Fluctuations in Oil Prices Affect Our Living Standards: Yes or No?

Updated: Aug 29


Proposals to reduce the rate at which oil prices are adjusted, known as price discovery mechanisms, have long been discussed in the energy industry for several years. The most common proposals focus on quickly increasing or gradually reducing prices than current situations. These proposed mechanisms would impact anyone who purchases products with a high amount of oil in their final price. There is no simple answer to the question, 'how fluctuations in oil prices affect our living standards.' This article explores the long-term implications of these proposed changes on costs and standards of living across different industries and regions.


What is Price Discovery?


Price discovery is the process of determining the market price for a specific commodity.

Every day, millions of transactions are conducted for commodities such as oil, metals, and grains. Traders purchase these commodities, hoping to sell them at a higher price later. Rising demand for particular commodity results in an increase in its price. However, falling demand causes decreasing trend in its price. The prices of a commodity are set in the marketplace through a process known as price discovery. Determining the prices of certain commodities requires information from many sources, such as supply and demand forecasts, current stock levels, weather events, and political actions. The information gathered is used to create a futures price for the commodity - a futures contract - an agreement to sell commodities at specific prices at specific times in the future.

The Importance of Knowing the Effects of Fluctuations in Oil Prices:


The majority of goods used by people around the world have a high percentage of oil in their production costs. If oil prices rise, many of these goods would also rise in price. Standard of living is an economic term used to describe a person’s overall quality of life. A sudden increase in the price of oil would affect the production costs of a wide variety of goods. Initially, many companies that manufacture these goods absorb some rising production costs to maintain their current profit margins. The increase in production costs for companies temporarily slows the rate at which prices increase for these goods. Yet, at some point, companies will not be able to continue to offset rising production costs, and prices will increase.

The Change in Oil Prices under Different Price Discovery Mechanisms:


The degree to which oil prices change under different price discovery mechanisms is difficult to determine.

"Different prices at different times for the same commodity" are difficult to compare directly. Also, the impact of price discovery mechanisms on the degree to which oil prices change is dependent on market conditions. The proposed mechanisms for price discovery include a formula-based method, a hybrid approach, and the full spot market method. These are similar to current price discovery mechanisms but with a few key differences. For example, oil producers and refiners nowadays set prices for their products that are later adjusted to reflect market conditions.

  • Producers under the formula-based approach would be required to set a specific price for the oil they produce. The price of oil would then get determined by the current price of imported crude oil, the quantity of oil produced domestically and imported.

  • The hybrid approach combines elements of both current and formula-based approaches.

  • The full spot market approach requires all oil produced in the US to be sold in the open market.

Short-term Impact:


The short-term impact of fluctuations in oil prices on standards of living is determined by the degree of change in oil prices and the timing of those changes.

  • If the prices of oil are to rise dramatically, the impact on standards of living would be significant.

  • If oil prices were to increase gradually over several years, the impact on standards of living would be less significant.

The timing of a price increase is also crucial. Using the example of a drastic price increase: if the price of oil were to rise dramatically in the winter -- when oil demand is traditionally the highest, the impact on standards of living would be more significant than if the price rise occurred during the summer -- when oil demand is lower.


Long-term Impact:


The long-term impact of fluctuations in oil prices on our standards of living is determined by the rate at which oil prices are adjusted.

  • If oil prices are adjusted more quickly than they currently are, the long-term impact on standards of living would be more significant.

  • If oil prices are adjusted more slowly than they currently are, the long-term impact on standards of living would be less significant.

Conclusion:


The short-term impact of fluctuations in oil prices on standards of living is determined by the extent of change in oil prices and the timing of those changes. The long-term impact of fluctuations in oil prices on standards of living is determined by the rate at which oil prices are adjusted.

If the price of oil were to rise dramatically, the impact on standards of living would be significant. If the price of oil were to rise gradually over several years, the impact on standards of living would be less critical.

Thank you for reading Samanyu's article this week! He is passionate about contributing to Risametric this summer :) For more articles like this, visit his website: https://samanyu.medium.com/what-is-inflation-and-its-types-80928b764eff

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