The invisible hand of world oil markets: expectations, political uncertainty, geopolitical risk, and price volatility.
See “IEA ready to fill gap if Iran halts exports” (Business, page 8)By Jon Fernquest
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This might happen. Nothing has actually happened, but many people are suddenly buying and selling on oil markets and oil prices are rising because they believe something might happen. How can you measure what people think might happen? This is what makes economics a difficult science unlike physics. If you drop a ball, the laws of physics tell you how fast it will fall, but how fast will oil prices increase if people believe Iran might halt oil exports?
The International Energy Agency (IEA) is responsible for oil price stabilization. It reduces price volatility by providing a temporary supply of oil when there is a shortage or supply disruption, but it does not try to permanently reduce the price of oil. How long will its reserves last? What other countries besides Iran might cause supply disruptions? Could the IEA have anticipated this jump in oil prices due to market expectations and prevented it? If the IEA intervenes in oil markets in a predictable way, won't speculators be able to anticipate these interventions and make money off of them?
This is a good opportunity to study the vocabulary that is used to talk about price trends and movements and to express uncertainty. While you are reading see how many words or phrases you can find that express uncertainty, risk, fear, and expectations about the future (See answer key at end). Note also how markets are described as living beings with a mind of their own, for example: "are taken into account by the market" or "the market is saying" (See Wikipedia:Personification, Pathetic Fallacy, and Anthropomorphism)
Also learn about the way international energy markets work and how markets in general work, what the economist Adam Smith called the Invisible Hand of markets (see picture on the right).
Vocabulary (in discussion above)
allocation - dividing up resources (for example money in your department's budget) and giving it to different people for different purposesinvisible hand - how markets can coordinate the complex allocation of scarce resources efficiently without government help, the economist Friedrich Hayek further developed this idea in what he called the economic calculation problem meaning that coordinating all the complex decisions of a modern economy requires free markets and is beyond the ability of a government to coordinate (See Wikipedia:Invisible_hand)
price volatility - when prices change suddenly and unexpectedly
price stabilization - when the government acts to reduce price volatility
to intervene - to become involved in a situation and try to change it
speculators - people who buy assets like stocks, bonds, or real estate in order to resell them later for a profit (See Wikipedia:Speculation)
anticipate - know in advance that something is going to happen
Vocabulary (in article)
IEA – International Energy Agency, an international agency started in Europe to prevent disruptions in the supply of oil and to provide information about the international oil and energy markets (See Wikipedia:International_Energy_Agency and the agency's homepage)supply disruption – the good suddenly becomes unavailable on the market
supply gap – shortage
fill gap – using another source for oil if there is a shortage in the market
reserves – an extra supply of a good to protect you from supply disruptions
tame prices – keep prices from rising (when you tame a dangerous animal, you make it less dangerous)
oil stocks – supply of oil ready to sell
emergency stocks – reserves (See above)
Organisation of Petroleum Exporting Countries (OPEC) – a group of countries that controls two-third of the worlds oil reserves which means it can control world oil prices (See Wikipedia:OPEC)
low spare capacities – enough oil is not kept for emergencies
are taken into account by the market – market prices are set by supply and demand using all information available, Adam's Smith's invisible hand (See Wikipedia:Invisible_hand)
geopolitical risks – when changes in the relations between nation states make investors believe that their investment is more risky (so they demand a higher return (risk premium) for their investments)
political uncertainty – when current political events make investors believe there is more risk investing in a country (so they demand a higher return (risk premium) for their investments)
room for manoeuvre – freedom for making decisions to deal with a problem, “no room for manoeuvre” means that you have few options to choose from
MTBE – a chemical added to gasoline to reduce air pollution (gasoline additive), this chemical has health risks, so it is being replaced by other additives. (See Wikipedia:Methyl_tert-butyl_ether)
reformulated gasoline – a special form of gasoline that reduces air pollutants
ethanol – a replacement for gasoline (petrol) in cars that is made from sugar, grain or corn (when blended with gasoline it is called “gasohol”) (See Wikipedia:Ethanol)
IPE Brent Crude – the commodity used as the standard for world oil prices, it is traded on the International Petroleum Exchange in London (See Wikipedia:Brent_crude, North_sea_oil, and Crude_oil_classification)
mitigating – making something bad less serious and painful
biofuels – a fuel made from biological material like sugar (since you can always grow more we’ll never run out of it, which means renewable energy, See Wikipedia:Biofuel)
More things to do and read
Are higher oil prices good or bad for economic growth? Why? Read a recent open letter from the Federal Reserve Bank of San Francisco that answers the question: “Why hasn’t the jump in oil prices led to a recession?"
Check out the Wikipedia article: Oil price increases of 2004 and 2005. Also read about the first oil crisis: the 1973 Oil Crisis and Wikipedia articles on cost push inflation, price/wage spiral, and the general article on inflation. There is also an informative background article published by the OECD entitled: "Oil price developments: Drivers, economic consequences and policy responses"
Answer Key
Words and phrases that express uncertainty, risk, fear, concerns, and expectations about the future:
a. “Fears that Iran’s nuclear dispute with the west may interrupt exports…”
b. “I don’t know what will happen with Iran, but if we have to….”
c. “The market is saying, if there is a political or technical accident…”
d. “Oil markets have also been driven up by concerns over the move in the US to cut MTBE completely…”
e. “If there is a problem…”
f. You never know what it would have been with lower prices…”
g. I think it would have been even better.”
You can see there are many different ways to express uncertainty.
To summarize: fears that…, may…, don’t know…, if…, concerns over…, would have been…
