereas in China was due to massive importation and the government spending on expansion of storage and reserve facility.
World press releases also contributed to the fluctuation of prices in both countries at different at different times. IMF’s report proved to be very accurate since it justified the changes in prices on demand expectations. OPEC has now shifted its market strategy by understanding the economic decision that China and Us are making about Oil storage and production. The capacity of US and China to produce and export threatens OPEC market and hence the supply to the rest of the world. On the other hand, when the two global economy drivers fail to meet their local demand and reserve refills, they attract more supply from OPEC and world price in the world rise.
References
Baumeister, C. & Kilian, L., 2016. Forty Years of Oil Price Fluctuations: Why the Price of Oil May Still Surprise Us. The Journal of Economic Perspectives, 30(1), pp. 139-160.
Baumeister, C. & Kilian, L., 2016. Understanding the Decline in the Price of Oil since June 2014. Journal of the Association of Environmental and Resource Economists, 3(1), pp. 131-158.
Cheng, K., Yang, X. & Li, Q., 2017. Response pattern of stock returns to international oil price shocks: From the perspective of China’s oil industrial chain. Elsevier, 185(2), pp. 1821-1831.
China Oil Analytics, 2016. Platts Report: China Oil Demand Contracts 0.8% Year over Year in December. PRNewswire.
Clauss, C., 2016. Oil Prices: What’s Behind the Volatility? Simple Economics. Newyork Times, 12 12.
Ferrel, O. C. & Hartline, M., 2013. Marketing Strategy, Text and Cases. 6 ed. Boston, Massachusetts, United States: Cengage Learning.
Frenie, J., Fernie, S. & Moore, C., 2015. Principles of Retailing. Revised ed. Abingdon-on-Thames: Routledge.
Griffin, J. M. & Teece, D. J., 2016. OPEC Behavior and World Oil Prices. Abingdon-on-Thames: Routledge.
Hiduke, G. & Ryan, J. D., 2013. Small Business: An Entrepreneur’s Business Plan. 9 ed. Boston, Massachusetts, United States: Cengage Learning.
Hilyard, J., 2012. The Oil & Gas Industry. Tulsa: PennWell Books.
Jensen, M., 2013. Setting Profitable Prices. New Jersey: John Wiley & Sons.
Knoema, 2017. Crude Oil Price Forecast: Long Term 2016 to 2025. [Online]
Available at: http://jp.knoema.com/infographics/yxptpab/crude-oil-price-forecast-long-term-2016-to-2025-data-and-charts
[Accessed 01 02 2017].
Krauss, C., 2016. Oil Prices: What’s Behind the Volatility? Simple Economics. New York Times.
Lamb, C. W., Hair, J. F. & McDaniel, C., 2008. Essentials of Marketing. 6, illustrated ed. Boston, Massachusetts, United States: Cengage Learning.
Lee, M. & Denver, V., 2016. Pricing Strategy. oil and gas financial journal, 13(9).
Madaan, K. V. S., 2009. Fundamentals of retailing. 2 Pennsylvania Plaza: Taata.
MOTILAL OSWAL INVESTMENT SERVICES, 2016. Market Volatility. [Online]
Available at: http://www.motilaloswal.com/article.aspx/1110/Market-Volatility
[Accessed 01 02 2017].
OPEC, 2016. Monthly Oil Market Report. OPEC, pp. 1-96.
Schindler, R. M., 2011. Pricing Strategies. Illustrated ed. Thousand Oaks, California: SAGE.
Sovacol, B. K., Sidortsov, R. V. & Jones, B. R., 2013. Energy Security, Equality, and Justice. Abingdon-on-Thames: Routledge.
Wan, J.-T., Lau, E. & Brahmana, R. K., 2016. Contagious Effects of Oil Prices on Asian Stock Markets’ Behaviour. Journal of Indonesian Economy and Business: JIEB, 31(2), pp. 141-162.
World Bank, 2017. Commodity Market Outlook, Washington: World Bank.
Appendix
The proposal came up with the following questionnaire that functioned as a data collection tool.
SURVEY QUESTIONNAIRE
TOPIC: FACTORS AFFECTING FLUCTUATION OF OIL PRICES IN 2016
AVERAGE MONTHLY OIL PRICE IN US
AVERAGE MONTHLY OIL PRICE OF THE PREVIOUS MONTH
PERCENTAGE INCREASE/DECREASE
POSSIBLE REASON FOR THE CHANGE:
AVERAGE MONTHLY OIL PRICE IN US
AVERAGE MONTHLY OIL PRICE OF THE PREVIOUS MONTH
PERCENTAGE INCREASE/DECREASE
POSSIBLE REASON FOR THE CHANGE:
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