International Oil Markets and the Global Economy

International Oil Markets and the Global Economy
                                        Oil has a significant influence on international trade, economics and politics.

Starting with the industrial revolution and the introduction of the internal-combustion engine, oil has been an essential factor in the economic expansion of the twentieth century. Its importance has become more pronounced with the spread of transportation and manufacturing. Not all countries can produce all the oil they use however, resulting in two groups: net importers and net exporters of oil. The interdependence between these groups plays a significant role in shaping global economic and political developments.
The Organization of Petroleum Exporting Countries(OPEC), a group of 11 countries,1 produces close to 40 percent of total world oil production2 and owns about 70 percent of proven oil reserves. Other major oil producers in decreasing order of production are the U.S., Russia, Mexico, China, Canada, and Norway.3 Overall, the Middle East, especially the Persian Gulf, remains the major oil-producing region, and holds around 60 percent of the proven global oil reserves.4
How Oil Prices Are Determined
There are three schools of thought in relation to the determination of crude oil prices, but none have been entirely successful in predicting the path of oil prices. The first school examines the interaction of demand and supply in the determination of the spot price. Microeconomic theory states that if there is excess demand, prices will rise to restore equilibrium. Alternatively, if there is excess supply, prices will fall. The presence of excess supply or demand is evidenced in crude oil inventories. There has been much research on the relationship between inventory levels and primary commodity prices [Gustafson (1958); Thurman (1988); Pindyck (1993)]. The traditional relationship between spot prices and inventory levels, however, broke down after 2004.
The second school of thought...