NYJC H1 ECONS Q2 suggested answer

Are low oil prices here to stay? Extract 4: Predicting the oil price is challenging What we do know is that, despite a recent upturn, the price of oil has slumped almost 50% since last summer following the longest-running decline for 20 years. And we know why - US shale oil, and to a lesser extent Libyan oil returning to the market, has pushed up supply together with a slowdown in the Chinese and EU economies. With the booming US shale industry showing little signs of slowing, and growing concerns about the strength of the global economy, there are good reasons to suspect that the current slump in the oil price will continue for some time. Source: BBC News, 24 February 2015 Figure 2: Latest Price for Crude Oil Source: Nasdaq.com Jan 14 th 2015

Figure 3: The value of oil exports based on different oil prices per barrel for selected countries Source: Energy Matters, 18 Nov 2015 Extract 5: What are the effects of fracking on the environment? The oil and gas industry has been expanding consistently for decades due, in part, to the advances in technology in the processes of extracting, transporting and delivering the resource to consumers. One of the most-discussed technological advances is hydraulic fracturing, also known as fracking. This extraction process combines often dangerous chemicals with large amounts of water and sand at high rates of pressure into rock formations to fracture surrounding material for the purpose of extracting oil and gas. Fracking is controversial because of the amount of natural resources needed to complete its process, and more notably because of the negative effects like air pollution and water contamination. In addition to air and water pollution, fracking also increases the potential for oil spills, which can harm the soil and surrounding vegetation. Fracking may cause earthquakes due to the high pressure used to extract oil and gas from rock and the storage of excess wastewater on site. Source : Investopedia, 19 January 2015 Extract 6: Can Indonesia phase out energy subsidies without hurting the poor? Indonesia enacted a major reform recently. On 1 January, President Joko Widodo followed through with his electoral promise to cut decades-long subsidies for energy products. Many leaders had tried before him, but retreated in the face of fierce resistance from the people. Thanks in part to low oil prices, the newly-elected President got the reform through without much trouble. The true challenge will be how to support poor households when prices start rising again. Source : OECD Insight 28 April 2015 0 50 100 150 200 250 300 350 Saudi Arabia UAE Kuwait Qatar $US 2014 billions 2013 base period Value of Oil Exports $110/barrel $50/barrel

Extract 7: Little cheer for Singapore’s economy despite lower oil prices Singapore: Lower global oil prices should stimulate global economic growth, according to the International Monetary Fund, which estimates that every US$10 fall in per-barrel oil price can lift global GDP by 0.2 per cent. In particular, countries which are net importers of oil, such as Singapore, should benefit more from lower global oil prices . For example, electricity bills and petrol costs have fell about 15% and 5.5% respectively. Crude oil prices have slumped by 48% on average from 2014 to last year. But now that oil has dipped below US$30 a barrel, and is hovering its lowest price levels in over a decade, initial cheer from energy cost savings appears to be turning into fear over a global economic slowdown. The current slump in oil prices has done little to prop up consumer spending and spur growth, according to CIMB Private Banking economist Song Seng Wun, “because the slump in global trade has overtaken the benefits of cheaper oil”, he said. Hit by slowing global demand, Singapore’s trade-dependent economy grew 2.1 per cent in 2015, clocking its weakest pace of growth since 2009. “Last year for example, was one of the worst years for the petrochemical industry, even though the industry had the benefit of lower input prices. Due to low global demand, the firms over-invested and could not run at capacity,” said Mr Song. Singapore-based Keppel Corp announced that it had cut around 8,000 jobs as weak energy prices hammered profits at the world’s largest oil rig builder. Further, the global economic slump that has resulted from low oil price has also had a chain effect on Singapore’s economy. These effects extend beyond just the oil and gas industry. Overall, some clear winners from lower oil prices could be consumers, and businesses in energy-intensive industries, such as aviation and shipping, which stand to gain from lower utility bills. Meanwhile, the losers include oil-related firms, like rig builders and offshore and marine companies, which have seen orders thin out in line with lower oil exploration activity. Source: CNA online 22 Jan 2016

Questions: (a) (i) Using Figure 2, describe the trend of oil price s between January 2014 and January 2015? Oil prices are generally falling/decreasing between Jan 2014 and Jan 2015. (1m) Steep fall in oil prices after July 2014 to Jan 2015 (1m) [2] (ii) With the help of a diagram, explain the demand and supply factors that are responsible for the trend in oil prices identified in (i). Reasons for falling oil prices : Fall in demand due to a slowdown in global economies (extract 1 : “growing concerns about the strength of the global economy”) Increase in supply due to increase in oil supplies due to shale gas production & increase in oil production by Libya (extract 1) Explain how the fall in demand and increase in supply cause a sharp fall in price Diagram 2 m for identify & explanation, 2 m for diagram and price adjustment [4] (b) Using the evidence from Figure 3, what can you con clude about the price elasticity of demand for oil in Saudi Arabia? Define PED (1m) From figure 2, price of oil in Saudi Arabia fall and total export revenue falls. This implies a fall in price exceeds leads to a less than proportionate increase in quantity, hence, demand for oil is price inelastic (2m) [3] (c) With reference to Extract 6, explain how a complet e removal of energy subsidies will affect households’ expenditure on electricity. Removal of energy subsidies will lead to an increas e in cost of production of electricity (decrease SS) which will lead to an increase in the price of electricity. (1m) Household expenditure on electricity is price of electricity multiplied by the volume of electricity consumed. Increase in price of electricity will lead to a less than proportionate fall in volu me of electricity consumed since demand for electricity is price inelastic (high degree of necessity) and hence leading to an increase in h ousehold expenditure on electricity. (2m) [3]

(d) (i) Explain one possible reason why the price of cr ude oil has fallen by 48% whereas price of petrol has fallen only by 5.5%. Price of petrol has fallen only marginally because price of petrol includes costs of processing/refining the crude oil, costs of rental and government indirect taxes. So the initial price fal l was eroded along the process and resulted in only a smaller price fa ll for the price of petrol. [2] (ii) With reference to Extract 7, discuss the impact of changes in oil prices on the economic growth of Singapore. 1) Short-Run: Economic Growth (1) Increase in SRAS Singapore is a net oil importer. As a result of the decrease in price of crude oil leading to a fall in the price o f petrol & electricity leading to fall in costs of production. This will lead to an increase in SRAS leading to an increase in real NY (diagram). For eg, the aviation, shipping, logistic and transp ortation industries where petroleum accounts for a large percentage of input costs will benefit from th