Political Risk and Impact on Oil Prices

Question: Discuss the setting up of oil prices and role of OPEC? Answer: Introduction Risks are evident in respect to every kind of businesses, and the oil and gas industry in particular is also faced with this risk to a greater level. An analysis indicates that there are different important ways in which the political risks impact the performance of oil and gas companies and this in turn affects the prices of oil at which they are traded across the world. The oil and gas industry is a global industry, and as a result, the interference of government is significantly higher in such industry performance. As for example, oil and gas extraction companies often moves to international places which have rich oil and gas resources. In performing the extraction of oil and gas across such destinations, they are required to take permission from the local government. However, in many cases, the terms and conditions as agreed are changed by the government because of their motive to earn higher profits. But the huge investments as made by such companies in the oil extraction proces s make its difficult for them to take decisions. Apart from this, there are different other ways in which the political risks affects the performance of oil and gas companies (Goldthau, 2013). This report is aimed at performing an analysis of political risks that are applicable in respect to such oil and gas industry. After having an in-depth analysis of such political risk, the next step is to analyse the ways in which prices of oil are set and also the role as played by OPEC in such setting of prices. An analysis of oil prices since 2003 till date will also be performed, and finally, the prices of oil in the next five years would be predicted. Summary of Political Risks Political risk is mainly the risk posed by the government of an economy. The role of government in affecting the performance of an industry is significant, as there are rules and policies that are set by the government and they are required to be observed by the companies or industries operating in the economy. The political risks arise from the non compliance of such rules and regulations, or it can be because of unrests in the economy, or it can be because of changes introduced by the government. The oil and gas industry in particular is exposed to political risks to a greater level because oil and gas companies often cross national boundaries with a view to perform the extraction of oil and gas. This exposes them to different countrys governments and their policies and procedures, which are mostly incompatible with the ways in which they perform the management of their operations. Such kinds of clashes between the policies and procedures often create problems between oil and gas c ompanies and governments, and the resulting impact is the oil and gas companies exposed to political risks (Inkpen and Moffett, 2011). Apart from the above, the political risks to oil and gas industry are also because of the political uncertainties in the form of increasing risks of political violence. In the political violence index, there has been increasing number of countries that have witnessed a rise in the political risks. In addition to this, the industry is also faced with increasing threats of political risk mainly because of heightened threat of increasingly sophisticated forms of resource nationalism. This aspect of resource nationalism has resulted into a completely different approach by the governments with respect to international oil and gas companies, and the resulting impact is political risks affecting their performance conditions. Apart from this, the higher level of corruption has also become a major contributory factor that has given rise to the issue of political risks to oil and gas companies operating within the country (Ingham, 2013). Political risk can be in the form of sudden nationalisat ion decisions by the government whereby they would look for protecting the local producers (Beattie, 2014). The oil and gas industry as a whole is exposed to higher level of political risks. This is evident from the fact that there are five major political risks in 2014 that have adversely impacted the performance of oil and gas industry and created huge level of political risks. These are identified as the revolution that takes place in the energy market in North America and they have shaped the global markets for oil and gas industry. The existence of political insecurities in major oil producing countries such as Iraq and Libya has raised concerns for the global oil industry, internal strains faced by OPEC because of US Shale boom, and also the rising oil demands. These are identified as important political risk factors that have affected the oil markets in 2014 (Batovic, 2014). The low oil price is also a positive contributor towards higher political risks especially in respect to developing economies. The countries such as Russia, Iraq, Venezuela, and Libya are likely to face further level of political risks and pressure because of such declining prices of oil and gas at the global levels. This is mainly because these economies loses revenue because of such lower prices of oil and gas, and this in turn puts pressures on economic performance. The resulting impact is increasing political risks to them (Oil prices pose biggest political risk: Aon, 2015). Overall, the analysis above indicated the political risks that are evident in respect to the oil and gas industry. There are various ways in which political risk is accrued to such an industry, and a proper management of such risks is essential. Setting up of Oil Prices and Role of OPEC Having understood the political risks associated with oil and gas industry, this section of analysis is now focused towards analysing the ways in which oil prices are set and the role as played by OPEC in this process. In performing the setting up of oil prices, there has been a specific process being followed. As for instance, an analysis of the existing literature indicates that there have been certain specific indices that are responsible for setting up the prices of oil. The trading of oil is usually done in barrels and there are a number of published indices all around the world that are utilised by the oil industry in determining the prices. There are two important factors that are mostly responsible for the determination of oil prices, and these are identified as the demand and supply of oil. These two important factors decide the prices of oil in the international markets (Kosakowski, 2014). However, the actual setting up of prices of oil is mainly through indices that are operating all across the world. The first most significant indices are West Texas Intermediate which was set at the New York Mercantile Exchange. Brent Crude Index is the second major index responsible for the setting up of oil prices and it was set up at the Intercontinental Exchange in London. The third is the OPEC basket and it decides on the oil prices by way of identifying the average of the prices that are achieved across all the major OPEC countries that are a part of it. There has been upward and downward movement of these indices with respect to the oil prices, and such fluctuation of oil prices is mainly because of the number of people that want to buy oil on a particular day. The actual intention of these buyers has never been to actually make the purchases of oil, but they are aimed at entering into a contract at lower price so that it can be sold at a higher price and they can make profit. This suggests that the oil indices that are operating across the globe are mainly responsible