Dubai: After a surprise announcement last weekend that the world’s major oil-producing countries would cut their output of crude oil, many would have wondered how this move would impact fuel prices worldwide. Let’s look at how such a collaborative global decision can affect your finances.
The group of countries, referred to as ‘Organisation of the Petroleum Exporting Countries’ or ‘OPEC’, announced it would cut oil production starting May, running through the end of the year. The price of ‘Brent’ crude, the international oil standard, jumped 6 per cent or $5 (Dh18) to $85 (Dh312) for a barrel following the news.
But what does this mean for world fuel prices?
“When oil production is collectively cut, globally, motorists can evidently expect prices at fuel pumps to rise, but the severity of the price impact is felt differently by countries worldwide,” explained Ahmed Ghazi, a commodities analyst and industry researcher based in Abu Dhabi.
“This is because not every country has crude oil. And as it’s vital for every economy, many import crude oil. Given refineries that process crude oil are often located in a different country than where the crude oil is produced, countries also have to import oil for refineries at an additional cost.”
So the price of fuel covers the cost of acquiring and refining crude oil as well as distributing and marketing it. But oil prices, and in turn the everyday cost of fuel, are fundamentally determined by the market forces of supply and demand. Here, we take a detailed look at these detrimental factors.
Impact of oil production cuts on global oil prices
Global oil supply has to do with how much oil is available in the world, which has historically been decided by countries that form part of OPEC, an intergovernmental organisation of 13 countries, which collectively controls most of the world's supply of oil.
Demand, on the other hand, is determined by how much need there is for oil at a given time. That need is for things like heat, electricity and transportation, driven by everything from fuel for cars and airline travel to electrical generation. These two factors in turn affect fuel prices worldwide.
“Reducing oil production means less supply on the market, which obviously pushes prices higher. Because the current cuts are planned to last from May through the end of the year, the effect on oil prices is also expected to be prolonged,” added Ghazi.
Edward Bell, Senior Director, Market Economics at Emirates NBD, too agreed that the latest oil production cuts will cause global oil prices to rise, particularly in in the second half of 2023, while citing that the announced cuts from OPEC will widen the oil market deficit.
When oil production is collectively cut globally, motorists can evidently expect prices at fuel pumps to rise
How does the cost of oil determine the cost of fuel?
“The cost of crude oil is the largest factor in the price at which fuel is sold worldwide. Because of this, changes in the retail price of petrol or diesel typically track changes in the global crude oil price,” explained Ghazi.
Some of the crude oil that the country imports is refined by refineries into petroleum products – such as petrol, heating oil, diesel fuel, and jet fuel. Also, some of imported petroleum may be stored and subsequently exported.
“The cost of crude accounts for about half of the overall price of fuel, according to regulatory data from most key economies worldwide, apart from refining, distribution and marketing costs, which are generally reflected in the wholesale costs that fuel retailers pay to distributors,” added Ghazi.
How are people affected when the price of oil rises?
While studies show that crude oil and petrol prices are highly “correlated”, or linked, economists widely estimate that every $10 (Dh36.7) rise in the cost of a barrel of oil triggers a 0.4 per cent rise in inflation worldwide — the general increase in prices (and fall in the purchasing value of money).
However, prices may not rise as much as analysts cautioned that OPEC's announcement could turn out less impactful than feared. The reason being that just last year OPEC announced a similar-sized production cut, but the actual cut turned out to be just half that.
"Will the size of the cut really be a million [barrels per day] plus or will it be something less? That's entirely possible,” added Ghazi. “They have a month to figure out what they really want to do."
Like most commodities, the fundamental driver of the global price of oil (and also the cost of fuel) is supply and demand. While oil supply is somewhat controlled by a 13-member group of oil-producing nations called OPEC, oil demand is driven by fuel for transportation to generating electricity.
Reducing oil production pushes prices higher, and as the cuts are planned to last till the end of the year, the effect on oil prices is also expected to be prolonged
Generally, if the oil supply increases, prices respond by going down and rising if supply decreases. Likewise, if demand decreases, prices should decrease and rise if demand increases. So with the recently announced production cut, oil prices are expected to rise worldwide.
“If you're assuming demand [for fuel] doesn't change but supply now does, then it implies higher prices – but it’s not that simple,” added Ghazi. “Pricing in the effects of more expensive crude oil could drive fuel price higher, but that also depends on how much lesser people drive.”
However, it’s not just supply and demand that drives the price of oil. When it comes to how the price translates to the everyday cost of fuel, it also depends on how the cost of extracting and producing oil factors into the price, in your respective country.