A Level 2014 Paper 1 CSQ Answers

1 CSQ 1 (a) (i) The price of oil relative to the price of natural gas is significantly higher in 2012 than in 1993. (a) (ii) According to Extract 1, the practice of fracking has led to a substantial increase in the supply of both oil and natural gas. However, the price of oil has increased relative to the price of gas. This is due to differences in the change in demand. The demand for both oil and gas is expected to increase due to economic growth and improvement in standard of living. However, the demand for oil is expected to increase more than the increase in demand for gas. The extensive applications of oil, including transportation fuel, electricity generation, and manufacturing of chemicals and synthetic materials, compared to natural gas will lead to a stronger increase in demand for oil from economic growth. Also, possible oil hoarding due Middle East turmoil will lead to countries stockpiling oil in speculation of possible decrease in supply in the future. Hence, countries will choose to buy oil now in anticipation of possible shortages in the future, increasing the demand for oil. Assuming that the increase in demand for oil is dominates the increase in supply of it, the price of oil will increase from P0 to P1 according to the diagram below.

2 On the other hand, it is expected that the increase in demand for gas will only marginally dominate the increase in supply of gas. Hence, the price of gas will increase by a smaller extent from P0 to P1 according to the diagram below.

3 This divergence will lead to the increase in the price of oil relative to the price of gas. (b) The fracking boom in the US has led to a large increase in the supply of US oil and positioned it to potentially be the largest oil producer in the world (Extract 1). Assuming that OPEC does not increase its oil production or only marginally, the proportion of the supply of US oil in the world market will increase relative to that of the OPEC, as OPEC forecast that non-OPEC oil supply would grow significantly according to Extract 2. Under the same pricing of oil, US will gain a larger market share while OPEC’s market share will be reduced. Due to availability of substitutes from other countries, this reduces the world’s dependency on OPEC oil. Traditionally, OPEC is able to cut back on production of oil in order to drive prices up to increase their revenue as the demand for oil is price inelastic. However, if OPEC’s market share of 40% (Extract 2) continues to decline, it may find itself losing market power and the cartel losing its effectiveness. This is because it will be increasingly difficult for them to influence the price of oil given that their oil supply is now a smaller proportion of the world’s output. As such, any decision to reduce oil production will not significantly affect the world’s supply and will thus cause only minimal change in price. In fact, this will only serve to further reduce their market