for the determination of actual prices of crude oil and this in turn decides the rate at which oil is traded. The role of oil indices is important in this respect (Austin, 2015). Role of OPEC: In order to analyse the role of OPEC, it is highly essential that a proper level of understanding about this governing body should be achieved. An analysis of OPEC indicates that it stands for Organisation of the Petroleum Exporting Countries (OPEC) (OPEC and Oil Prices is the story cover?, 2014). An analysis of main mission of OPEC indicates that it is aimed at coordinating and unifying the policies of its member countries (Lee, 2014). This is mainly to make it sure that there is the availability of oil to meet out the demands of markets across the world. The OPEC is therefore concerned with providing steady income to producers and also the fair return to the companies that perform investment in such industry. At the same time, it also makes it sure that there should be proper supply of oil to the countries that require them so that proper balance can be ensured (OPEC Mission, 2015). With such an important role being played by OPEC in regulating the oil industry, there has also been an important role being played by this governing body in ensuring that the prices for oil are set on reasonable grounds. An analysis above has indicated that it is mainly the market indices for oil that determines the prices for oil. However, there has been influential role being played by OPEC in the price setting process by way of influencing the demand and supply of oil (Vactor, 2010). The OPEC is responsible for setting up the production limits in respect to the member countries, and this influence on the production ability of oil and gas generating process allows OPEC in playing an important role in affecting the demand and supply of oil. As identified above, there has been the influential role being played by the demand and supply of oil over its prices levels, and thus, it can be evaluated that by controlling such factor of prices, OPEC plays a significant role in the process ( Streifel, 1995). Oil Prices Since 2003 till Date This section of analysis is now focused towards performing a critical analysis of the oil prices movements beginning 2003. Oil prices are determined through the indices and as a result, it has been possible to extract the information about the oil price performance. As a result, this section of analysis not only evaluates the movements in terms of trends in such oil price performance, but it assesses three major increases/decreases in such prices over the period, and the relationship of such increase/decrease with the political issues. An analysis of the oil prices in last 10 yeas can be made from the chart as indicated below: (Source: Historical Crude Oil Prices and Charts, 2015). The chart above indicates the prices of crude oil over the last ten years period and the analysis of the chart above implies that there are various major ups and downs that can be evident in respect to the prices of crude during such period. Beginning from 2003, it can be evaluated that the prices of crude oil per barrel was less than 40$, but it has shown a rising trend since then and reaches the maximum during the beginning of 2008. This is the most significant increase in the crude oil prices since 10 years, as the per barrel cost reached at $140 by that time. This has been the major increase being witnessed in the crude oil prices. As the crude oil reached $140 a barrel during July of 2008, it has resulted into political issues across different economies. With such rising prices, the countries having government control over the oil prices have witnessed significant level of opposition against the government by the local public. The global concerns for war between Iraq and Afghani stan have also become a contributing factor towards such increase in the oil prices, and it led to tensions across government in different countries (What Affect Oil Prices?, 2009). Apart from the above major increase in the oil prices, the second major fluctuation is noted by the beginning of 2009 when the global financial recession has impacted the economy. There has been a dramatic decrease in the oil prices being witnessed, as the chart above shows that the prices for crude oil reached nearby to 40$ a barrel. This has resulted into reduction in the political concerns within governments across countries which imports oils. However, such price reduction has become a cause of concern to the oil rich countries because it led to lower revenue being earned by their economy. This has also given rise to political woes across oil rich countries. The third major decline is evident recently in 2015 when the prices for crude oil has reached to 45$ from a level of $100. This is another major decline being witnessed and this has raised political issues especially in respect to oil rich nations because it creates the situation of concern for them in terms of their revenue generation process. Prices of Oil in the Next 5 Years Time An analysis of the prices of oil above indicates that it has been extensively fluctuating and it is highly difficult to make exact level of prediction in this regard. However, based on the current performance of oil rich countries, and also the lower dependence of US on the Middle Eastern regions for its oil requirements, the demand is likely to remain lower or stable and this would not likely to impact the prices of oil to go high. The prediction as made with respect to the oil prices in the next five years is that it would remain within the target of $40 to $50 per barrel in the years to come depending on the current level of performance. Conclusion In this report, a critical assessment has been carried out in respect to the political risks as evident in respect to the oil and gas industry and also an assessment of the oil price performance over the years. The performance of analysis indicated that political risk is evident in respect to every kinds of business and it is also identified in respect to the given case of oil and gas industry whereby the governmental interference is identified as significantly huge. As a result, the political risk affecting such industry condition is also higher. The analysis indicated that the oil prices are being determined by the oil indices operating across the world and the role of OPEC is also identified as significant in this regard. There are major fluctuations being identified in respect to the performance of oil prices in the last ten years and it has also been evaluated that there has been the association of political risks from such major increase/decrease in the oil prices. Finally, the prices of oil in the years to come revealed that they are not likely to increase much because of lower dependence of economies such as US on the Middle Eastern regions. References Austin, S. (2015). What Sets Oil Prices? [Online]. Available at: https://www.oil-price.net/en/articles/what-sets-oil-prices.php [Accessed: 21 March 2015]. Beattie, A. (2014). 5 Biggest Risks Faced By Oil And Gas Companies [Online]. Available at: https://www.investopedia.com/articles/fundamental-analysis/12/5-biggest-risks-faced-by-gas-and-oil-companies.asp [Accessed: 21 March 2015]. Batovic, A. (2014). Five political risk factors affecting oil markets in 2014 [Online]. Available at: https://globalriskinsights.com/2014/01/five-political-risk-factors-that-will-affect-oil-markets-in-2014/ [Accessed: 21 March 2015]. Goldthau, A. (2013), The Handbook of Global Energy Policy, John Wiley Sons. Historical Crude Oil Prices and Charts, (2015) [Online]. 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